Question

South, Inc., earns book net income before tax of $400,000 in year 1. South acquires a depreciable asset in year 1, and first year tax depreciation exceeds book depreciation by $50,000. At the end of year 1, South’s deferred tax liability account balance is $10,500. In year 2, South earns $500,000 book net income before tax, and its book depreciation exceeds tax depreciation by $20,000. South records no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 21% in both years, what is South’s balance in its deferred tax liability account at the end of year 2?

Answer 1

South, Inc.'s deferred tax liability account balance at the end of year 2 is $6,300, after accounting for the year-over-year changes in the depreciation differences between book and tax purposes at a 21% tax rate.

Step-by-step explanation:

To calculate South’s balance in its deferred tax liability account at the end of year 2, we need to take into account the changes due to depreciation differences between book accounting and tax accounting, as well as the previous year’s deferred tax liability balance.

In year 1, the tax depreciation exceeded the book depreciation by $50,000. At a 21% tax rate, this results in a deferred tax liability of $10,500 (21% of $50,000), which matches the provided end-of-year 1 balance.

In year 2, the book depreciation exceeds the tax depreciation by $20,000. This reverses some of the liability created in year 1 by an amount of $4,200 (21% of $20,000).

Therefore, to find the ending deferred tax liability balance in year 2, we subtract the $4,200 from the beginning balance of $10,500 created in year 1. That gives us a new ending balance of $6,300 at the end of year 2 ($10,500 - $4,200).

Answer 2

South's Balance in its deferred tax Liability Account at the end of Year 2= $5,500

Step-by-step explanation:

First, Identify that the Book Income after permanent differece is $500,000 and calculate the Total Tax Expense for year 2 before excess depreciation is accounted for

• U.S. Tax rate for the two years is 21%
• Total Tax Expense= $500,000× 21%
• = 500,000×0.21=%105,000

Second, Identify the Current Portion/Increase in this total tax expense for the 2nd Year due to the fact that Book Deprciation exceeds tax depreciation. The excess must be added back to calculate the total tax expense. This is because unlike year 1, where tax depreciation exceeds book depreciation.

• =(Book Net Income before tax + Excess Book Depreciation)× U.S. Tax rate for the year
• ($500,000+$20,000)× 0.21
• =$520,000×0.21
• =$109,200

Third, Find the Difference between the Total tax expense from step one and the Increase in the total tax expense from step 2

• Total tax Expense from step 1= $105,000
• Current Portion of Total tax expense from stp 2= $109,200
• The difference= $109,200-$105,000= $4,500

Fourth, Subtract the difference from the Deferred Tax Liability of Year 1, to get the balance of the deferred tax liability account for year 2

• Deferred Tax Liability of year 1= $10,500
• Balance in the Deferred Tax Liability Account at the end of year 2
• =$10,500-$4,500= $5,500