Question

At December 31, DePaul Corporation had a $16 million balance in its deferred tax asset account and a $68 million balance in its deferred tax liability account. The balances were due to the following cumulative temporary differences:

Estimated warranty expense, $15 million: expense recorded in the year of the sale; tax-deductible when paid (one-year warranty).

Depreciation expense, $120 million: straight-line in the income statement; MACRS on the tax return.

Income from installment sales of properties, $50 million: income recorded in the year of the sale; taxable when received equally over the next five years.

Rent revenue collected in advance, $25 million; taxable in the year collected; recorded as income when earned the following year.

Required: Show how any deferred tax amounts should be classified and reported in the December 31 balance sheet. The tax rate is 40%.

Option 1:

What is the total amount of DePaul Corporation's deferred tax asset and liability?

Option 2:

How is the estimated warranty expense treated in the deferred tax account?

Option 3:

What is the tax rate used for reporting deferred tax amounts on DePaul Corporation's balance sheet?

Option 4:

How is rent revenue collected in advance reflected in DePaul Corporation's deferred tax accounts?

Answer 1

The tax effect of rent revenue collected in advance in the deferred tax account is $10 million.

Step-by-step explanation:

Option 1: To calculate the total amount of DePaul Corporation's deferred tax asset and liability, we need to subtract the deferred tax asset balance from the deferred tax liability balance. In this case, the total deferred tax amount can be calculated as follows:

Total deferred tax amount = Deferred tax liability - Deferred tax asset

= $68 million - $16 million

= $52 million

The total amount of DePaul Corporation's deferred tax liability is $52 million.

Option 2: The estimated warranty expense is treated as a temporary difference because it is recognized as an expense for accounting purposes in the year of sale but is tax-deductible when paid. To account for this temporary difference in the deferred tax account, we would need to calculate the tax effect of the estimated warranty expense. The tax effect is calculated by multiplying the estimated warranty expense by the tax rate:

Tax effect of estimated warranty expense = Estimated warranty expense * Tax rate

= $15 million * 40%

= $6 million

The tax effect of the estimated warranty expense in the deferred tax account is $6 million.

Option 3: The tax rate used for reporting deferred tax amounts on DePaul Corporation's balance sheet is 40%. This tax rate is applied to calculate the tax effect of temporary differences and determine the deferred tax asset and liability balances.

Option 4: Rent revenue collected in advance is reflected in DePaul Corporation's deferred tax accounts based on when it becomes taxable and when it is recorded as income. Since the rent revenue is collected in advance and taxable in the year collected but recorded as income when earned the following year, there is a temporary difference. The tax effect of this temporary difference is calculated by multiplying the rent revenue collected in advance by the tax rate:

Tax effect of rent revenue collected in advance = Rent revenue collected in advance * Tax rate

= $25 million * 40%

= $10 million