a. Assuming that ABC had no significant permanent differences between book incom

Question

a. Assuming that ABC had no significant permanent differences between book income and
taxable income, did income before taxes for financial reporting exceed or fall short of taxable
income for 2013? Explain.

b. Did income before taxes for financial reporting exceed or fall short of taxable income for
2014? Explain.

c. Will the adjustment to net income for deferred taxes to compute cash flow from operations
in the statement of cash flows result in an addition or a subtraction for 2013? For 2014?

d. ABC does not contract with an insurance agency for property and liability insurance;
instead, it self-insures. ABC recognizes an expense and a liability each year for financial
reporting to reflect its average expected long-term property and liability losses. When it
experiences an actual loss, it charges that loss against the liability. The income tax law
permits self-insured firms to deduct such losses only in the year sustained. Why are
deferred taxes related to self-insurance disclosed as a deferred tax asset instead of a
deferred tax liability? Suggest reasons for the direction of the change in amounts for this
deferred tax asset between 2012 and 2014.

e. ABC treats certain storage and other inventory costs as expenses in the year incurred for financial
reporting but must include these in inventory for tax reporting. Why are deferred
taxes related to inventory disclosed as a deferred tax asset? Suggest reasons for the direction
of the change in amounts for this deferred tax asset between 2012 and 2014.

f. Firms must recognize expenses related to postretirement health care and pension obligations
as employees provide services, but claim an income tax deduction only when they
make cash payments under the benefit plan. Why are deferred taxes related to health
care obligation disclosed as a deferred tax asset? Why are deferred taxes related to pensions
disclosed as a deferred tax liability? Suggest reasons for the direction of the change
in amounts for these deferred tax items between 2012 and 2014.

g. Firms must recognize expenses related to uncollectible accounts when they recognize
sales revenues, but claim an income tax deduction when they deem a particular customer’s
accounts uncollectible. Why are deferred taxes related to this item disclosed as a
deferred tax asset? Suggest reasons for the direction of the change in amounts for this
deferred tax asset between 2012 and 2014.

h. ABC uses the straight-line depreciation method for financial reporting and accelerated
depreciation methods for income tax purposes. Why are deferred taxes related to depreciation
disclosed as a deferred tax liability? Suggest reasons for the direction of the
change in amounts for this deferred tax liability between 2012 and 2014.

Exhibit 2.15 ABC Corporation Income Tax Disclosures amounts in millions) (Problem 2.17) For the Year Ended January 31 Income before income taxes United States Income tax expense Current: 2014 2013 3,031 2,603 Federal State and local $ 908 144 $1,052 669 107 $ 776 Total Current Deferred: $ 184 24 S 208 $984 $ 83 Federal State and local S 94 1,146 Total Deferred Total January 31: 2014 2013 2012 Components of deferred ta:x assets and liabilities Deferred tax assets Self-insured benefits Deferred compensation Inventory Postretirement health care obligation Uncollectible accounts Other $ 179 332 47 38 147 128 $ 871 $ 143 297 $ 188 184 56 42 133 53 113 166 $748 Total Deferred Tax Assets 712 Deferred tax liabilities: (1,136) (268) S (945) (218) Depreciation Pensions Other $ (826) (190) (59) $ (1,075) $ (327) (1,247) S(535) Total Deferred Tax Liabilities $ (1,500) S (629) Net Deferred Tax Liability

Explanation / Answer

a.

Income before taxes for financial reporting exceeds or falls short of taxable income in 2013:

ABC is seen to have high income before tax which exceeds its taxable income since its net deferred tax liability is increased within the period of 2013 and 2014 it is also to be noted that the total income tax expense is higher than income tax payable which will create some deferred tax payment in future.

b.

Income before taxes for financial reporting exceeds or fall short of taxable income for 2014:

The increase in deferred tax liability in between 2013 and 2014 is the reason that income before taxes is higher than the taxable income.

c.

Adjustment to net income for deferred taxes to compute cash flow from operations in statement of cash flows by addition or subtraction: The deferral of tax payment in the period of 2013 and 2014 has resulted an increase of net income of $208 and $94 million. This rise is noticed when the cash flow is computed. It is quite evident that ABC has not paid a high amount of in income tax as suggested by the income statement in regards to subtraction for income tax expense.

d.

Deferred tax related to self-insurance will be treated as deferred tax asset or deferred tax liability: There is a rise in deferred tax asset when ABC recognizes the expense in regard to insurance earlier for financial reporting than for tax reporting this lead to a future savings in income tax when the actual loss occurs. The steep decline in deferred tax asset for self-insured benefits in between the period of 2012 and 2013 highlights that ABC had paid more in claims than recognized as expense. The vice versa is seen in 2013 and 2014 were the claims are lower than the recognized expenses.

e.

Reason for disclosing the deferred taxes as the deferred tax asset: ABC recognizes these costs and expenses earlier in financial reporting than tax reporting resulting in an increase of deferred tax asset and giving it a benefit of tax saving when they actually sells the inventory. The fall in tax assets in relation to inventory for the period 2012 and 2013 states that the there is a decrease in inventory in 2013 resulting in an larger expense for tax reporting than financial reporting, vice versa is noticed in 2013 and 2014 were the inventory roused.

f.

Deferred tax liability and deferred tax asset: There is a deferred tax asset for health care obligation highlighting to the point that ABC has recognized high expenses for financial reporting than for actual payments towards health plans. ABC must have grown its employees or have increased the health care benefits which are reflected with the increase in deferred tax asset between the end of 2012 and 2013. The decrease in tax asset for healthcare is backed up by either decreasing number of employees or lower health cost. The growing amount of deferred tax liability in view of pension states that ABC has spent a large amount on a cumulative basis than actually recognizing the same in financial reporting.

g.

Deferred taxes relate to deferred tax asset: Deferred tax asset in relation to uncollectible accounts indicates that ABC recognized losses for uncollectible accounts much earlier in financial reporting than in tax reporting. The deferred tax asset reflects that ABC will have future savings in income taxes when it writes off the actual uncollectible accounts, there is an increasing trend in deferred tax asset in support with sales.

h.

Reasons for change in amount for deferred tax liability between 2012 and 2014: ABC recognizes depreciation in tax reporting earlier than financial reporting which creates a deferred tax liability. The increase in tax liability indicates that ABC has incurred high capital expenditure each year resulting in more depreciation in early years, when accelerated depreciation goes over straight line depreciation than it has depreciable assets in the later years of their lives when straight line depreciation exceeds accelerated depreciation.

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