FAR · Select transactions · 9 practice questions
Current vs Deferred Tax: Compute Income Tax Expense
Compute current tax from taxable income, then add deferred tax expense or subtract the deferred tax benefit. Below: a worked ASC 740 example separates the two rates before you try free practice questions.
Try one first
Hint
Separate the permanent difference from the temporary differences, and use the enacted rate for the period in which each temporary difference is expected to reverse.
Answer B. Taxable income = 600,000 - 20,000 (tax-exempt interest) - 50,000 (tax depreciation in excess of book) + 30,000 (warranty expense not yet deductible) = 560,000. Current tax payable = 560,000 × 25% = 140,000. Deferred taxes are measured at the enacted 30% rate applicable when the temporary differences reverse: DTL = 50,000 × 30% = 15,000; DTA = 30,000 × 30% = 9,000; net deferred tax expense = 6,000. Total income tax expense = 140,000 + 6,000 = 146,000.
Why not A: Tempting if the candidate fails to recognize the $20,000 municipal bond interest as a permanent nontaxable item; that error gives taxable income of 580,000 and current tax of 145,000. The deferred amounts are measured correctly here, but the current tax is wrong because the permanent difference reduces taxable income only in Year 1.
Why not C: Tempting if the candidate computes current tax correctly but measures deferred taxes at the Year 1 enacted 25% rate instead of the 30% rate that will apply when the temporary differences reverse in Year 2, understating deferred tax expense (net temporary difference 20,000 × 25% = 5,000).
Why not D: Tempting if the candidate identifies the temporary differences but reverses their tax effect. The excess tax depreciation creates a deferred tax liability of 15,000 and the warranty accrual a deferred tax asset of 9,000, so the net is a deferred tax expense of 6,000 (liability > asset), not a benefit.
Worked example
Vale Co. has Year 1 pretax book income of $400,000, including $100,000 of installment-sale profit taxable in Year 2. This is its only book-tax difference, and beginning deferred balances are zero. Enacted rates are 25% for Year 1 and 30% for Year 2. All tax effects are recognized in income.
| 1 | Taxable income$400,000 - $100,000 | $300,000 |
| 2 | Current tax payable$300,000 × 25% | $75,000 |
| 3 | Ending deferred tax liability$100,000 × 30% | $30,000 |
| 4 | Deferred tax expense$30,000 ending liability - $0 beginning liability | $30,000 |
| 5 | Total income tax expense$75,000 + $30,000 | $105,000 |
Vale reports $75,000 of current tax payable, $30,000 of deferred tax expense, and $105,000 of total income tax expense.
Check: Shortcut: $400,000 × 25% + $100,000 × (30% - 25%) = $105,000.
Key points
- Permanent differences change taxable income but never create deferred tax assets or liabilities.
- Future taxable amounts create deferred tax liabilities; future deductions create deferred tax assets.
- Deferred expense is a balance change, not the ending balance, unless beginning deferred balances are zero.
How the exam traps you
- Reporting current tax payable as total tax expense. Add deferred tax expense or subtract deferred tax benefit.
- Using the current-year rate for every tax calculation. Use the current-year rate for current tax and enacted reversal-year rates for deferred balances.
- Treating tax-exempt interest as a temporary difference. Remove it from taxable income; do not record a deferred tax balance.
Question 2
Hint
Separate permanent differences from temporary differences. Then compute current tax using this year's taxable income, and measure deferred taxes using the enacted rate for the year the temporary differences reverse.
Answer B. Taxable income in 20X5 = 500,000 - 20,000 (tax-exempt) - 120,000 (installment profit not yet taxable) + 40,000 (warranty accrued, not yet deductible) - 80,000 (excess tax depreciation) = 320,000. Current tax payable = 320,000 × 25% = 80,000. Net temporary difference reversing in 20X6 = 120,000 + 80,000 - 40,000 = 160,000, and deferred tax = 160,000 × 30% = 48,000. Total income tax expense = 80,000 + 48,000 = 128,000.
Why not A: This equals only the current tax payable for 20X5. It omits the deferred tax effect of temporary differences that will reverse in 20X6; GAAP income tax expense includes both current and deferred components.
Why not C: This arises if the deferred tax on the 160,000 net temporary difference is measured at the 20X5 rate (25%) instead of the enacted 20X6 rate (30%). Deferred taxes must be measured using the rate expected when differences reverse.
Why not D: This results from treating only the 120,000 installment profit and the 80,000 depreciation as future taxable amounts (total 200,000) and ignoring the 40,000 future deductible warranty amount; that overstates deferred tax and total expense.
Question 3
Hint
First identify which differences are permanent and which are temporary. Then compute current taxable income separately from the deferred tax effect of the temporary differences.
