FAR · Select transactions · 6 practice questions
Deferred Tax Presentation and Outside-Basis Exceptions
Recognize deferred taxes unless an exception applies, then net only within the same tax-paying component and jurisdiction; all deferred tax balances are noncurrent. Sort Falcon's independent year-end cases by recognition and presentation.
Try one first
Hint
First determine which DTA and DTL can be offset within each taxing jurisdiction; then apply current U.S. GAAP balance-sheet presentation rules for deferred taxes.
Answer D. ASC 740 requires deferred tax assets and liabilities to be presented as noncurrent and to be offset only within the same tax-paying component and jurisdiction. Federal: DTA = $80 + $50 = $130; DTL = $100 + $20 = $120 → net federal = DTA $10. State A: DTA = $30; DTL = $70 → net State A = DTL $40. Present a noncurrent DTA of $10 and a noncurrent DTL of $40; do not offset federal and State A amounts against each other.
Why not A: This is tempting because summing all jurisdictions gives total DTL $190 and total DTA $160, and $190 − $160 = $30. However, ASC 740 permits offsetting only within the same tax jurisdiction; you cannot net federal and State A deferred tax positions into a single balance, so the $30 single liability presentation is incorrect.
Why not B: This distractor appeals to the older practice of classifying deferred taxes by expected reversal (e.g., federal warranty DTA $80 + State A DTA $30 = current DTA $110; federal NOL DTA $50 = noncurrent). But under current U.S. GAAP deferred tax assets and liabilities are presented as noncurrent regardless of reversal timing, and the option also fails to net within jurisdictions, so the classification and presentation are incorrect.
Why not C: This option correctly keeps amounts noncurrent but is tempting to candidates who avoid any netting. The arithmetic (total DTA = $130 + $30 = $160; total DTL = $120 + $70 = $190) is correct as gross sums, but ASC 740 requires that DTA and DTL be netted when they relate to the same tax-paying component and jurisdiction; therefore gross-only presentation is incorrect here.
Sort it
A deductible temporary difference creates an asset, or permitted offsetting leaves a net asset.
A taxable temporary difference is not covered by an exception, or permitted offsetting leaves a net liability.
The difference is permanent, or a qualifying outside-basis recognition exception covers it.
A deferred tax asset and liability belong to different tax jurisdictions or different tax-paying components.
| Item | Goes to |
|---|---|
| Falcon accrues warranty expense for books this year. The costs will be deductible when claims are paid next year. | Noncurrent deferred tax assetThe future deduction creates a DTA now. Payment next year does not make the DTA current. |
| Falcon has measured federal DTAs of $130 and DTLs of $120, all within the same tax-paying component. | Noncurrent deferred tax assetOffsetting is required within this component and jurisdiction: $130 minus $120 leaves a $10 noncurrent DTA. |
| Falcon's foreign subsidiary earnings create an outside-basis taxable temporary difference. Falcon supports indefinite reinvestment of the entire difference. | No deferred taxThe supported indefinite-reinvestment exception covers the entire difference, so no outside-basis DTL is recognized. |
| Falcon has a net federal DTA of $10 and a net State A DTL of $40 within one tax-paying component. | Separate noncurrent balancesDifferent jurisdictions prevent further offsetting. Present a $10 noncurrent DTA and a $40 noncurrent DTL, not one $30 liability. |
| Falcon recognizes installment-sale gross profit for books this year. Taxable income will include that profit as cash is collected later. | Noncurrent deferred tax liabilityBook income precedes taxable income. Future taxable amounts create a DTL. |
| Falcon includes qualifying municipal bond interest in book income. The interest is permanently exempt from federal income tax. | No deferred taxThe federal difference never reverses and creates no future taxable or deductible amount. |
| Falcon expects to recover its domestic subsidiary investment through a qualifying tax-free liquidation approved by management. | No deferred taxExpected recovery through the qualifying tax-free liquidation permits the outside-basis DTL recognition exception. |
| Falcon receives advance rent that is taxable this year but remains unearned for books until next year. | Noncurrent deferred tax assetThe rent is taxed before book recognition. Future book revenue without corresponding taxable revenue creates a DTA. |
| Within Falcon's reporting group, a $30 DTA and a $70 DTL belong to separate tax-paying components in the same jurisdiction. | Separate noncurrent balancesA shared jurisdiction is not enough. Separate tax-paying components cannot offset these balances into one $40 liability. |
| Falcon's equipment tax basis is below its book carrying amount because tax depreciation exceeded book depreciation. The difference will reverse later. | Noncurrent deferred tax liabilityThe taxable temporary difference creates a DTL. Its reversal schedule does not change noncurrent classification. |
| Falcon has measured State A DTAs of $30 and DTLs of $70, all within the same tax-paying component. | Noncurrent deferred tax liabilityOffset within the component and jurisdiction: $70 minus $30 leaves a $40 noncurrent DTL. |
| Falcon's foreign subsidiary has an $18 million outside-basis difference from undistributed earnings. At year-end, $14 million qualifies for indefinite reinvestment and $4 million is planned for remittance. The only incremental tax is 5% withholding. | Noncurrent deferred tax liabilityOnly the planned $4 million reversal requires recognition: $4 million × 5% = $200,000 noncurrent DTL. |
Key points
- Remember: decide whether deferred tax exists before deciding which balances may be netted.
