FAR · Select transactions · 8 practice questions
ASC 740 Tax Provision Practice Problems With Solutions
Compute current tax using this year's taxable income and rate, then add deferred tax expense or subtract deferred tax benefit. Below: a worked installment-sale provision and free practice problems with solutions.
Try one first
Hint
Compute current taxable income separately from pretax book income, and do not use the same tax rate automatically for both current and deferred amounts.
Answer B. Current taxable income = $500,000 - $20,000 (tax-exempt muni interest) + $60,000 (warranty not deductible until Year 2) - $80,000 (excess tax depreciation) = $460,000. Current tax payable = $460,000 × 25% = $115,000. Deferred taxes are measured at the enacted Year 2 rate (30%): DTA = $60,000 × 30% = $18,000; DTL = $80,000 × 30% = $24,000; net increase in deferred tax liability = $24,000 - $18,000 = $6,000 (deferred tax expense).
Why not A: This reflects correctly computed current tax but an incorrect deferred tax measurement using the Year 1 rate (25%) on the net temporary difference (20,000 × 25% = $5,000). Deferred taxes should be measured at the enacted rate expected to apply when the differences reverse (30%).
Why not C: This treats the municipal bond interest as the only adjustment (taxable income = $500,000 - $20,000 = $480,000) and ignores the warranty and depreciation timing differences that affect current taxable income and create deferred tax balances.
Why not D: This recognizes the $24,000 deferred tax liability from excess tax depreciation but ignores the $18,000 deferred tax asset from the deductible warranty difference; the net deferred tax expense is the increase in net DTL, which is $6,000.
Worked example
Vale Co. has Year 1 pretax book income of $360,000, including $60,000 of installment-sale profit taxable entirely in Year 2. The enacted rates are 25% for Year 1 and 30% for Year 2. Beginning deferred balances are zero. All items relate to continuing operations in one tax jurisdiction. There are no other book-tax differences.
| 1 | Year 1 taxable income$360,000 - $60,000 | $300,000 |
| 2 | Current income tax payable$300,000 × 25% | $75,000 |
| 3 | Ending deferred tax liability$60,000 × 30% | $18,000 |
| 4 | Deferred income tax expense$18,000 ending liability - $0 beginning liability | $18,000 |
| 5 | Total income tax expense$75,000 current + $18,000 deferred | $93,000 |
Vale reports $75,000 of current income tax payable, $18,000 of deferred tax expense, and $93,000 of total income tax expense.
Check: Shortcut: $360,000 × 25% + $60,000 × (30% - 25%) = $93,000.
Key points
- Warranty accruals deductible later and advance payments taxed before book revenue create deferred tax assets.
- Tax-exempt municipal interest and nondeductible fines affect taxable income but create no deferred taxes.
- Year-end cumulative temporary differences determine ending deferred balances, not the period's deferred expense.
How the exam traps you
- Treating installment profit recognized for books before tax as a deferred tax asset. Future taxable profit creates a deferred tax liability. Subtract only the profit not yet taxable when computing current taxable income.
- Measuring every deferred amount at the current-year tax rate. Apply the enacted rate for each scheduled reversal year.
- Reporting current tax payable as total income tax expense. Add deferred tax expense or subtract deferred tax benefit.
Question 2
| # | Item |
|---|---|
| 1 | Tax-exempt interest income of $40,000 (permanent difference) |
| 2 | Installment-sale gain of $300,000 recognized for book in Year 1; for tax, $120,000 will be taxed in Year 2 and $180,000 in Year 3 |
| 3 | Warranty expense of $160,000 recognized for book in Year 1; for tax, $100,000 will be deductible in Year 2 and $60,000 in Year 3 |
| 4 | Tax depreciation exceeded book depreciation by $80,000 in Year 1, and that difference will reverse in Year 3 |
Hint
Separate current tax payable from deferred tax expense. For each temporary difference, identify the year(s) it reverses and apply the enacted rate at the balance-sheet date expected to apply in those years.
Answer B. Compute current tax payable first: taxable income = 900,000 - 40,000 - 300,000 + 160,000 - 80,000 = 640,000, so current tax = 640,000 × 20% = 128,000. Measure deferred taxes at the enacted rates expected to apply when each temporary difference reverses: installment-sale DTL = 120,000×20% + 180,000×30% = 78,000; warranty DTA = 100,000×20% + 60,000×30% = 38,000; depreciation DTL = 80,000×30% = 24,000. Deferred tax expense equals the change in net deferred tax liability (DTL − DTA) recognized in income, so deferred tax expense = (78,000 + 24,000) − 38,000 = 64,000. Total income tax expense = 128,000 + 64,000 = 192,000.
Why not A: Tempting because it equals current tax payable only: taxable income = 640,000 and current tax = 640,000 × 20% = 128,000. It is wrong because it omits deferred tax effects from the temporary differences that will reverse in Years 2 and 3.
Why not C: Results from netting the temporary differences in dollars and applying the Year 1 rate to that net: net temporaries = 300 + 80 − 160 = 220; 220 × 20% = 44; 128 (current tax) + 44 = 172. This is incorrect because ASC 740 requires measuring each deferred tax using the enacted rate expected to apply when that specific difference reverses (20% for Year 2 reversals, 30% for Year 3 reversals), not a single rate applied to the net dollar amount.
