Question

Ayres Services acquired an asset for $86 million in 2018. The asset is depreciated for financial reporting purposes over four years on a straight-line basis (no residual value). For tax purposes the asset’s cost is depreciated by MACRS. The enacted tax rate is 40%. Amounts for pretax accounting income, depreciation, and taxable income in 2018, 2019, 2020, and 2021 are as follows:

	($ in millions)
	2018				2019				2020				2021
Pretax accounting income	$	345			$	365			$	380			$	415
Depreciation on the income statement		21.5				21.5				21.5				21.5
Depreciation on the tax return		(26.5	)			(34.5	)			(16.5	)			(8.5	)
Taxable income	$	340			$	352			$	385			$	428

Required:
Determine (a) the temporary book–tax difference for the depreciable asset and (b) the balance to be reported in the deferred tax liability account. (Leave no cell blank, enter "0" wherever applicable. Negative amounts should be indicated by a minus sign. Enter your answers in millions rounded to 1 decimal place (i.e., 5,500,000 should be entered as 5.5).)

Answer 1

Solution :

Part A )

Due to the difference in depreciation, the firm will pay a lower amount of tax in first two years then higher taxes in next 2 years

2018 : Tax expense (40% x 345) 138

Deferred tax liability (40% x 5) 2

Taxes payable (40% x 340) 136

2019 : Tax expense (40% x 365) 146

Deferred tax liability (40% x 13) 5.2

Taxes payable (40% x 352) 140.8

2020: Tax expense (40% x 380) 152

Deferred tax liability (40% x 5) 2

Taxes payable (40% x 385) 154

2021: Tax expense (40% x415) 166

Deferred tax liability (40% x 13) 5.2

Taxes payable (40% x 428) 171.2

Part B )

Tax liability will increase by 2 in 1st year and by 5.2 in 2nd year then reduces by 2 in 3rd year and finally reduces by 5.2 in 4th year to have net zero effect

2018: + 2

2019: +5.2

2020: -2

2021: -5.2