Answer A. Taxable income = $500,000 + $30,000 (warranty not deductible until paid) + $40,000 (tax depreciation < book depreciation) - $20,000 (tax-exempt municipal interest) = $550,000. Current tax expense = 25% × $550,000 = $137,500. The $30,000 warranty accrual and $40,000 depreciation difference are deductible temporary differences totaling $70,000, producing a deferred tax asset (benefit) of 25% × $70,000 = $17,500; total tax expense = $137,500 - $17,500 = $120,000.
Why not B: This option correctly computes current tax but assigns the wrong sign to the deferred item. The warranty accrual and excess book depreciation create deductible temporary differences (deferred tax assets), which reduce income tax expense (a deferred tax benefit), not increase it.
Why not C: This choice treats municipal bond interest as permanent (correct) and the warranty as temporary (correct) but ignores the $40,000 depreciation timing difference; omitting that temporary difference understates taxable income and the deferred tax benefit.
Why not D: This attracts candidates who misclassify the municipal bond interest as taxable or who incorrectly compute the temporary differences. Municipal bond interest is a permanent difference (it reduces taxable income but creates no deferred tax), so both the current tax and deferred amounts in this choice are incorrect even though the total happens to match the correct amount.
Question 4
Hint
Separate permanent differences from temporary differences first, then remember that deferred taxes use the enacted rate for the years of reversal.
Answer A. Taxable income = 500,000 − 20,000 (tax-exempt interest) + 60,000 (warranty not yet deductible) − 80,000 (excess tax depreciation) = 460,000. Current tax payable = 460,000 × 25% = 115,000. Deferred taxes use the enacted future rate of 30%: DTA = 60,000 × 30% = 18,000; DTL = 80,000 × 30% = 24,000, so net deferred tax expense = 6,000. Total income tax expense = 115,000 + 6,000 = 121,000.
Why not B: This reflects applying the current-year 25% rate to the net temporary difference (20,000 × 25% = 5,000) instead of the enacted reversal rate of 30% (which yields a 6,000 net deferred tax expense). Using 25% understates total tax expense by 1,000.
Why not C: This equals current tax payable only. It ignores the net temporary differences (DTA and DTL) created in Year 1 that produce a net deferred tax expense of 6,000.
Why not D: This overstates current taxable income (for example, by failing to exclude the $20,000 tax-exempt interest) or otherwise miscalculates temporary differences, producing an inflated current tax or deferred tax amount.
Question 5
Hint
Classify each book-tax difference first: permanent differences affect current tax only, while temporary differences affect deferred taxes measured at the enacted reversal-period rate.
Answer D. Taxable income = $600,000 − $20,000 (tax-exempt municipal interest) − $40,000 (excess tax depreciation) + $30,000 (warranty not yet deductible) = $570,000. Current tax payable = $570,000 × 25% = $142,500. Deferred taxes are measured at the Year 2 enacted rate of 30%: DTL = $40,000 × 30% = $12,000 and DTA = $30,000 × 30% = $9,000, yielding net deferred tax expense of $3,000. Total income tax expense = $142,500 + $3,000 = $145,500.
Why not A: Tempting because it correctly computes current tax payable ($570,000 × 25% = $142,500), but it omits deferred tax effects from the temporary differences. The net deferred tax expense of $3,000 must be added to current tax.
Why not B: This reflects recognizing deferred tax but measuring it at the Year 1 rate (25%). The correct practice under ASC 740 is to measure deferred taxes at the enacted rate expected to apply when the temporary differences reverse (30%), so the deferred amount is $3,000, not $2,500.
Why not C: This results from incorrectly including the $20,000 municipal bond interest in taxable income. Including it raises taxable income by $20,000 (extra tax of $5,000 at 25%), producing a higher current tax; adding the correct net deferred tax expense then yields $150,500, which is incorrect because municipal bond interest is tax-exempt.
Question 6
Hint
Separate permanent differences (tax‑exempt interest) from temporary differences (installment profit and warranty); compute taxable income first, then compute deferred tax for each temporary difference at the enacted rate and net the results.
Answer A. Taxable income = 500,000 − 20,000 (tax‑exempt interest) − 80,000 (installment profit deferred for tax) + 50,000 (warranty not deductible until paid) = 450,000. Current tax payable = 450,000 × 25% = 112,500. Deferred tax: DTL = 80,000 × 25% = 20,000; DTA = 50,000 × 25% = 12,500; net deferred tax = 20,000 − 12,500 = 7,500 (liability).
Why not B: Tempts candidates who only remove the tax‑exempt municipal interest and compute tax on 480,000 (500,000 − 20,000) to get 120,000. It fails because it ignores the temporary differences (the 80,000 installment profit deferred for tax and the 50,000 warranty expense deductible later); taxable income is 450,000 and current tax is 112,500.
Why not C: Tempts candidates who compute current tax correctly but confuse the direction of deferred amounts. The installment sale creates a DTL of 20,000 and the warranty accrual a DTA of 12,500, so the net is a 7,500 deferred tax liability, not an asset.
