CPA Financial Accounting and Reporting (FAR) : Income Taxes
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Example Questions
Example Question #1 : Income Taxes
In Year 1, a company has revenues of $600,000 and expenses of $400,000. Of the expenses, $70,000 represents a warranty on a company product. However, the company only paid $30,000 as a result of this warranty. The remainder is expected to be paid in a future year in which company officials believe there is a 60% chance that the company will have taxable income to be reduced by this warranty cost. The relevant tax rate is 30% for Year 1 and 32% for periods after that. What is the total amount of income tax expense to be recognized in Year 1?
$62,000
$70,000
$59,200
$49,000
$59,200
Reported net income of $200K ($600K revenue - $400K expenses) must be adjusted to $240K to exclude the portion of the warranty expenses that weren't paid in Year 1. This means the the current portion of income expense is $72K ($240K x 30%). The remaining $40K deduction is deferred to a future year, so the company recognizes a deferred benefit of $12,800 ($40K x 32%). Total Year 1 tax expense is equal to $72K - $12,800.
Example Question #2 : Income Taxes
The Faulkner Company had an enacted income tax rate of 25%. The company ended Year 1 with a deferred income tax liability of $30,000, a deferred income tax asset of $40,000, and a valuation allowance of $9,000. The enacted tax rate at the beginning of Year 2 was raised to 28%. The company ended Year 2 with a deferred income tax liability of $60,000, a deferred income tax asset of $30,000, and a valuation allowance of $14,000. On the company's Year 2 income statement, what is the amount of income tax expense (deferred) that is reported?
$45,000
$10,000
$40,000
$20,000
$45,000
The deferred tax liability increases by $30K from Year 1 to Year 2 ($30K to $60K) and the deferred asset decreased by $10K ($40K to $30K). The valuation allowance increased by $5K ($9K to $14K). Therefore, a balancing expense of $45K must be booked ($30K + $10K + $5K).
Example Question #3 : Income Taxes
A firm's ending inventory balance was overstated by $1,000. Which of the following statements is correct according to a periodic inventory system?
The cost of goods sold was overstated by $1,000
The gross margin was understated by $1,000
The cost of goods sold available for sale was overstated by $1,000
The retained earnings were overstated by $1,000
The retained earnings were overstated by $1,000
An ending inventory balance that is overstated by $1,000 implies that cost of goods sold is understated by the same $1,000.
Example Question #4 : Income Taxes
The Motown Company produces cars. When a customer buys a car, the company issues a warranty guaranteeing that any defects found within three years will be fixed free of charge. Cars are sold during Year 3 and none are brought in for repair, though the company expects to incur $3,000,000 before the time limit expires. Motown has considerable evidence to believe that it will continue to be profitable for the foreseeable future. Which of the following results from sales that are made in Year 3?
A deferred tax asset should be recognized
A current deferred tax asset is recognized along with a non-current deferred tax liability
No recognition of any deferred income taxes should be made
A deferred tax liability should be recognized
A deferred tax asset should be recognized
A deferred tax asset will be recognized in Year 3, because the company reasonably expects to pay out warranty expenses incurred in Year 3, in future years.
Example Question #5 : Income Taxes
ABC Company recorded goods in transit purchased FOB shipping point at year end as purchases. The goods were excluded from ending inventory. What effect does the omission have on ABC's assets and retained earnings at year end?
Both assets and retained earnings understated
No effect
Assets understated
Retained earnings understated
Both assets and retained earnings understated
Because the goods are in transit, the buyer should have included them in inventory. By not including them, inventory and assets are understated.
Example Question #6 : Income Taxes
Under US GAAP, which of the following approaches would be used to determine income tax expense?
Perpetual expense approach
Net of tax and liability approach
The asset and liability approach
Border approach
The asset and liability approach
The asset and liability approach is also known as the balance sheet approach and it is the approach used in US GAAP to determine income tax expense. The other approaches are distractors.
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