Question

A reconciliation of pretax financial statement income to taxable income is shown below for Shaw-Anderson Industries for the year ended December 31, 2018, its first year of operations. The company offers quality-assurance warranties that extend six months after goods are purchased. The income tax rate is 40%.

Pretax accounting income (income statement)$640,000 Interest revenue on municipal securities (20,000) Warranty expense in excess of deductible amount 45,000 Depreciation in excess of financial statement amount (120,000) Taxable income (tax return)$545,000

What amount should Shaw-Anderson report as a current item related to deferred income taxes on its 2018 balance sheet?
Multiple Choice
• $0 current deferred tax asset or liability
• Deferred income tax liability of $30,000
• Deferred income tax liability of $18,000
• Deferred income tax asset of $18,000

Answer 1

The correct answer is option 4. Shaw-Anderson should report a current deferred tax asset of $18,000 for the warranty expenses on its 2018 balance sheet, calculated as 40% of the $45,000 warranty expense in excess of the deductible amount.

Step-by-step explanation:

The student's question seeks to identify the proper amount to report as a current item related to deferred income taxes on Shaw-Anderson's 2018 balance sheet. To calculate the deferred tax asset or liability, we need to analyze the differences between pretax financial income and taxable income. We note the permanent difference due to interest revenue on municipal securities of $20,000, which is not taxable.

There is also a temporary difference because of warranty expenses($45,000) and depreciation expenses ($120,000). The difference due to depreciation will reverse in the future, creating a deferred tax liability calculated by multiplying the difference by the tax rate. Since the tax rate is 40%, the deferred tax liability for the excess depreciation is $120,000 * 40% = $48,000. However, the only current amount in question is related to the warranty expenses, as the depreciation-related liability might not be due within the next year.

The current deferred tax asset for the warranty expenses is $45,000 * 40% = $18,000. Since this represents an amount the company anticipates to recover, the correct answer is a deferred tax asset of $18,000 for the warranty expense.