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 income tax expense reported on its GAAP financial statements for year 2?

Question

Quizplus · Accepted Answer

In year 1, the taxable income is $450,000 ($400,000 + $50,000). Applying the tax rate of 35% gives an income tax expense of $157,500. The deferred tax liability account balance increases by $17,500, so the total income tax expense reported on the GAAP financial statements is $175,000 ($157,500 + $17,500).

In year 2, the taxable income is $530,000 ($500,000 - $20,000). Applying the tax rate of 35% gives an income tax expense of $185,500. However, in year 1, South created a deferred tax liability of $17,500. Therefore, the total income tax expense for year 2 is $168,000 ($185,500 - $17,500).