A firm has revenues of $20,000 for each of three years. The firm estimates the w

Question

A firm has revenues of $20,000 for each of three years. The firm estimates the warranty expense to be 8.0% of revenues each year. The actual expenditure of $4,800 to meet warranty claims was not made until the third year. According to tax rules, such expenses cannot be recognized until actually paid. The current tax rate is 35% 2. IRS Revenue Warranty Expense EOY1 EOY2 EOY3 20,000 20,000 20,000 Financial Reporting (GAAP) Revenue Warranty Expense EOY1 EOY2 EOY3 20,000 20,000 20,000 Carrying amount Tax base Taxes Payable Tax Expense DTA DTL

Explanation / Answer

Year Year Year Financial Reporting 1 2 3 Revenue          20,000          20,000          20,000 warranty expense          (1,600)          (1,600)          (1,600) Profit          18,400          18,400          18,400 Year Year Year Tax profit 1 2 3 Revenue          20,000          20,000          20,000 warranty expense                   -                     -            (4,800) Profit          20,000          20,000          15,200 Tax rate 35% 35% 35% Tax payable            7,000            7,000            5,320 Opening Amount of DTA base 0            1,600            3,200 current year DTA base            1,600            1,600          (3,200) carrying amount of DTA base            1,600            3,200                   -   Opening DTA                   -                  560            1,120 Current DTA                560                560          (1,120) Closing DTA                560            1,120                   -   Tax expense Current tax            7,000            7,000            5,320 DTA             (560)             (560)            1,120 Tax expense            6,440            6,440            6,440

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