Deck 14: Taxes on the Financial Statements

Question 1

Temporary differences are book-tax differences that appear in both the GAAP financial statements and the Federal income tax return but not in the same reporting period.

Answer 1

True

Question 2

A deferred tax liability represents a potential future tax benefit associated with income reported in the current-year
GAAP financial statements.

Answer 2

False

Question 3

The valuation allowance can reduce either a deferred tax asset or a deferred tax liability.

Answer 3

False

Question 4

Yahr, Inc., is a domestic corporation with no subsidiaries. It operates in almost every U.S. state. Yahr records no permanent or temporary book-tax differences this year. It's tax expense on its GAAP financial statements and its tax liability reported on its Federal income tax return are identical.

Question 5

An example of a deferred tax asset is the excess of accelerated MACRS depreciation over GAAP straight-line depreciation.

Question 6

A deferred tax asset is the expected future tax benefit savings) associated with income reported in the current-year
GAAP financial statements.

Question 7

If a valuation allowance is decreased released) in the current year, the corporation's effective tax rate is lower than had the valuation allowance not decreased.

Question 8

A valuation allowance expresses on the GAAP balance sheet that there exists uncertainty that the taxpayer will be able to recover a deferred tax asset.

Question 9

Permanent differences include items that appear in the Federal income tax return as income or deduction and in the
GAAP financial statements as revenue or expense but in different reporting periods.

Question 10

A deferred tax liability represents a current tax liability associated with income or expense to be reported in future year GAAP financial statements.

Question 11

If a corporation has no operations outside the United States, its GAAP book and taxable income are identical.

Question 12

Giant uses the equity method to account for the operations of its 40% owned subsidiary Little. A portion of Little's profits for the year are included in Giant's GAAP book income.

Question 13

The income tax footnote to the GAAP financial statements includes a reconciliation of a corporation's hypothetical tax on book income to its book-tax expense as if it were taxed in full at the applicable U.S. income tax rates.

Question 14

Schedule UTP of the Form 1120 reconciles financial statement net income after tax with a large corporation's taxable income.

Question 15

In general, the purpose of ASC 740 is to compute and disclose the taxes payable by a business entity to state, local, Federal, and foreign governments for the current year and all future years.

Question 16

In the rate reconciliation of GAAP tax footnotes, temporary book-tax differences are reconciled between book income as if taxed at U.S. tax rates and the actual book income tax expense.

Question 17

A partnership owned at least 80% by a corporation is included in a consolidated group's U.S. income tax return.

Question 18

The operations of 80% or more owned domestic subsidiaries can be included in the parent corporation's consolidated tax return if a proper election is made.

Question 19

The current tax expense reported on the GAAP financial statements generally represents the taxes actually payable to domestic or foreign governmental authorities.

Question 20

Only U.S. corporations are included in a combined GAAP financial statement.

Question 21

Gravel, Inc., earns book net income before tax of $600,000. Gravel puts into service a depreciable asset this year, and its first-year tax depreciation exceeds book depreciation by $120,000. Gravel has recorded no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 21%, what is Gravel's current income tax expense reported on its GAAP financial statements?

A) $151,200
B) $126,000
C) $100,800
D) $25,200

Question 22

Which of the following items represents a temporary book-tax difference?

A) Municipal bond interest.
B) Federal income tax paid.
C) Addition to bad debt allowance.
D) Nondeductible penalties.

Question 23

Never, Inc., earns book net income before tax of $500,000. In computing its book income, Never deducts $50,000 more in warranty expense for book purposes than is allowed for tax purposes. Never records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 21% and no valuation allowance is required, what is Never's deferred income tax asset reported on its GAAP financial statements?

A) $115,500
B) $105,000
C) $94,500
D) $10,500

Question 24

Create, Inc., a domestic corporation, owns 100% of Vinyl, Ltd., a foreign corporation and Digital, Inc., a domestic corporation. Create also owns 12% of Record, Inc., a domestic corporation. Create receives no distributions from any of these corporations. Which of these entities' net income is included in Create's income statement for current-year financial reporting purposes?

A) Create, Vinyl, and Digital.
B) Create, Vinyl, and Record.
C) Create, Digital, and Record.
D) Create, Vinyl, Digital, and Record.

Question 25

Which of the following taxes are included in the total income tax expense of a corporation as reported on its GAAP financial statements?

A) Federal income taxes.
B) Foreign income taxes.
C) State income taxes.
D) All of these taxes are included.

