Excess Tax Depreciation: Deferred Tax Liability Calculation

Answer C. At December 31, Year 1, the equipment's book carrying amount is $80,000 ($100,000 cost less $20,000 book depreciation), while its tax basis is $40,000 ($100,000 cost less $60,000 tax depreciation). The $40,000 difference is a taxable temporary difference because Pine received larger tax deductions now and will have relatively higher taxable income later as the asset is recovered. Applying the 25% enacted tax rate gives a deferred tax liability of $10,000.

Why not A: This reverses the classification. Faster tax depreciation reduces taxable income now and creates future taxable amounts (not future deductible amounts), which produces a deferred tax liability rather than an asset.

Why not B: This result comes from erroneously applying the tax rate to the $60,000 Year 1 tax depreciation instead of to the temporary difference. Deferred tax is measured on the book-tax basis difference at year-end (which is $40,000), so the liability is $40,000 × 25% = $10,000, not $15,000.

Why not D: Although total depreciation equals cost over the asset's life, deferred tax accounting focuses on timing differences. The fact that deductions occur earlier for tax purposes creates a temporary difference at year-end that gives rise to deferred tax.

Answer B. Taxable income is $440,000 ($500,000 pretax financial income less the $60,000 excess tax depreciation), so current income tax payable is $132,000 at 30%. The $60,000 excess tax depreciation is a taxable temporary difference, producing a deferred tax liability of $15,000 measured at the enacted future rate of 25%. Total income tax expense is $147,000 ($132,000 current + $15,000 deferred).

Why not A: This equals current income taxes payable based on taxable income only. It is wrong because total income tax expense includes both the current tax and the deferred tax effect from the temporary difference.

Why not C: This equals pretax financial income multiplied by the current 30% rate (500,000 × 30%). It is wrong because deferred taxes must be measured using the enacted rate expected to apply when the temporary difference reverses (25%), not the current-year rate.

Why not D: This would result from subtracting the deferred amount instead of adding it (132,000 − 15,000). Excess tax depreciation creates a taxable temporary difference and a deferred tax liability, which increases total tax expense, not decreases it.

Answer C. Tax depreciation ($32,000) exceeds book depreciation ($20,000) by $12,000 in Year 1, so taxable income is lower now and will be higher in future years when the difference reverses. That future increase in taxable income creates a deferred tax liability. Measure the liability as the temporary difference multiplied by the enacted tax rate: $12,000 × 25% = $3,000.

Why not A: Deferred taxes arise from temporary differences between book and tax bases, regardless of whether the related expense is cash or noncash. Different depreciation methods commonly create temporary differences that require deferred tax accounting.

Why not B: This is tempting because the company pays less tax now, which feels like a benefit. However accelerated tax depreciation causes taxable income to be higher in future periods when the temporary difference reverses, producing a liability (deferred tax liability), not an asset.

Why not D: This confuses the temporary difference with the tax effect. The $12,000 is the temporary difference (32,000 − 20,000); ASC 740 measures deferred taxes by applying the enacted tax rate, so the deferred tax liability is $12,000 × 25% = $3,000.

Answer C. Taxable income = Pretax financial income − (Tax depreciation − Book depreciation) = $400,000 − ($100,000 − $60,000) = $360,000. Current income tax payable = $360,000 × 25% = $90,000. Because tax depreciation is higher now (reducing current taxable income), the company will pay more tax in future years when the timing difference reverses, so a deferred tax liability of $40,000 × 25% = $10,000 is recognized.

Why not A: Although the current payable is correct, the deferred tax direction is wrong: higher tax depreciation now causes a future taxable amount, which creates a deferred tax liability, not an asset.

Why not B: This applies the 25% rate to pretax financial income instead of taxable income; taxable income is lower ($360,000) because tax depreciation exceeds book depreciation, and the timing difference creates a deferred tax effect rather than disappearing.

Why not D: This combines two errors, using pretax book income for current tax (giving $100,000) and misclassifying the deferred tax (it should be a liability because taxes are lower now and higher later).

Answer D. Tax depreciation exceeds book depreciation by $120,000 ($320,000 − $200,000), so taxable income is $780,000 ($900,000 − $120,000). The temporary difference creates a deferred tax liability of $30,000 ($120,000 × 25%). Total income tax expense is based on pretax financial income: $900,000 × 25% = $225,000 (current tax payable $195,000 plus deferred tax expense $30,000).

Why not A: This overstates the base used to measure deferred taxes. Deferred tax is measured on the temporary difference ($120,000), not on the full book depreciation amount. Using an incorrect base (for example $200,000) would produce the $50,000 figure and overstate both the deferred tax liability and total expense.

Why not B: This mistakes the direction of the timing difference. Accelerated tax depreciation reduces taxable income now and increases it later, which gives rise to a deferred tax liability (future taxable amounts), not a deferred tax asset. The $195,000 figure is the current tax payable (taxable income $780,000 × 25%), not total income tax expense.

Why not C: Temporary differences are the exact cause for deferred tax assets or liabilities under ASC 740. Although the difference is temporary, the company must record the future tax effect (a deferred tax liability of $30,000); recording only the current tax payable ($195,000) understates total income tax expense.