Why not D: Could arise from treating the tax-exempt interest as taxable: taxable income would be 640,000 + 40,000 = 680,000, current tax = 680,000 × 20% = 136,000; adding the correct deferred tax expense 64,000 gives 200,000. This is wrong because tax-exempt interest is a permanent difference (it reduces current taxable income and creates no deferred tax).
Question 3
Hint
Compute the NOL from book loss after permanent and temporary differences, measure deferred taxes at the enacted future rate, and only then assess how much of the remaining deferred tax asset needs a valuation allowance.
Answer A. Taxable loss = -500,000 +140,000 -180,000 +20,000 = -520,000, so the NOL DTA = 520,000 × 20% = 104,000. Warranty DTA = 140,000 × 20% = 28,000. Taxable temporary difference DTL = 180,000 × 20% = 36,000. Net DTA before valuation = 104,000 + 28,000 - 36,000 = 96,000. Management concludes only 50% of the remaining deductible amounts are realizable after considering reversing DTL, so valuation allowance = 96,000 × 50% = 48,000, leaving net DTA = 48,000.
Why not B: This result comes from applying the 50% realizability rate to gross deferred tax assets before using the taxable temporary difference as positive evidence (gross DTA = 104,000 + 28,000 = 132,000; 50% = 66,000; less DTL 36,000 = 30,000). That misorders the analysis, reversing taxable temporary differences should be considered when assessing realizability.
Why not C: This is reached if deferred taxes are incorrectly measured at the 25% 20X5 rate instead of the enacted 20% rate expected to apply when reversals and NOL utilization occur (520,000 × 25% + 140,000 × 25% − 180,000 × 25% = 120,000; 50% realizable → 60,000). ASC 740 requires using enacted rates expected to apply when temporary differences reverse.
Why not D: This is the net deferred tax asset before applying the valuation allowance (104,000 + 28,000 − 36,000 = 96,000). The fact pattern explicitly states that only 50% of the remaining deductible amounts are more likely than not to be realized, requiring a valuation allowance that reduces the net DTA.
Question 4
Hint
Separate the permanent difference from the temporary differences, compute current taxable income first, and then determine whether the net temporary effect creates deferred tax expense or deferred tax benefit.
Answer C. Compute current taxable income: start with pretax book income of $800,000, add the $90,000 warranty expense (not deductible until paid), subtract the $20,000 tax-exempt interest, and subtract the $50,000 excess tax depreciation; taxable income = $820,000. Current income taxes payable = $820,000 × 25% = $205,000. Deferred taxes: DTA = $90,000 × 25% = $22,500 and DTL = $50,000 × 25% = $12,500, giving a net deferred tax benefit of $10,000, so total income tax expense = $205,000 − $10,000 = $195,000.
Why not A: This gets current taxes right but overlooks the net deferred tax benefit from the warranty accrual (DTA) offset partially by the excess tax depreciation (DTL); total expense should be lower than current payable here.
Why not B: Tempting if a candidate ignores the $90,000 warranty temporary difference when computing current taxable income (only removing the $20,000 tax-exempt interest to get $780,000 → $195,000) and then misapplies the deferred amount as additional expense rather than a benefit.
Why not D: Results from focusing only on the permanent difference (tax-exempt interest) and ignoring both temporary differences; both the warranty and depreciation timing differences affect current taxes and deferred taxes.
Question 5
Hint
Compute current taxable income first, then measure deferred taxes using the enacted rate for the year in which the stated temporary differences reverse.
Answer D. Taxable income is $480,000 (start with pretax financial income of $500,000, subtract the $60,000 excess tax depreciation, and add the $40,000 warranty expense that is not yet deductible). Current income taxes payable = $480,000 × 25% = $120,000. Deferred taxes are measured at the rate expected when the differences reverse (30% in Year 2): DTL = $60,000 × 30% = $18,000 and DTA = $40,000 × 30% = $12,000, so net deferred tax expense = $6,000 and total income tax expense = $126,000.
Why not A: This option uses the correct reversal-year rate for deferred taxes but miscomputes current taxable income (excess tax depreciation reduces current taxable income, so current taxes payable should be $120,000, not $130,000).
Why not B: Tempting because 25% of pretax financial income (500,000) is 125,000, but this ignores the temporary differences from depreciation and warranty expense that require deferred tax accounting under ASC 740.
Why not C: This choice computes current taxes correctly but measures the deferred taxes using the current-year 25% rate instead of the enacted 30% rate that will apply when the temporary differences reverse in Year 2.
Question 6
Hint
Separate permanent differences from temporary differences first, then compare the net deferred tax effect with current tax payable.
Answer D. Taxable income = $500,000 - $20,000 (tax-exempt interest) + $8,000 (nondeductible fines) + $30,000 (warranty expense not yet deductible) - $40,000 (installment-sale profit taxable later) = $478,000. Current tax payable = 25% × $478,000 = $119,500. Deferred tax asset = 25% × $30,000 = $7,500 and deferred tax liability = 25% × $40,000 = $10,000, so net deferred tax liability = $2,500 and total income tax expense = $119,500 + $2,500 = $122,000, which exceeds current tax payable.