Question 26

Clipp, Inc., earns book net income before tax of $600,000. Clipp puts into service a depreciable asset this year, and its first-year tax depreciation exceeds book depreciation by $120,000. Clipp has recorded no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 21%, what is Clipp's deferred income tax liability reported on its GAAP financial statements?

A) $151,200
B) $126,000
C) $100,800
D) $25,200

Question 27

ASC 740 addresses how an entity should report uncertain tax positions in its financial statements.

Question 28

Purple, Inc., a domestic corporation, owns 80% of Blue, Ltd., a foreign corporation and Yellow, Inc., a domestic corporation. Purple also owns 50% of Green, Inc., a domestic corporation. Purple receives no distributions from any of these corporations. Which of these entities' net income is included in Purple's Federal income tax return for the current year, assuming that Purple elects to include all eligible entities in its consolidated Federal income tax return?

A) Purple, Blue, Yellow, and Green.
B) Purple, Blue, and Yellow.
C) Purple, Blue, and Green.
D) Purple and Yellow.

Question 29

ASC 740 is the GAAP equivalent of the Form 1120 Schedule UTP.

Question 30

Kling Corporation reports a $150,000 cash tax savings from a temporary book-tax difference. This item has the same effect on Kling's current-year effective tax rate as a $150,000 cash tax savings that is a permanent book-tax difference.

Question 31

Which of the following taxes are included in the total income tax liability of a corporation reported on its Federal income tax return?

A) Federal income taxes.
B) Foreign income taxes.
C) State income taxes.
D) All these taxes are included.

Question 32

Create, Inc., a domestic corporation, owns 90% of Vinyl, Ltd., a foreign corporation and Digital, Inc., a domestic corporation. Create also owns 60% of Record, Inc., a domestic corporation. Create receives no distributions from any of these corporations. Which of these entities' net income is included in Create's Federal income tax return for the current year, assuming that Create elects to include all eligible entities in its consolidated Federal income tax return?

A) Create, Vinyl, Digital, and Record.
B) Create, Vinyl, and Digital.
C) Create, Vinyl, and Record.
D) Create and Digital.

Question 33

Morrisson, Inc., earns book net income before tax of $500,000. In computing its book income, Morrisson deducts $50,000 more in warranty expense for book purposes than is allowed for tax purposes. Morrisson records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 21% and no valuation allowance is required, what is Morrisson's current income tax expense reported on its GAAP financial statements?

A) $115,500
B) $105,000
C) $94,500
D) $10,500

Question 34

Qute, Inc., earns book net income before tax of $500,000. In computing its book income, Qute deducts $50,000 more in warranty expense for book purposes than is allowed for tax purposes. Qute records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 21% and no valuation allowance is required, what is Qute's total income tax expense reported on its GAAP financial statements?

A) $115,500
B) $105,000
C) $94,500
D) $10,500

Question 35

South, Inc., earns book net income before tax of $400,000 in year 1. It acquires a depreciable asset in year 1, and its first-year tax depreciation exceeds book depreciation by $50,000. At the end of year 1, South's deferred tax liability account balance is $10,500. In year 2, South earns $500,000 book net income before tax, and its book depreciation exceeds tax depreciation by $20,000. South records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 21%, what is South's total provision for income tax expense reported on its GAAP financial statements for year 2?

A) $4,200
B) $94,500
C) $105,000
D) $109,200

Question 36

Purple, Inc., a domestic corporation, owns 100% of Blue, Ltd., a foreign corporation and Yellow, Inc., a domestic corporation. Purple also owns 40% of Green, a domestic corporation. Purple receives no distributions from any of these corporations. Which of these entities' net income is included in Purple's GAAP income statement for current- year financial reporting purposes?

A) Purple, Yellow, and Green.
B) Purple, Blue, and Yellow.
C) Purple, Blue, and Green.
D) Purple, Blue, Yellow, and Green.

Question 37

Jogg, Inc., earns book net income before tax of $600,000. It puts into service a depreciable asset this year, and its first-year tax depreciation exceeds book depreciation by $120,000. Jogg has recorded no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 21%, and that this is Jogg's first year of operations, what is Jogg's balance in its deferred tax asset and deferred tax liability accounts at year-end?

A) $25,200 and $0.
B) $0 and $0.
C) $0 and $25,200.
D) $25,200 and $25,200.

Question 38

A chief financial officer CFO) probably prefers a tax planning strategy that produces a temporary book-tax savings difference to one that produces a permanent difference.

