South, Inc., earns book net income before tax of $400,000 in year 1. South acquires a depreciable asset in year 1, and first year tax depreciation exceeds book depreciation by $50,000. At the end of year 1, South's deferred tax liability account balance is $17,500. 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 35%, what is South's total provision for income tax expense reported on its GAAP financial statements for year 2?
A)$7,000
B)$168,000
C)$175,000
D)$182,000

Question

Quizplus · Accepted Answer

South's taxable income for Year 1 is $450,000 ($400,000 book net income + $50,000 excess tax depreciation). Applying the tax rate of 35% results in income tax payable of $157,500. South's deferred tax liability balance at the end of Year 1 is $17,500, indicating that South's income tax payable must have been $175,000 ($157,500 + $17,500) and that South recognized a $17,500 deferred tax expense.

In Year 2, book depreciation exceeds tax depreciation, creating a temporary difference that will reverse in the future, reducing taxable income and income tax payable. The amount of the difference is $20,000, so South's taxable income for Year 2 is $480,000 ($500,000 book net income - $20,000 excess book depreciation). Applying the tax rate of 35% results in income tax payable of $168,000. South has no other temporary or permanent differences, and therefore, its income tax expense for Year 2 is $168,000. However, because South recognized $17,500 of deferred tax expense in Year 1, its total provision for income tax expense reported on its GAAP financial statements for Year 2 is $175,000 ($168,000 + $17,500).

Thus, the correct answer is C, $175,000.