Why not A: Tempting if a candidate remembers that permanent differences (like municipal interest) don't create deferred taxes and stops there. However, the warranty expense and installment-sale profit are temporary differences that create deferred tax balances, so current tax payable will not equal total tax expense.
Why not B: This attracts candidates who focus on the future deductible warranty expense and conclude the deferred position is an asset. It is incorrect because the $40,000 installment-sale difference gives rise to a larger deferred tax liability than the warranty-related deferred tax asset.
Why not C: This gets the relationship between current payable and total expense correct (total expense is larger) but misclassifies the net deferred position. The net effect of the temporary differences is a deferred tax liability, not an asset.
Question 7
Hint
Separate the problem into two pieces: current tax based on current-year taxable income, and deferred tax based on temporary differences measured at the enacted reversal rate.
Answer C. Compute current taxable income: $700,000 − $30,000 (tax-exempt municipal interest) + $40,000 (warranty not deductible yet) − $60,000 (excess tax depreciation) = $650,000. Current tax payable = $650,000 × 20% = $130,000. Deferred tax is measured at the enacted future rate (25%): DTL = $60,000 × 25% = $15,000 and DTA = $40,000 × 25% = $10,000, so net deferred tax expense = $5,000; total income tax expense = $130,000 + $5,000 = $135,000.
Why not A: This equals current tax payable only (650,000 × 20%). It ignores the deferred tax effects of the temporary differences (the DTL from accelerated tax depreciation and the DTA from the warranty), so it understates total income tax expense.
Why not B: This results if the student mixes measurement rates (for example, measuring the warranty DTA at the 20% current rate but the depreciation DTL at 25%), producing a larger net deferred tax than is correct. Both temporary differences should be measured at the enacted rate expected when they reverse (25%).
Why not D: This comes from computing current tax on pretax financial income adjusted only for the permanent difference (700,000 − 30,000 = 670,000 → 670,000 × 20% = 134,000) and then adding the net deferred tax of $5,000. The correct current taxable income must also reflect the temporary differences (warranty and excess tax depreciation), so current tax is $130,000, not $134,000.
Question 8
Hint
Separate permanent differences from temporary differences first, then compute current tax and deferred tax using the rate that applies to each.
Answer A. Current taxable income = $500,000 - $20,000 (municipal interest non-taxable) + $60,000 (warranty not deductible until paid) - $100,000 (excess tax depreciation) = $440,000. Current tax payable = $440,000 × 25% = $110,000. Deferred tax expense is $12,000 (DTL from depreciation $100,000 × 30% = $30,000 less DTA from warranty $60,000 × 30% = $18,000), so total income tax expense = $110,000 + $12,000 = $122,000.
Why not B: This results from correctly identifying the temporary differences but measuring deferred taxes at the Year 1 rate (25%) instead of the 30% rate enacted for the years when those differences reverse.
Why not C: This equals current tax payable only and omits the deferred tax effects from the temporary differences (the depreciation DTL and the warranty DTA), so it understates total income tax expense.
Why not D: This arises if municipal bond interest is incorrectly treated as taxable (increasing current tax) while deferred taxes are computed correctly; municipal bond interest is a permanent, non-taxable item and should be excluded from current taxable income.
Common questions
How do you calculate deferred tax expense with beginning balances?
For balances allocated to income, deferred tax expense equals ending net deferred tax liability minus beginning net deferred tax liability. Treat a net deferred tax asset as a negative liability; a negative result is a benefit.
What if an installment-sale gain is partly taxable this year?
Subtract only the portion taxable in future years from pretax book income. That remaining untaxed profit creates the deferred tax liability, measured at its enacted reversal-year rates.
Can deferred tax assets and liabilities be netted under ASC 740?
Yes, for the same tax-paying component and tax jurisdiction. Balance-sheet netting does not override intraperiod allocation: tax effects follow the related item in continuing operations, discontinued operations, or OCI.
Watch it solved
A full CPA FAR task-based simulation on Accounting for income taxes, worked step by step.
FAR Simulation: ASC 740 Rate, Valuation Allowance and Provision on YouTube
Practice FAR like the real exam
The free ChatCPA simulator: real exam layout, timed testlets, starting with a question on this topic. No account needed to start.
Open the free simulator →More on Accounting for income taxes
- Warranty Accrual Deferred Tax Asset: ASC 740 Calculation
- Excess Tax Depreciation: Deferred Tax Liability Calculation
- Current vs Deferred Tax: Compute Income Tax Expense
- Which Tax Rate Applies to Deferred Taxes Under ASC 740?
- ASC 740: Valuation Allowance vs. Uncertain Tax Positions
- Deferred Tax Presentation and Outside-Basis Exceptions
Questions from the ChatCPA bank of 17,658 CPA exam questions, each with a written reason for every wrong answer. ChatCPA is built by Nicholas Miller, CPA (Oregon #14907). How these pages are made. Spot an error? Tell us.