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 balance in its deferred tax liability account at the end of year 2?
A)$0
B)$7,000
C)$10,500
D)$17,500

Question

Quizplus · Accepted Answer

In year 1, the temporary difference between book and tax depreciation is $50,000 - this creates a future tax liability of $17,500 ($50,000 x 35%). Therefore, at the end of year 1, the deferred tax liability account balance is $17,500.
In year 2, the temporary difference between book and tax depreciation is -$20,000 (i.e. book depreciation is lower than tax depreciation). This creates a future tax asset of $7,000 ($20,000 x 35%). Therefore, the balance in the deferred tax liability account at the end of year 2 is $17,500 - $7,000 = $10,500.