Question 39

Phyllis, Inc., earns book net income before tax of $600,000. Phyllis puts into service a depreciable asset this year, and its first-year tax depreciation exceeds book depreciation by $120,000. Phyllis has recorded no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 21%, what is Phyllis's total income tax expense reported on its GAAP financial statements?

A) $151,200
B) $126,000
C) $100,800
D) $25,200

Question 40

The release of a valuation allowance may relate to a tax planning strategy adopted by the taxpayer that will produce taxable income in the future.

Question 41

Which of the following items is not included in the GAAP financial statement income tax footnote's effective tax rate reconciliation?

A) Hypothetical tax on book income at U.S. Federal corporate tax rate.
B) Total tax expense per the GAAP financial statements.
C) Tax effect of temporary differences.
D) Tax effect of permanent differences.

Question 42

South, Inc., earns book net income before tax of $400,000 in year 1. It acquires a depreciable asset in year 1, and its first-year tax depreciation exceeds book depreciation by $50,000. At the end of year 1, South's deferred tax liability account balance is $10,500. In year 2, South earns $500,000 book net income before tax, and its book depreciation exceeds tax depreciation by $20,000. South records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 21% in both years, what is South's current income tax expense reported on its GAAP financial statements for year 2?

A) $4,200
B) $94,500
C) $105,000
D) $109,200

Question 43

Bunker, Inc., is a domestic corporation. It owns 100% of Texas, Inc., a domestic corporation; 100% of Paris, a foreign corporation and 35% of Iowa, Inc., a domestic corporation.
a. Which entities' incomes are included in Bunker's Federal consolidated income tax return?
b. How would your answer change if Bunker instead owned 15% of Iowa?

Question 44

Which of the following items is not included in the income tax footnote for a publicly traded company?

A) Rate reconciliation.
B) Analysis of deferred tax assets and liabilities.
C) Breakdown of income tax between foreign and domestic.
D) Breakdown of income tax among U.S. states.
E) Analysis of total tax expense components.

Question 45

Ursula, Inc. is a domestic corporation. It owns 100% of Texas, Inc., a domestic corporation; 100% of Paris, a foreign corporation and 45% of Iowa, Inc., a domestic corporation.
a. Which entities' incomes are included in Ursula's combined GAAP financial statements?
b. How would your answer change if Ursula instead owned 15% of Iowa?

Question 46

A GAAP financial statement includes footnotes that:

A) Give estimates of the dates on which the deferred tax liability will be paid.
B) Show the journal entries to determine the deferred income tax expense.
C) Break down the state-by-state profitability of the entity.
D) Include a reconciliation of the book effective tax rate with the applicable statutory tax rate.

Question 47

Van Dyke, Inc., hopes to report a total book-tax expense of $150,000 in the current year. This amount consists of $200,000 in current tax expense and a $50,000 tax benefit related to the expected future use of an NOL by Van Dyke. If the auditors determine that a valuation allowance of $20,000 must be placed against Van Dyke's deferred tax
Assets, what is Van Dyke's total book-tax expense?

A) $150,000
B) $170,000
C) $200,000
D) $250,000

Question 48

The best estimate of the actual current-year income tax liability i.e., perhaps the amount of the checks that the taxpayer will write to taxing jurisdictions) is the:

A) Change in the deferred tax asset account balance.
B) Change in the deferred tax liability account balance.
C) Current tax expense.
D) Current E&P.

Question 49

JuarezCo constructs the following table in determining how to apply ASC 740-10 to its filing position for its domestic production activities deduction. Its book-tax provision for the year, including $3 million for the uncertain transfer pricing issue, is $10 million. $$\begin{array} { c c c } \begin{array} { c } \text { Resulting Estimated Tax } \\\text { Benefit }\end{array} & \begin{array} { c } \text { Probability of Agreement between } \\\text { JuarezCo and IRS }\end{array} & \begin{array} { c } \text { Cumulative Probability of } \\\text { Agreement }\end{array} \\\text { \$3 million } & 10 \% & 10 \% \\\text { \$2 million } & 45 \% & 55 \% \\\text { \$1.6 million } & 40 \% & 95 \% \\\text { \$1.1 million } & 5 \% & 100 \%\end{array}$$ Under ASC 740-10, JuarezCo's book income tax expense for this item is:

A) $13 million.
B) $12 million.
C) $11.4 million.
D) $11 million.

