Lin has just completed its first year of operations and has a number of differen
ID: 2471760 • Letter: L
Question
Lin has just completed its first year of operations and has a number of differences between its pretax financial income and taxable income. The differences at the end of 2016 are as follows: Lin recorded $7.000 of interest revenue on municipal bonds during 2016. $15,000 of accrual basis vales were recognized in income during 2016. They are expected to be received in cash during January 2017. Depreciation on machinery totaled $28,000 using straight-line depreciation for financial statements. Lin's tax accountant recorded $36,000 of depreciation on the company's tax return. Lin was fined $3,000 for violating certain labor laws during 2016. Lin paid the fine during 2016 and agreed to ensure future violations would not occur. Bryant Corporation has agreed to rent space from Lin in 2017. In December 2016, Lin received $7,500 from Bryant in advance for rent. For 2016, Lin reported $9,500 of warranty expense on its income statement. The company's warranty liability at the end of 2016 was $6,250. Lin expects additional warranty costs to be paid during 2017. Required: For each item, determine if it results in a temporary or permanent difference. It the item results in a temporary difference, determine if it results in a deferred tax asset or deferred tax liability. For each item, determine if it initially results in pretax financial income being greater than or less than taxable income. Next Level Discuss why permanent differences do not impact future periods' taxable income and how these differences affect tax rates.Explanation / Answer
Transaction
Type of Difference
a
Lin recorded $7,000 of interest revenue on municipal bonds during 2016
Permanent Difference, because for income tax purposes, Interest revenue on municipal bonds is not taxable
b
$15,000 of actual-basis sales were recognized in income during 2016. They are expected to be receive in cash during January 2017
Temporary Difference and creates deferred tax liability
c
Depreciation on Machinery totaled $28,000 using straight-line depreciation for financial statements. Lin's tax accountant recorded $36,000 of depreciation on the company's tax return.
Temporary Difference and creates deferred tax Asset
d
Lin was fined $3,000 for violating certain labor laws during 2016. Lin paid the fine during 2016 and agreed to ensure future violations would not occur.
Permanent Difference, because for income tax purposes, fines and other expenses for violating law are not deductible
e
Bryant Corporation has agreed to rent space from Lin in 2017. In December 2016, Lin received $7,500 from Bryant in advance for rent.
Temporary difference and it is a deferred tax asset.
f
For 2016, Lin reported $9,500 of warranty expense on its income statement. The company's warranty liability at the end of 2016 was $6,250. Lin expects additional warranty costs to be paid during 2017.
Temporary difference and it is a deferred tax asset.
Transaction
Impact on Initial financial Income
a
Lin recorded $7,000 of interest revenue on municipal bonds during 2016
It will increase the pretax income, because as the same is not taxable
b
$15,000 of actual-basis sales were recognized in income during 2016. They are expected to be receive in cash during January 2017
It will increase the pretax income, because as the same is future taxable income i.e. taxable at the time receipt.
c
Depreciation on Machinery totaled $28,000 using straight-line depreciation for financial statements. Lin's tax accountant recorded $36,000 of depreciation on the company's tax return.
It will decrease pretax financial income, because for the taxation depreciation is $36000. The difference of $8,000 will be deductible in the future from financial statements.
d
Lin was fined $3,000 for violating certain labor laws during 2016. Lin paid the fine during 2016 and agreed to ensure future violations would not occur.
It will increase the pretax income, because as the same is not taxable
e
Bryant Corporation has agreed to rent space from Lin in 2017. In December 2016, Lin received $7,500 from Bryant in advance for rent.
It will increase the pretax income, because it is taxable when received.
f
For 2016, Lin reported $9,500 of warranty expense on its income statement. The company's warranty liability at the end of 2016 was $6,250. Lin expects additional warranty costs to be paid during 2017.
It will decrease the Financial pretax income, because for income tax purpose warranty costs are only $6,250.
The discrepancy between a firm’s before tax financial income and taxable income is known as temporary difference. This difference results because of reporting expenses and revenue in one period for the purpose of income tax and in another period for the purpose of financial reporting. These reverse in future years and therefore they result in DTA and DTL.
The discrepancy between a firm’s before tax financial income and taxable income is known as permanent difference. This difference results because of reporting revenues and expenses for financial accounting purpose under GAAP, which are never reported for income tax purpose under internal Revenue Code.
Transaction
Type of Difference
a
Lin recorded $7,000 of interest revenue on municipal bonds during 2016
Permanent Difference, because for income tax purposes, Interest revenue on municipal bonds is not taxable
b
$15,000 of actual-basis sales were recognized in income during 2016. They are expected to be receive in cash during January 2017
Temporary Difference and creates deferred tax liability
c
Depreciation on Machinery totaled $28,000 using straight-line depreciation for financial statements. Lin's tax accountant recorded $36,000 of depreciation on the company's tax return.
Temporary Difference and creates deferred tax Asset
d
Lin was fined $3,000 for violating certain labor laws during 2016. Lin paid the fine during 2016 and agreed to ensure future violations would not occur.
Permanent Difference, because for income tax purposes, fines and other expenses for violating law are not deductible
e
Bryant Corporation has agreed to rent space from Lin in 2017. In December 2016, Lin received $7,500 from Bryant in advance for rent.
Temporary difference and it is a deferred tax asset.
f
For 2016, Lin reported $9,500 of warranty expense on its income statement. The company's warranty liability at the end of 2016 was $6,250. Lin expects additional warranty costs to be paid during 2017.
Temporary difference and it is a deferred tax asset.
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