Use the following information for questions.
Hopkins Co.at the end of 2010, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows:

The estimated litigation expense of $1,000,000 will be deductible in 2011 when it is expected to be paid.Use of the depreciable assets will result in taxable amounts of $500,000 in each of the next three years.The income tax rate is 30% for all years.
-Cross Company reported the following results for the year ended December 31, 2010, its first year of operations:

The disparity between book income and taxable income is attributable to a temporary difference which will reverse in 2011.What should Cross record as a net deferred tax asset or liability for the year ended December 31, 2010, assuming that the enacted tax rates in effect are 40% in 2010 and 35% in 2011?

Question

Use the following information for questions.
Hopkins Co.at the end of 2010, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows:
  
The estimated litigation expense of $1,000,000 will be deductible in 2011 when it is expected to be paid.Use of the depreciable assets will result in taxable amounts of $500,000 in each of the next three years.The income tax rate is 30% for all years.
-Cross Company reported the following results for the year ended December 31, 2010, its first year of operations:

The disparity between book income and taxable income is attributable to a temporary difference which will reverse in 2011.What should Cross record as a net deferred tax asset or liability for the year ended December 31, 2010, assuming that the enacted tax rates in effect are 40% in 2010 and 35% in 2011?

Quizplus · Accepted Answer

Cross Company has a temporary difference which will reverse in 2011, meaning that the difference between book income and taxable income will eventually be eliminated. This results in a deferred tax asset or liability being recorded, depending on whether the temporary difference will result in a future tax benefit or tax liability. In this case, since the enacted tax rate is lower in 2011, there will be a future tax benefit, resulting in a net deferred tax asset. To calculate the amount, we need to determine the temporary difference ($300,000 - $240,000 = $60,000) and multiply by the difference in tax rates (40% - 35% = 5%). $60,000 x 5% = $3,000, which is the net deferred tax asset. However, since the question asks for the net deferred tax asset or liability, we also need to consider the current year's tax expense. The tax payable is $96,000 (based on taxable income of $240,000 and a tax rate of 40%), while the tax expense based on book income is $90,000. The difference of $6,000 will result in a future tax liability, which offsets part of the deferred tax asset. Therefore, the net deferred tax asset is $3,000 - $6,000 = ($3,000), which is a deferred tax asset.

Use the Following Information for Questions