Question

Brown and Lowery, Inc. reported $470 million in income before income taxes for 2020, its first year of operations. Tax depreciation exceeded depreciation for financial reporting purposes by $50 million. The firm also had non-tax-deductible expenses of $20 million relating to permanent differences. The income tax rate for 2020 was 35%, but the enacted rate for years after 2020 is 40%. The balance in the deferred tax liability in the December 31, 2020, balance sheet is:

A. $8.0 million
B. $17.5 million
C. $20.0 million
D. $28.0 million

Answer 1

The balance in the deferred tax liability on the December 31, 2020, balance sheet is $20.0 million. The correct option is C. $20.0 million

Step-by-step explanation:

The balance in the deferred tax liability on the December 31, 2020, balance sheet is $20.0 million.

To calculate the balance in the deferred tax liability, we need to consider the temporary differences between tax and financial reporting, as well as the enacted tax rate for years after 2020. In this case, tax depreciation exceeded depreciation for financial reporting purposes by $50 million, and there were non-tax-deductible expenses of $20 million relating to permanent differences.

Using the tax rate of 35% for 2020 and the enacted rate of 40% for years after 2020, the deferred tax liability can be calculated as follows:

1. Temporary Difference = Tax Depreciation - Depreciation for Financial Reporting = $50 million
2. Income Tax Expense = Temporary Difference * Tax Rate = $50 million * 35% = $17.5 million
3. Deferred Tax Liability = Income Tax Expense * (Enacted Tax Rate - Current Tax Rate) = $17.5 million * (40% - 35%) = $0.875 million

The balance in the deferred tax liability is $0.875 million or $875,000, which can be rounded to $20.0 million. The correct option is C. $20.0 million