Question 50

Which of the following statements best describes considerations regarding a company's tax expense that users of GAAP financial statements may make?

A) The breakdown of tax expense between current and deferred may provide useful information regarding the comparison of tax burdens between companies.
B) An analysis of earnings before interest, taxes, depreciation, and amortization EBITDA) is often a better approach to comparing the operating results of two companies.
C) One-time effects within a company's effective tax rate should be removed before comparing the effective tax rates across companies or across years for the same company).
D) All these observations are correct.

Question 51

Black, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 21% corporate tax rate and no valuation allowance. Black, Inc.'s, book income before tax is $6,000. Black records two permanent book-tax differences.
It earned $250 in tax-exempt municipal bond interest, and it incurred $500 in nondeductible business meals expense. Determine the change in Black's deferred tax assets for the current year.

Question 52

Cold, Inc., reported a $100,000 total tax expense for financial statement purposes in year 1. This total expense consisted of $150,000 in current tax expense and a deferred tax benefit of $50,000. The deferred tax benefit consisted of $90,000 in deferred tax assets reduced by a valuation allowance of $40,000. In year 2, Cold reports $600,000 in book net income before tax. Cold records no other permanent or temporary book-tax differences. At the end of year 2, Cold's auditors determine that the existing valuation allowance of $40,000 should be reduced to zero. What is Cold's total tax expense for year 2?

A) $250,000
B) $126,000
C) $86,000
D) $40,000

Question 53

Black, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 21% corporate tax rate and no valuation allowance. Black, Inc.'s, gross deferred tax assets and liabilities at the beginning of Black's year are listed below. Black, Inc.'s, book income before tax is $6,000. Black records two permanent book-tax differences.
It earned $250 in tax-exempt municipal bond interest and incurred $500 in nondeductible business meals expense. Determine the change in Black's deferred tax liabilities for the current year.

Question 54

South, Inc., earns book net income before tax of $400,000 in year 1. It acquires a depreciable asset in year 1, and its first-year tax depreciation exceeds book depreciation by $50,000. At the end of year 1, South's deferred tax liability account balance is $10,500. In year 2, South earns $500,000 book net income before tax, and its book depreciation exceeds tax depreciation by $20,000. South records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 21% in both years, what is South's balance in its deferred tax liability account at the end of year 2?

A) $0
B) $4,200
C) $6,300
D) $10,500

Question 55

Budlow, Inc., reported the following results for the current year. Determine Budlow's taxable income for the current year. Identify any temporary or permanent book-tax differences.

Question 56

Hot, Inc.'s primary competitor is Cold, Inc. When comparing relative deferred tax asset and liability accounts with Cold, which of the following benchmarking activities should Hot undertake?

A) Scale the deferred tax assets and liabilities by total sales or total assets.
B) Compare raw dollar amounts of deferred tax assets and liabilities.
C) Ignore deferred tax assets and liabilities and focus on overall effective tax rate.
D) Ignore all tax information other than the current tax expense.

Question 57

JiangCo constructs the following table in determining how to apply ASC 740-10 to its filing position for a transfer pricing issue. Its book-tax provision for the year, including $3 million for the uncertain transfer pricing issue, is $10 million. $$\begin{array} { c c c } \begin{array} { c } \text { Resulting Estimated } \\\text { Tax Benefit }\end{array} & \begin{array} { c } \text { Probability of Agreement } \\\text { between JiangCo and IRS }\end{array} & \begin{array} { c } \text { Cumulative Probability } \\\text { of Agreement }\end{array} \\\text { \$3 million } & 10 \% & 10 \% \\\text { \$2 million } & 35 \% & 45 \% \\\text { \$1.6 million } & 40 \% & 85 \% \\\text { \$1.1 million } & 15 \% & 100 \%\end{array}$$ Under ASC 740-10, JiangCo's book income tax expense for this item is:

A) $13 million.
B) $11.6 million.
C) $11.4 million.
D) $10 million.

Question 58

In the typical case, the taxpayer would prefer to see an):

A) Increase in the current tax expense.
B) Increase in the deferred tax asset account balance.
C) Decrease in the deferred tax liability account balance.
D) Increase in the deferred tax liability account balance.

Question 59

Healy, Inc., reports an effective tax rate in its income tax footnote of 6%. The only reconciling item with regard to the hypothetical tax at 21% is a valuation allowance reversal of negative 15%. Which of the following statements is true concerning comparing Healy's effective tax rate with its competitors, all of whom have an effective tax rate between 20 and 24%?

