Basic deferred tax calculation & differentiating a DTA from a DTL
Financial Reporting is filled to the brim with complex concepts, but this one is extremely important and many students struggle with it. You know the one I’m talking about… basic deferred tax calculations and differentiating a DTA from a DTL. (If you don’t know what I am talking about, you better hit the study guide and read up on Module 4!)
Consider a tractor purchased for $100,000. This will be the accounting cost and also the tax cost.
Now for accounting purposes, the tractor is depreciated over 5 years but for tax purposes the tractor is depreciated over 4 years.
These different depreciation methods will result in a ‘TEMPORARY’ difference for the five-year period but at the end of the 5 years, both the accounting carrying amount and the tax base will be zero (i.e. fully depreciated).
Here’s an easy way to do deferred tax calculations. You can use my table to make life easier on yourself.
(Also, check out the Deferred Tax video in Module 4 of the free FR CPA Assist course – register here).
Step 1: Use my table method (below)
Step 2: Is the 1,500 deferred tax a DTA or a DTL?
To do this, you use the table. Now go back to the UNDERLYING item you were working with. (i.e. the tractor). Is it an asset or a liability?
The tractor is an asset and so you would block out the ‘liability’ part of the table.
Step 3: Look at the table and compare the carrying amount to the tax base.
Negative 20,000 is larger than negative 25,000. So, you simply put a ruler under that part of the Study Guide table and follow through to determine if movement is a DTA or a DTL. As per below, you would see that the answer is a DTL.
Step 4: If you were asked for the journal entries, you need to look at the middle row relating to the movement (i.e. what caused the movement).
In this case the depreciation gave rise to the deferred tax. So the journal entry would be:
Dr Deferred tax expense 1,500
Cr Deferred tax liability 1,500
If you were asked for the deferred tax balance, you would use the last row. Which in the first year, would be equal to the movement, but note that the balance accumulates every year so would not be equal to the movement in subsequent years. Hence you need to know what is being asked and where to look to get that answer.
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KnowledgEquity Financial Reporting students have been using the KnowledgEquity support resources, including video tutorials, weekly webinars, module quizzes plus the CPA study guide to prepare for their all important exam.
All the best with your studies!
To learn more and get access to support resources for your CPA, check out KnowledgEquity’s Financial Reporting Support for your CPA courses. You can try our CPA Assist for Financial Reporting which includes 10 hours of free content, there are short explanatory videos, module quizzes, webinars and flowcharts to help you embed your knowledge and be able to understand the subject. Plus in our paid courses, you can access all the resources, including practice exams (marked) and an exam preparation webinar – learn more here, Financial Reporting courses. Once you have concepts like these embedded in your knowledge data bank, you will be ready to take on your CPA exam!