XYZ Corporation Expenses On Financial Statements
XYZ Corporation Expensed On The Financial Statements 2000000 For De
XYZ Corporation expensed on the financial statements $2,000,000 for depreciation expense during the year using straight-line depreciation and deducted $3,000,000 of depreciation on the tax return using DDB depreciation. Also, the corporation expensed $1,000,000 of warranty expense on the income statement using an estimate of work to be done on current year's sales (matching) but deducted on the tax return only $600,000 of warrant work since tax law only allows deduction of work done – no estimates. The corporation’s tax rate is 30%. What is the deferred tax asset or liability at the end of the year – show work – see if you can compute how many taxes have been postponed or had to be prepaid because of the financial statement and tax return differences.
Paper For Above instruction
The analysis of deferred tax assets and liabilities arising from temporary differences requires a comprehensive understanding of the differences in accounting and tax treatments. In the case of XYZ Corporation, two primary differences exist: depreciation expense and warranty expense. This paper explores each of these differences, computes the resulting deferred tax asset or liability, and interprets the implications for the company's financial statements.
Depreciation Expense Difference
XYZ employed straight-line depreciation for financial reporting, resulting in a depreciation expense of $2,000,000 for the year. However, for tax purposes, the company used the double-declining balance (DDB) method, which led to a depreciation deduction of $3,000,000. The difference in depreciation expense creates a temporary difference that impacts taxable income and pretax financial income.
To quantify this difference, subtract the financial depreciation from the tax depreciation:
$3,000,000 (tax) - $2,000,000 (financial) = $1,000,000
This indicates that the company has claimed $1,000,000 more in depreciation on its tax return than on its financial statements, which reduces taxable income more than accounting income for the year. As a result, this creates a deferred tax liability, because the tax benefit has been realized earlier than it will be in future periods when the depreciation expense will reverse.
Calculating the deferred tax liability:
Deferred tax liability = Temporary difference × Tax rate
= $1,000,000 × 30% = $300,000
Warranty Expense Difference
The warranty expense recognized on the financial statements was $1,000,000, based on an estimate of work to be done, aligning with the matching principle. Conversely, the tax deduction was only $600,000 because tax law permits deductions only for work that has actually been completed, not estimated future expenses.
The difference here is:
$1,000,000 (financial) - $600,000 (tax) = $400,000
This indicates that the company has accrued $400,000 more in warranty expense for financial reporting than it has been able to deduct for tax purposes, resulting in higher taxable income in the current period. This creates a deferred tax asset, as the company will likely lower future taxable income when the estimated warranty costs are paid and deducted.
Calculating the deferred tax asset:
Deferred tax asset = Temporary difference × Tax rate
= $400,000 × 30% = $120,000
Summary of Deferred Taxes
Combining both differences:
- The depreciation difference results in a deferred tax liability of $300,000.
- The warranty expense difference results in a deferred tax asset of $120,000.
Net deferred tax position = Deferred tax asset - Deferred tax liability
= $120,000 - $300,000 = -$180,000
This net amount indicates a net deferred tax liability of $180,000 at year-end. The company has prepaid more taxes upfront due to accelerated depreciation but recognizes a future benefit owing to warranty expense accruals.
Conclusion
At the end of the year, XYZ Corporation's consolidated deferred tax position reflects a liability of $180,000. This outcome underscores the importance of recognizing temporary differences arising from differing depreciation methods and warranty expense recognition. These deferred taxes can significantly impact financial planning, tax strategy, and financial statement presentation. Proper disclosure and understanding of these figures ensure accurate financial communication and compliance with accounting standards such as ASC 740.
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