Question

Company B purchased a new piece of plant equipment in 2008. They used the straight-line depreciation method for financial reporting but used the accelerated depreciation method for tax purposes. Thus, the taxable income is different from the income before taxes for 2013. This difference has caused the depreciation deduction to be less than the depreciation expense. What will be the entry required due to this difference?

a) Credit the deferred tax liability account.

b) Debit the deferred tax liability account.

c) Credit the deferred tax asset account.

d) Debit the deferred tax asset account.

Answer 1

The correct entry required due to the difference caused by using different depreciation methods for financial reporting and tax purposes would be to credit the deferred tax liability account (option a), as it represents a future tax obligation.

Step-by-step explanation:

When a company uses different depreciation methods for financial reporting and tax purposes, this gives rise to a temporary difference between the book value of an asset and its tax base. In the case described, Company B used the straight-line method for financial reporting, resulting in a higher depreciation expense, and an accelerated method for tax purposes, leading to a higher depreciation deduction initially. This means that the company will pay less tax in the earlier years compared to the expense recognized in its financial statements, creating a deferred tax liability.

Since the taxable income is lower than the income before taxes, due to the accelerated depreciation on the tax return, the entry required would be to credit the deferred tax liability account. This is because the company expects to pay more taxes in the future when the tax deductions have been higher than the financial reporting expenses. The credit to the deferred tax liability reflects this future tax obligation.

The correct answer to the question is:

• Credit the deferred tax liability account.