Question

Dexter Company appropriately uses the asset-liability method to record deferred income taxes. Dexter reports depreciation expense for certain machinery purchased this year using the modified accelerated cost recovery system (MACRS) for income tax purposes and the straight-line basis for financial reporting purposes. The tax deduction is the larger amount this year. Dexter received rent revenues in advance this year. These revenues are included in this year's taxable income. However, for financial reporting purposes, these revenues are reported as unearned revenues, a current liability.

Instructions

a. What are the principles of the asset-liability approach?

b. How would Dexter account for the temporary differences?

c. How should Dexter classify the deferred tax consequences of the temporary differences on its balance sheet?

Answer 1

a. The asset-liability approach principles are:

-- A deferred tax asset or liability would be recognized for the estimated effects of future tax attributable to temporary differences and loss carry forwards with the usage of the enacted marginal rate of taxation.

-- Measurement of current and deferred tax assets and liabilities would be based on the enacted tax law provisions; the impacts of changes in future on tax rates or laws are not anticipated.

-- A current tax asset or liability is recognized for the estimated taxes refundable or payable for the current year on the tax return.

-- Measurement of deferred tax assets is adjusted, when required, to not recognize gains of taxation that, based on available evidence, would not be expected for realization.

b. Dexter should iidentify the amounts and types of existing temporary differences. He should measure the total deferred tax liability using the enacted marginal rate of taxation for the taxable temporary difference. To measure the total deferred tax asset use the enacted marginal rate of taxation for the deductible temporary difference. Dexter can decrease the deferred tax asset with the valuation allowance, when based on the weight of available evidence, it would be more likely than not all or that a certain portion of the deferred tax asset would not be realized

c. Deferred tax accounts should be classified in a net current and a net noncurrent amount; and reported as assets and liabilities on the balance sheet. The deferred tax asset due to the advance collection of rents needs to be reported as a current asset because the unearned rent revenue (related obligation) would be classified as a current liability. The deferred tax liability due to the difference in depreciation need to be reported as a long-term liability because asset being depreciated (a related asset) would be a noncurrent classification