Why not D: Tempts candidates who treat the warranty expense as currently tax‑deductible (reducing taxable income to 430,000 and yielding tax of 107,500) and who record only the 20,000 DTL. It fails because the warranty is deductible in Year 2, so Year 1 taxable income is 450,000, current tax is 112,500, and a 12,500 DTA offsets part of the 20,000 DTL, leaving a 7,500 net liability.
Question 7
Hint
Separate permanent differences from temporary differences first, then decide which tax rate applies to current tax versus deferred tax.
Answer B. Taxable income = $600,000 - $20,000 (tax-exempt municipal interest) + $50,000 (warranty not deductible until paid) - $80,000 (excess tax depreciation) = $550,000. Current income taxes payable = $550,000 × 25% = $137,500. Deferred taxes use the enacted Year 2 rate of 30%: DTA for the warranty = $50,000 × 30% = $15,000; DTL for depreciation = $80,000 × 30% = $24,000; net deferred tax expense = $24,000 - $15,000 = $9,000. Total income tax expense = $137,500 + $9,000 = $146,500.
Why not A: This gets current taxes right but understates total expense because it appears to measure deferred tax effects using the current 25% rate (yielding a smaller net deferred tax expense) instead of the enacted 30% reversal rate.
Why not C: This is plausible if the municipal bond interest was treated as taxable (omitted from permanent differences), which raises taxable income and current tax payable; it also mixes up the rate applied to the deferred differences.
Why not D: This could result from failing to exclude municipal bond interest from taxable income (so current payable is too high) while correctly measuring deferred taxes at the enacted 30% reversal rate.
Question 8
Hint
Separate the permanent difference from the temporary differences, then compute current tax and deferred tax separately using the appropriate tax rates.
Answer A. Current taxable income = 800,000 - 20,000 + 100,000 - 140,000 = 740,000, so current tax payable = 740,000 × 30% = 222,000. Deferred tax: warranty DTA = 100,000 × 25% = 25,000 (Year 2 rate); depreciation DTL = 140,000 × 20% = 28,000 (Year 3 rate). Net deferred tax expense = 28,000 - 25,000 = 3,000. Total income tax expense = 222,000 + 3,000 = 225,000.
Why not B: This equals the current tax payable only (740,000 × 30%). It omits deferred tax effects from the temporary warranty and depreciation differences, so it understates total income tax expense.
Why not C: This results from measuring both deferred taxes at the current 30% rate (100,000 × 30% = 30,000 DTA; 140,000 × 30% = 42,000 DTL, net deferred = 12,000), which is incorrect because deferred taxes must be measured using enacted rates expected to apply when the differences reverse.
Why not D: This arises if the tax-exempt municipal bond interest is left in taxable income (i.e., failing to remove the $20,000 permanent difference), producing a higher current tax payable; tax-exempt interest reduces current taxable income and does not create a deferred tax item.
Question 9
Hint
Compute current taxable income first, then separately measure the year-end temporary differences using the tax rate that applies when they reverse.
Answer B. Year 1 taxable income = $900,000 + $120,000 (warranty not deductible now) - $160,000 (excess tax depreciation) + $80,000 (rent taxed now) = $940,000. Current tax payable = $940,000 × 21% = $197,400. Deferred taxes are measured at the 25% enacted future rate: warranty DTA = $120,000 × 25% = $30,000; rent-advance DTA = $80,000 × 25% = $20,000; depreciation DTL = $160,000 × 25% = $40,000; net DTA = $30,000 + $20,000 - $40,000 = $10,000.
Why not A: Tempting because the magnitude of the net deferred amount is $10,000; it's wrong because the future deductible amounts (warranty and rent) exceed the future taxable amount (excess depreciation), so the net position is an asset, not a liability.
Why not C: Tempting if a candidate measures deferred taxes using the current 21% rate instead of the enacted 25% rate expected to apply when the temporary differences reverse; using 21% would produce $8,400 net, but the correct measurement rate is 25%.
Why not D: Tempting if a candidate applies the 21% rate to pretax book income ($900,000 × 21% = $189,000) and forgets that current tax payable is based on taxable income after the temporary-difference adjustments, which raises taxable income to $940,000.
Common questions
How do you calculate current and deferred income tax under ASC 740?
Adjust pretax book income for permanent and temporary differences, then multiply taxable income by the current-year enacted rate. Separately measure deferred balances at enacted reversal-year rates and calculate their net change.
Does an installment sale create a deferred tax asset or liability?
Profit recognized for book purposes now but taxable later creates a deferred tax liability. Subtract that profit when computing current taxable income.
Why doesn't total tax expense equal pretax book income times the current tax rate?
Different enacted reversal rates can change total expense even without permanent differences. Here, the extra 5% on $100,000 adds $5,000.
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