Taxes – Practice Problems
Problem #1
Permanent book/tax differences is/are:
a. differences in book/tax income that will be reversed in following years.
b. used to determine book income but never used to determine taxable income.
c. depreciation expenses, warranty expenses, and unrealized gains on corporate stock held for
investment.
d. income/loss that is recorded for book purposes which is not recorded for tax purposes until the
next year.
Problem #2
Company X reports pre-tax financial income of $45,000 which includes interest revenues of $500 from a
municipal bond. What is the amount of financial income subject to tax?
Problem #3
In 20X1, Gus Electric Company generated service revenues totaling $40,000, all taxable in 20X1. Gus Electric
offers a warranty on its services. No warranty claims were made in 20X1, but Gus Electric estimates that in
20X2 warranty costs of $6,000 will be incurred for warranty claims relating to 20X1 service revenues. Assume
an income tax rate of 21%.
What is the amount of the Deferred Tax Asset (DTA) or Deferred Tax Liability (DTL) recorded in 20X1?
Problem #4
On January 1, 20X1, a company purchased a piece of equipment for $117,000. The equipment has a 6-year
useful life and $0 residual value. The company uses straight-line depreciation for financial accounting
purposes. Assume that the depreciation deduction for income tax purposes is $23,000 for 20X1. Income before
taxes is $32,000. The income tax rate is 21%.
What is the amount of the Deferred Tax Asset (DTA) or Deferred Tax Liability (DTL) recorded in 20X1?
Problem #5
Techsmart reported the following information:
Pre-tax Income 100,000
Life Insurance Premium Paid (CEO’s policy) 1,000
Municipal bond interest revenue 8,000
Restructuring charge (no cash has yet been paid) 15,000
Tax rate 21%
Compute the following: (1) financial income subject to tax, (2) taxable income, (3) Total income tax expense, (4)
current income tax expense, (5) deferred income tax expense, (6) net income, and (7) effective tax rate.
What will be reported on Techsmart’s balance sheet?
Problem #6
Nope Industries reported the following information:
Pre-tax Income 16,000
Non-deductible political contribution 2,000
Bad Debt Expense 12,000
Actual Bad Debt Write-offs 10,000
Tax rate 21%
Compute the following: (1) financial income subject to tax, (2) taxable income, (3) Total income tax expense, (4)
current income tax expense, (5) deferred income tax expense, (6) net income, and (7) effective tax rate.
What will be reported on Nope’s balance sheet?
Problem #7
Yep Industries reported the following information:
Pre-tax Income 65,000
Fines paid to the SEC 15,000
Municipal bond interest revenue 2,000
Tax depreciation 30,000
Book depreciation 12,000
Tax rate 21%
Compute the following: (1) financial income subject to tax, (2) taxable income, (3) Total income tax expense, (4)
current income tax expense, (5) deferred income tax expense, (6) net income, and (7) effective tax rate.
What will be reported on Yep’s balance sheet?
Problem #8
Listed below are items that are commonly accounted for differently for financial reporting purposes
than they are for tax purposes.
Instructions
For each item below, indicate whether it involves:
(1) A temporary difference that will result in future deductible amounts and, therefore, will usually
give rise to a deferred income tax asset.
(2) A temporary difference that will result in future taxable amounts and, therefore, will usually give
rise to a deferred income tax liability.
(3) A permanent difference.
Use the appropriate number to indicate your answer for each.
(a) ______ For some assets, straight-line depreciation is used for tax purposes while double-declining
balance method is used for financial reporting purposes.
(b) ______ Warranty expenses are accrued when the sale is made, but cannot be deducted until the
work is actually performed.
(c) ______ Accelerated depreciation for tax purposes, and the straight-line depreciation method is
used for financial reporting purposes for some equipment.
(d) ______ A landlord collects some rents in advance. Rents received are taxable in the period when
they are received.
(e) ______ Tax-exempt income.
(f) ______ An SEC fine related to financial reporting irregularities.
(g) ______ For financial reporting purposes, an estimated loss from a lawsuit is accrued. The tax
return will not report a deduction until an amount is paid.
ANSWERS
Problem #1
Permanent book/tax differences is/are:
a. differences in book/tax income that will be reversed in following years.
b. used to determine book income but never used to determine taxable income.
c. depreciation expenses, warranty expenses, and unrealized gains on corporate stock held for
investment.
d. income/loss that is recorded for book purposes which is not recorded for tax purposes until the next
year.
Problem #2
Company X reports pre-tax financial income of $45,000 which includes interest revenues of $500 from a
municipal bond. What is the amount of financial income subject to tax?
45,000 - $500 = $44,500; Interest from a municipal bond is a permanent difference.