- A permanent difference never reverses; a recognition exception can exclude an otherwise taxable temporary difference.
- A remittance decision made by year-end matters even if formal board approval comes later.
How the exam traps you
- Netting federal assets against state liabilities or across separate tax-paying components. Keep those positions separate; both the component and jurisdiction must match.
- Calling a deferred tax asset current because the deduction occurs next year. Classify all deferred tax balances as noncurrent, regardless of reversal timing.
- Exempting all foreign earnings after management plans a partial remittance. Recognize the tax effect of the planned taxable reversal; exclude only the portion supported as indefinitely reinvested.
Question 2
Hint
Ask whether the book-tax difference will reverse in a future period. If it never reverses, deferred taxes usually are not recorded.
Answer A. Interest on qualifying municipal bonds is a permanent difference: it is included in pretax book income but permanently excluded from taxable income and does not reverse in future periods. Because there is no future taxable or deductible amount associated with the item, no deferred tax asset or deferred tax liability is recorded under ASC 740.
Why not B: This is a temporary difference: the company has recognized the expense for book purposes now but will receive the tax deduction when claims are paid later. That future deductible amount gives rise to a deferred tax asset.
Why not C: Revenue recognized for book purposes before it is taxable creates a temporary difference that will reverse when cash is collected and taxed in later years. The expected higher taxable income in future periods generally produces a deferred tax liability.
Why not D: Accelerated tax depreciation that exceeds book depreciation now reduces current taxable income but reverses over the asset's life as tax depreciation becomes lower than book depreciation. That reversal typically results in a deferred tax liability.
Question 3
Hint
Apply the ASC 740 DTL tests separately to each investment: does a qualifying tax-free recovery apply? Is indefinite reinvestment supported? Is there an approved plan that will reverse a portion in the foreseeable future?
Answer C. Under ASC 740, no DTL is recorded for the Domestic Sub because recovery is expected through a qualifying tax-free liquidation that management has approved. For the Foreign Sub, the approved plan will reverse $1,500,000 in 20X6 and that portion is taxable: $1,500,000 × 25% = $375,000. The remaining $4,500,000 of the foreign outside-basis is supported as indefinitely reinvested and therefore does not give rise to a DTL.
Why not A: This is tempting if one applies the indefinite-reinvestment exception to the entire foreign amount and also ignores the domestic facts. It is incorrect because Parent approved a specific remittance plan that will reverse $1,500,000 in 20X6; that portion is not covered by the indefinite-reinvestment expectation and gives rise to $1,500,000 × 25% = $375,000 of DTL.
Why not B: This equals $4,000,000 × 25% and reflects taxing only the Domestic Sub. It is incorrect because Parent expects to recover the domestic investment tax-free through an approved liquidation, which under ASC 740 means no DTL should be recognized for that outside-basis amount.
Why not D: This sums a domestic DTL ($1,000,000) and the taxable portion of the foreign DTL ($375,000). It is incorrect because it incorrectly treats the domestic recovery as taxable when management has approved a tax-free liquidation; only the $1,500,000 remittance portion of the foreign difference is taxable.
Question 4
Hint
Determine whether each temporary difference creates a future taxable amount or a future deductible amount, tax-effect each one, and then net them.
