Question

Hopkins Co. at the end of 2017, its first year of operations, prepared a reconciliation Between pretax financial income and taxable income as follows:

Pretax Financial Income....................................... $3,000,000

Estimated Litigation Expense............................... $4,000,000

Extra depreciation for taxes............................... ($6,000,000)

Taxable Income...................................................... $1,000,000

The estimated litigation expense of $4,000,000 will be deductible in 2018 when it is expected to be paid. Use of the depreciable assets will result in taxable amounts of $2,000,000 in each of the next three years. The income tax rate is 30% for all years. The deferred tax asset to be recognized is

a.   300,000

b.   1,200,000

c.   900,000

d.   1,500,000

Answer 1

Addition of Estimated litigation Expenses would result in Deferred Tax asset for Hopkins Co.

=Timing Difference* Tax Rate

=Estimated Litigation Expense* Tax Rate

=$4,000,000*30%

=$1,200,000

Answer would be Option B - $1,200,000

Note: Extra Depreciation for taxes will result in Deferred Tax Liability, as in the question mentioned we have to calculate Deferred tax asset, we ignored timing diffeence of depreciation. Otherwise, DTL would have been created of =$(6,000,000 - 4,000,000)*30% = $2,000,000*30% = $600,000 (DTL)