Question

Kara Fashions uses straight-line depreciation for financial statement reporting and MACRS for income tax reporting. Three years after its purchase, one of Kara’s buildings has a carrying value of $450,000 and a tax basis of $315,000. There were no other temporary differences and no permanent differences. Taxable income was $6 million and Kara’s tax rate is 40%.

What is the deferred tax liability to be reported in the balance sheet?

Answer 1

The deferred tax liability for Kara Fashions is calculated as 40% of the temporary difference between the carrying value and the tax basis of the building, which amounts to $54,000.

Step-by-step explanation:

To calculate the deferred tax liability, we need to identify the temporary difference between the carrying value of the asset for financial reporting purposes and its tax basis. The carrying value of Kara Fashions' building is $450,000, while the tax basis is $315,000, leading to a temporary difference of $135,000. Since Kara Fashions has a 40% tax rate, the deferred tax liability is 40% of the temporary difference.

Deferred Tax Liability = Temporary Difference × Tax Rate = ($450,000 - $315,000) × 40% = $135,000 × 40% = $54,000.

Therefore, Kara Fashions should report a deferred tax liability of $54,000 on its balance sheet.