Answer A. The excess tax depreciation creates a taxable temporary difference of $40,000, which produces a deferred tax liability of $10,000 ($40,000 × 25%). The warranty accrual creates a deductible temporary difference of $25,000, which produces a deferred tax asset of $6,250 ($25,000 × 25%). Because both items are in the same tax-paying component and jurisdiction, they are netted, resulting in a net deferred tax liability of $3,750.
Why not B: This is tempting because it correctly computes the deferred tax asset from the warranty accrual. However, it ignores the larger deferred tax liability created by the excess tax depreciation. The question asks for the net deferred tax liability, not just one component.
Why not C: This choice correctly computes the deferred tax liability from the depreciation difference. It is wrong because it fails to offset that liability with the deferred tax asset from the warranty accrual. Since both temporary differences are in the same jurisdiction and tax-paying component, netting is appropriate.
Why not D: This answer may attract a candidate who adds the two tax-effect amounts instead of netting them. Deferred tax assets and liabilities from the same tax-paying component and jurisdiction are not added together as separate balances for this purpose. The correct approach is to offset $10,000 and $6,250 to reach $3,750 net liability.
Question 5
Hint
Decide which portion of the $18M failed the indefinite-reinvestment assertion as of 12/31/20X5, then apply the 5% withholding rate to that portion; remember recognition is governed by facts at the balance-sheet date, not by later formalities.
Answer A. ASC 740 requires recognizing deferred tax liabilities for taxable outside basis differences unless an indefinite-reinvestment assertion applies as of the balance-sheet date. Apex can support indefinite reinvestment for $14 million, so no DTL is recorded for that portion. Management had decided by 12/31/20X5 to remit $4 million in early 20X6, so the tax effect of that portion should be recognized at 12/31/20X5: $4,000,000 × 5% = $200,000. The January board approval confirmed the prior decision before issuance and does not change the balance-sheet-date recognition.
Why not B: Tempting because it focuses on cash remittance timing, but ASC 740 looks to expected reversals as of the balance-sheet date; because management had decided by 12/31/20X5 to remit $4 million, the related tax effect must be recorded at year-end unless indefinite reinvestment can be supported.
Why not C: This states the right amount but misstates timing, the measurement and recognition are based on facts existing at the balance-sheet date. Management's decision existed at 12/31/20X5, so the deferred tax consequence is recognized in the 12/31/20X5 statements; the January approval simply confirmed the earlier decision.
Why not D: This applies the withholding rate to the entire $18 million and therefore overstates the liability; it ignores that $14 million qualified for indefinite reinvestment at the balance-sheet date, leaving only $4 million subject to the withholding tax measurement.
Question 6
Hint
Ask which difference will never reverse in a future year. Deferred taxes come from temporary differences, not permanent ones.
Answer C. Interest on municipal bonds is tax-exempt and therefore creates a permanent difference between pretax financial income and taxable income. Because the difference will never reverse in a future period, ASC 740 does not recognize a deferred tax asset or liability for it. Thus this item is an exception to deferred tax recognition.
Why not A: This is a timing (temporary) difference: accelerated tax depreciation reduces taxable income now compared with book and reverses over the asset's life. That reversal typically gives rise to a deferred tax liability rather than being a permanent exception.
Why not B: Warranty expense is recognized for book now while the tax deduction occurs when claims are paid; the timing difference reverses in future periods, which generally creates a deferred tax asset rather than a permanent difference.
Why not D: Rent taxed in the current year but recognized for book in a later year is a temporary timing difference that reverses when the revenue is recognized for book; it therefore leads to deferred tax accounting (typically a deferred tax asset), not an exception.
Common questions
Can deferred tax assets and liabilities be offset on the balance sheet?
Yes, but only within the same tax-paying component and tax jurisdiction. Present each resulting net balance as noncurrent, even when the underlying differences reverse next year.
Does tax-exempt municipal bond interest create a deferred tax asset?
No. Qualifying tax-exempt municipal bond interest is a permanent difference, so it creates neither a deferred tax asset nor a deferred tax liability.
When is an outside-basis deferred tax liability not recorded?
A qualifying domestic investment expected to be recovered tax-free may need no DTL. For foreign subsidiary earnings, supported indefinite reinvestment excludes that portion, but a planned taxable remittance creates a DTL.
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