Problem #3
In 20X1, Gus Electric Company generated service revenues totaling $40,000, all taxable in 20X1. Gus Electric
offers a warranty on its services. No warranty claims were made in 20X1, but Gus Electric estimates that in
20X2 warranty costs of $6,000 will be incurred for warranty claims relating to 20X1 service revenues. Assume
an income tax rate of 21%.
What is the amount of the Deferred Tax Asset (DTA) or Deferred Tax Liability (DTL) recorded in 20X1?
$6,000 * 0.21 = $1,260 DTA; It is a deferred tax asset because it is a future benefit that the company will be able
to use to lower its current tax liability.
Problem #4
On January 1, 20X1, a company purchased a piece of equipment for $117,000. The equipment has a 6-year
useful life and $0 residual value. The company uses straight-line depreciation for financial accounting
purposes. Assume that the depreciation deduction for income tax purposes is $23,000 for 20X1. Income before
taxes is $32,000. The income tax rate is 21%.
What is the amount of the Deferred Tax Asset (DTA) or Deferred Tax Liability (DTL) recorded in 20X1?
Tax depreciation = 23,000
Book Depreciation = 117,000 / 6 = 19,500
Temporary book/tax difference = 23,000 - 19,500 = 3,500
3,500 x 21% = 735 (shows up on the balance sheet as DT liability)
Problem #5
Techsmart reported the following information:
Pre-tax Income 100,000
Life Insurance Premium Paid (CEO’s policy) 1,000
Municipal bond interest revenue 8,000
Restructuring charge (no cash has yet been paid) 15,000
Tax rate 21%
Compute the following: (1) financial income subject to tax, (2) taxable income, (3) Total income tax
expense, (4) current income tax expense, (5) deferred income tax expense, (6) net income, and (7)
effective tax rate.
What will be reported on Techsmart’s balance sheet?
Pre-Tax Income 100,000
L.I.P.P 1,000
(Municipal bond revenue) (8,000)
Financial Income subject to tax 93,000 x 21% = 19,530 (total tax exp.)
Restructuring charge (no cash) 15,000 x 21% = (3,150) (deferred tax exp.)
Taxable Income 108,000 x 21% = 22,680 (current tax exp.)
Net income = 100,000 – 19,530 = 80,470
Effective tax rate = 19,530 / 100,000 = 19.5%
What will be reported on Techsmart’s balance sheet?
Taxes payable 22,680
Deferred Tax Asset 3,150
Problem #6
Nope Industries reported the following information:
Pre-tax Income 16,000
Non-deductible political contribution 2,000
Bad Debt Expense 12,000
Actual Bad Debt Write-offs 10,000
Tax rate 21%
Compute the following: (1) financial income subject to tax, (2) taxable income, (3) Total income tax expense,
(4) current income tax expense, (5) deferred income tax expense, (6) net income, and (7) effective tax
rate.
What will be reported on Nope’s balance sheet?
Pre-Tax Income 16,000
Political contribution 2,000
Financial Income subject to tax 18,000 x 21% = 3,780 (total tax exp.)
Bad debt difference (12K-10K) 2,000 x 21% = (420) (deferred tax exp.)
Taxable Income 20,000 x 21% = 4,200 (current tax exp.)
Net income = 16,000 – 3,780 = 12,220
Effective tax rate = 3,780 / 16,000 = 23.6%
What will be reported on Nope’s balance sheet?
Taxes payable 4,200
Deferred Tax Asset 420
Problem #7
Yep Industries reported the following information:
Pre-tax Income 65,000
Fines paid to the SEC 15,000
Municipal bond interest revenue 2,000
Tax depreciation 30,000
Book depreciation 12,000
Tax rate 21%
Compute the following: (1) financial income subject to tax, (2) taxable income, (3) Total income tax expense, ( 4)
current income tax expense, (5) deferred income tax expense, (6) net income, and (7) effective tax rate.
What will be reported on Yep’s balance sheet?
Pre-Tax Income 65,000
Fines paid 15,000
Muni Bonds (2,000)
Financial Income subject to tax 78,000 x 21% = 16,380 (total tax exp.)
Depreciation (18,000) x 21% = 3,780 (deferred tax exp.)
Taxable Income 60,000 x 21% = 12,600 (current tax exp.)
Net income = 65,000 – 16,380 = 48,620
Effective tax rate = 16,380 / 65,000 = 25.2%
What will be reported on Yep’s balance sheet?
Taxes payable 12,600
Deferred Tax Liability 3,780
Problem #8
a. 1 b. 1
c. 2
d. 1
e. 3
f. 3
g. 1
