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 liability to be recognized is

1. 1,200,000
2. 1,800,000
3. 900,000
4. 1,500,000
5. None of the above

Answer 1

Deferred tax liability is generated when firm have an expense that is deducted from taxable income as per tax return but the same is not yet deducted from books.

Temperory difference is created due to such difference.

Here, depreciation has been allowed in tax return but the same will will result in taxable amounts of $2,000,000 in each of the next three years . Here tax liability is deferred to next period.

So deffered tax liability will be created on depreciation.

=$6,000,000*30% tax rate

=$1,800,000

Answer B.

Here, litigation expense is not allowed in current year as per tax return .It will be allowed in future which will reduce tax liability in future ,so it will create deferred tax asset and not liability hence it will not be considered in calculation of income tax liability.