Deferred Tax Liabilities

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lola

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Which one of the following is TRUE? Under the liability method of accounting for deferred taxes, a decrease in the tax rate at the beginning of the accounting period will:

a) increase taxable income in current period
b) reduce income tax expense for the current period
c) reduce the deferred tax liability
d) increase the beginning-of-period deferred tax asset


Why is B wrong?

Thanks.
 
lola,

I'm not sure why B would be wrong. According to U.S. GAAP, "Changes in statutory tax rates be recognized in reported income tax expense in the year when the tax rate change is enacted, regardless of when the effective date is for the change".

I think C would also be correct....

Tax Liability = Temporary difference * statutory tax rate
 
The answer is C, but I wrote B. I think they're both correct.

Super I or hiredguns, are you guys around?
 
Clearly the offset when you reduce (debit) defered tax liability account is a reduction (credit) to tax expense.

Either they are wrong, or were trying to play around with wording in (B) and meant to diffrentiate between income tax expense related to current period earnings vs. adjustments to the income tax expense line on the income statement for things such as rate changes, valuation adjustments, etc.

(Hopefully) The actual exam will be less ambiguous.
 
lola, Schweser's 2006 notes summarize it nicely, here's two quotes from p.240 of Book 3.

"Besides the impact on current period taxes payable and income tax expense, under the liability method, all balance sheet deferred tax assets and liabilities are revalued when the tax rate the firm will face in the future changes"

"If the tax rate decreases, the decrease in deferred tax liabilities decreases the income tax expense, and the decrease in deferred tax assets increases the income tax expense. As long as deferred tax liabilities exceed deferred tax assets (the most common occurance), the net impact of the decrease in the tax rate will be to decrease the tax expense, which will cause net income and stockholder's equity to rise. The basic equation is:
income tax expense = taxes payable + delta(DTL) - delta(DTA)"

Cheers.
 
Hmm, I can't seem to edit my post above anymore...

I think the key point is that you can't select B w/o making assumptions regarding the company's current level of DTA and DTL, which wasn't given in the problem. Therefore, all you can claim with absolute certainty is that the DTL will decrease.

I've found exam questions to be similar in that many incorrect responses will seem reasonable, but frankly draw conclusions that can't be certain given the information available.
 
you guys are amazing! Thanks for all the help.

hiredguns, good point about the assumption. I didn't think of that.



Edited 1 time(s). Last edit at Friday, July 20, 2007 at 11:47AM by lola.
 
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