Warranty Expenses as a DTA

[gimm]

Longboat, Inc. sold a luxury passenger boat from its inventory on December 31 for $2,000,000. It is estimated that Longboat will incur $100,000 in warranty expenses during its 5-year warranty period. Longboat’s tax rate is 30%. To account for the tax implications of the warranty obligation prior to incurring warranty expenses, Longboat should:
A) record a deferred tax asset of $30,000
Warranty expense should be recorded when the inventory item covered by the warranty is sold. A deferred tax asset is created when warranty expenses are accrued on the financial statements but are not deductible on the tax returns until the warranty claims are paid. The full amount of the obligation, $100,000, is recorded as an expense, with a deferred tax asset of $30,000. Note that a deferred tax asset results when taxable income is more than pretax income and the difference is likely to reverse (warranty will be paid) in future years.
I really need some help with this one. Is the 100,000 being marked as an expense, or income for Longboat?
The tax liability is 30,000. I had answered it to be a DTL since they will be paying this in the future, it is owed in the future. I viewed it as an expense and not income, but now I am wondering if it actually is generating income for Longboat.

 

[Oscar]

On the financial income statment a liabilitiy is recorded in the amount of $100,000. On the tax statements a waranty is only deductible on a cash basis, i.e. once the waranty case has materialized.
Hence, we have a tax base of the waranty liability on the financial statment of $100,000 and on the tax statement of $0. This leads to a DTA of $100,000 x 0.3 = $30,000.
Another way to think about it: In the financial statements EBT is $100,000 lower than the taxable income in the tax statemens which results in a DTA amounting to the difference times the tax rate.
Regards,
Oscar

 

[gimm]

’Oscar’ wrote:On the financial income statment a liabilitiy is recorded in the amount of $100,000. On the tax statements a waranty is only deductible on a cash basis, i.e. once the waranty case has materialized.
Hence, we have a tax base of the waranty liability on the financial statment of $100,000 and on the tax statement of $0. This leads to a DTA of $100,000 x 0.3 = $30,000.
Another way to think about it: In the financial statements EBT is $100,000 lower than the taxable income in the tax statemens which results in a DTA amounting to the difference times the tax rate.

So if a tax base on the tax form is less than the tax base on financial, this is a DTA? The way I interpret this is that we will owe more on our tax forms in the future and thus should be a DTL, and this is the wrong way to think. My intuitive approach is always wrong with DTA/DTLs due to this thought I am having.
The 2nd way you mention seems to make more sense. If the financial statements earnings are less than what we are paying taxes on, then we will expect ourselves to pay less taxes in the future, thus DTA. I need help with keeping my head on straight when given the same information in two different ways, I always come up with this conflicting reasoning when working through this type of problem.

 

[Oscar]

Try to memorize the following scenarios:
For assets:
tax base financial statement > tax base tax statement: DTL (EBT > taxable income)
tax base financial statement < tax base tax statement: DTA (EBT < taxable income)
For liabilities:
tax base financial statement > tax base tax statement: DTA (EBT < taxable income)
tax base financial statement < tax base tax statement: DTL (EBT > taxable income)
Best,
Oscar