ExpertHard1 markMultiple Choice
CPA · Question 12 · Area III: Select Transactions
On July 1, Year 1, Alpha Co. pays $12,000 for a 2-year insurance policy. Alpha uses the cash basis for tax purposes and accrual basis for financial reporting. Tax rate is 25%. <br/><br/>What is the Deferred Tax Asset or Liability reported on the December 31, Year 1 Balance Sheet regarding this transaction?
On July 1, Year 1, Alpha Co. pays $12,000 for a 2-year insurance policy. Alpha uses the cash basis for tax purposes and accrual basis for financial reporting. Tax rate is 25%. <br/><br/>What is the Deferred Tax Asset or Liability reported on the December 31, Year 1 Balance Sheet regarding this transaction?
Answer options:
A.
Deferred Tax Asset of $2,250
B.
Deferred Tax Liability of $2,250
C.
Deferred Tax Liability of $3,000
D.
Deferred Tax Asset of $750
How to approach this question
1. Determine Book Basis of the asset/liability. 2. Determine Tax Basis. 3. Calculate Temporary Difference. 4. Determine if Taxable (DTL) or Deductible (DTA).
Full Answer
B.Deferred Tax Liability of $2,250✓ Correct
B
1. **Book Basis (Dec 31):** <br/> Paid $12,000 for 24 months. 6 months used. <br/> Remaining: $12,000 * (18/24) = $9,000.<br/>2. **Tax Basis:** <br/> Cash basis deducts when paid. Basis = $0.<br/>3. **Difference:** $9,000.<br/>4. **Analysis:** <br/> We have an asset ($9k) on books that is $0 for tax. In the future, when we expense this $9k on books, we cannot deduct it for tax (already deducted). Thus, future taxable income > book income. <br/> This is a **Taxable Temporary Difference** -> **Deferred Tax Liability**.<br/>5. **Calculation:** $9,000 * 25% = $2,250.
Common mistakes
Confusing DTA and DTL; calculating based on the expense ($3k) rather than the balance sheet amount ($9k).
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