The records for Good Co. show this data for 2013, the first year of the company:
ID: 2498038 • Letter: T
Question
The records for Good Co. show this data for 2013, the first year of the company:
Gross profit on installment sales recorded on the books was $200,000. Of this, only $150,000 was reported for tax purposes.
Life insurance on officers was $3,800.
Machinery was acquired in January for $300,000. Straight-line depreciation over a ten-year period (no salvage value) is used. For taxes, MACRS depreciation is used and Good may deduct 14% of the cost for 2013.
Interest received on tax-exempt Iowa State bonds was $9,000.
The estimated warranty liability on the books related to 2013 sales was $19,600. Of this, only $13,600 could be deductible for tax purposes. The remainder will be incurred in 2014.
Pretax financial income is $250,000. The tax rate is 30%. REQUIRED:
a) Suppose that the Company believes it is not more likely than not that it will be able to realize its deferred tax asset due to future expected losses. What would GAAP require the Company to do in this circumstance?
b) Suppose instead that the Company does expect to earn income in future years. However, it believes that its calculation of the book/tax difference associated with the installment sale is not likely to be sustained upon examination. What would GAAP require the Company to do in this circumstance?
Explanation / Answer
Answer to Q. No. A
Deferred Tax Asset recognition if future loss expected :-
As per AC 740 deferred tax asset is recognized for the estimated future tax effects attributable to temporary differences and carryforwards. Deferred tax assets are recognized in full and then reduced by a valuation allowance if it is more likely than not that some or all of the deferred tax assets will not be recognized. If the company expects that there will be future expected loss ond there are no sufficient temporary differences to be reversed in future then deferred tax should not be recognized.In the given scenario depreciation will create temporary dfiference of deffred tax liability and estimated warranty liability in books partial amount of 6000 USD is going to create deferred tax asset.So there does not seem to be any material temporary difference which is going to reverse in future and hence the deferred tax asset should not be recongnized. As deferred tax asset on warranty liability and deferred tax liability on depreciation will get offset by each other in FY 14.
Answer to Q. No. B
If the company expects the difference in book and tax books sale difference is not going to sustain upon examination will create future tax liability. And earning income will eventually add to the incremntal sales which will get recorded in books. As per GAAP if there is forseeable future income against which defrred tax asset can be set off the same should be recogbnized in books.
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