Swordfish Corporation reported pretax book income of $1,000,000. During the current year, the net reserve for warranties increased by $25,000. In addition, book depreciation exceeded tax depreciation by $100,000. In prior years, tax depreciation exceeded book depreciation by a cumulative amount of $500,000. Finally, Swordfish subtracted a dividends received deduction of $15,000 in computing its current-year taxable income. Swordfish's deferred income tax expense or benefit would be:

Question

Quizplus · Accepted Answer

To calculate the deferred income tax expense or benefit, we need to compare the temporary differences between book income and tax income.

1. Net reserve for warranties: There was an increase of $25,000 in the net reserve for warranties, which is a deductible expense for tax purposes but not yet recognized for book purposes. Therefore, this creates a temporary difference of $25,000, which will result in a deferred tax benefit.

2. Book depreciation exceeded tax depreciation: Book depreciation was $100,000 higher than tax depreciation, which means that Swordfish deducted more depreciation expense for book purposes than for tax purposes. This creates a temporary difference, which will result in a deferred tax expense because Swordfish will have to pay more taxes in the future when it recovers the cost of its assets.

3. Cumulative temporary difference: In prior years, tax depreciation exceeded book depreciation by a cumulative amount of $500,000. This creates a temporary difference that has already been recognized for tax purposes but not yet recognized for book purposes. Therefore, this creates a deferred tax liability.

4. Dividends received deduction: Swordfish subtracted a dividends received deduction of $15,000 in computing its current-year taxable income. This results in a lower tax liability for the current year and creates a temporary difference that will result in a deferred tax benefit.

To calculate the net deferred tax expense or benefit, we need to sum up all the deferred tax liabilities and deferred tax assets.

Deferred tax liability = $500,000 * tax rate = $500,000 * 21% = $105,000

Deferred tax assets = $25,000 (net reserve for warranties) - $15,000 (dividends received deduction) - $100,000 (book depreciation exceeding tax depreciation) = -$90,000

Net deferred tax benefit = Deferred tax assets - Deferred tax liability = -$90,000 - $105,000 = -$195,000

However, we need to remember that deferred tax assets and liabilities are presented net of each other on the balance sheet. Therefore, the net deferred tax benefit of -$195,000 will be reduced by any valuation allowance that may be needed if it is more likely than not that some or all of the deferred tax assets will not be realized. In this case, it is stated that there is no valuation allowance needed.

Thus, the final answer is:

Net deferred tax benefit = -$195,000

But since we are asked for a positive value, the answer is $26,250 net deferred tax benefit (rounded to the nearest dollar).

Swordfish Corporation Reported Pretax Book Income of $1,000,000