A) Healy is managing its tax burden in a more efficient manner than its competitors are.
B) Healy's structural effective tax rate is actually quite close to that of its competitors.
C) Healy earned more cash profits because of its lower effective tax rate.
D) Healy is likely to be engaged in tax shelter activities.

Question 60

Black, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 21% corporate tax rate and no valuation allowance. Black, Inc.'s, gross deferred tax assets and liabilities at the beginning of Black's year are as follows: Black, Inc.'s, book income before tax is $6,000. Black records two permanent book-tax differences.
It earned $250 in tax-exempt municipal bond interest, and it incurred $500 in nondeductible business meals expense. Determine the net deferred tax asset or net deferred tax liability at year-end.

Question 61

You are the tax adviser to a publicly traded U.S. corporation. How might you use a "benchmarking" analysis to begin your review of the entity's tax situation and planning opportunities?

Question 62

Book-tax differences can be explained in part by examining the objectives underlying financial accounting and taxable income computations. Evaluate this statement.

Question 63

Bryden Corporation is considering two tax planning strategies. Both would produce a $1 million tax savings. One of
the strategies would structure the plan so that the $1 million would represent a temporary book-tax difference, and the other would generate a permanent difference. In general, which plan would the Bryden CFO prefer? Which would a stock analyst reviewing the Bryden valuation prefer?

Question 64

At the beginning of the year, the balance sheet of Schrader, Inc., shows a $500,000 deferred tax asset relating to a net operating loss carryforward offset by a $90,000 valuation allowance. At the end of the year, Schrader's auditors
agree to release $20,000 of the allowance. Provide the journal entry to record this change in the valuation allowance.

Question 65

Black, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 21% corporate tax rate and no valuation allowance. Black, Inc.'s, gross deferred tax assets and liabilities at the beginning of Black's year are as follows: Black, Inc.'s, book income before tax is $6,000. Black records two permanent book-tax differences.
It earned $250 in tax-exempt municipal bond interest and incurred $500 in nondeductible business meals expense. Provide the income tax footnote rate reconciliation for Black, using either
dollars or percentages.

Question 66

Black, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 21% corporate tax rate and no valuation allowance. Black, Inc.'s, gross deferred tax assets and liabilities at the beginning of Black's year are as follows: Black, Inc.'s, book income before tax is $6,000. Black records two permanent book-tax differences.
It earned $250 in tax-exempt municipal bond interest, and it incurred $500 in nondeductible business meals expense. Provide the journal entry to record Black's current tax expense.

Question 67

A corporation's taxable income almost never is the same as its GAAP financial accounting income. Explain why this occurs. Use the terms permanent and temporary book-tax differences in your answer. Give at least two examples of each type of book-tax difference.

Question 68

Jacobsen Corporation has determined the appropriate changes to its deferred tax accounts. Its auditor now is discussing whether to place a valuation allowance against the deferred tax asset on the balance sheet. List some of the factors that the Jacobsen auditor will consider in this regard.

Question 69

At the beginning of the year, Schrader, Inc., holds a net operating loss carryforward, and its balance sheet shows a related deferred tax asset of $500,000. At the end of the year, the balance in the deferred tax asset account has not changed, but Schrader's auditors want to record a $90,000 valuation allowance against this amount, because of a persistent downturn in Schrader's profitability. Provide the journal entry to record the valuation allowance.

Question 70

You are assisting LipidCo, a U.S. corporation subject to GAAP, to determine its current-year book expense for income taxes. The following represent the steps that you will take in making this computation. Put the steps into the correct order.
A. Compute the deferred tax provision.
B. Determine book income before income tax effects. C. Determine the current tax provision.
D. Determine whether a valuation allowance is required, and apply or release it. E. Identify and measure temporary book-tax differences.
F. Prepare the disclosures for the financial statement footnotes. G. Add/Subtract any permanent book-tax differences.

Question 71

Black, Inc., is a domestic corporation with the following balance sheet for book and tax purposes at the end of the year. Assume a 21% corporate tax rate and no valuation allowance. Black, Inc.'s, gross deferred tax assets and liabilities at the beginning of Black's year are as follows: Black, Inc.'s, book income before tax is $6,000. Black records two permanent book-tax differences.
It earned $250 in tax-exempt municipal bond interest, and it incurred $500 in nondeductible business meals expense. Calculate Black's current tax expense.