Plaxo Corporation has a tax rate of 35% and uses the straight-line method of depreciation for its equipment,which has a useful life of four years.Tax legislation requires the company to depreciate its equipment using the following schedule: year 1- 50%,year 2 - 30%,year 3 - 15% and year 4 - 5%.In 2010 Plaxo purchases a piece of equipment with a four year life and an original cost of $100,000.What amount will Plaxo record as a deferred tax asset or liability in 2010?

Question

Quizplus · Accepted Answer

The difference in depreciation expense between tax depreciation and book depreciation will create either a deferred tax asset or liability. Since tax depreciation is higher in the earlier years and lower in the later years, there will be a temporary difference in the taxable income and the net income reported in the financial statements.

In this case, the tax depreciation for year 1 is 50% of the original cost, or $50,000. The book depreciation would be $100,000/4 years = $25,000 for each year. Therefore, the tax depreciation exceeds the book depreciation by $25,000 in year 1. The temporary difference will reverse over the remaining three years, resulting in a deferred tax liability of $25,000 (35% x $25,000). Therefore, the correct answer is (D) Deferred tax liability of $8,750.

Plaxo Corporation Has a Tax Rate of 35% and Uses