Ayres Services acquired an asset for $80 million in 2011. The asset is depreciated for financial reporting purposes over four years on a straight-line basis (no residual value). For tax purposes the asset's cost is depreciated by MACRS. The enacted tax rate is 40%. Amounts for pretax accounting income, depreciation, and taxable income in 2011, 2012, 2013, and 2014 are as follows:
($in millions)
for 2011
pretax accounting income - $330
deprecation on the income statement - 20
depreciation on the tax return - (25)
taxable income - $325
for 2012
pretax accounting income - $350
deprecation on the income statement - 20
depreciation on the tax return - (33)
taxable income - $337
for 2013
pretax accounting income - $365
deprecation on the income statement - 20
depreciation on the tax return - (15)
taxable income - $370
for 2014
pretax accounting income - $400
deprecation on the income statement - 20
depreciation on the tax return - (7)
taxable income - $413
Required: For December 31 of each year, determine a) the temporary book-tax difference for the depreciable asset and b) the balance to be reported in the deferred tax liability account.
To determine the temporary book-tax difference for the depreciable asset and the balance to be reported in the deferred tax liability account, you need to calculate the tax depreciation expense and the difference between tax depreciation and book depreciation for each year.
a) Temporary Book-Tax Difference for the Depreciable Asset:
For each year, the temporary book-tax difference is the difference between tax depreciation and book depreciation. It represents the deferred tax liability that will eventually reverse in the future when the asset is fully depreciated for tax purposes.
For 2011:
Book Depreciation: $20 million
Tax Depreciation: $25 million
Temporary Book-Tax Difference: $25 million - $20 million = $5 million
For 2012:
Book Depreciation: $20 million
Tax Depreciation: $33 million
Temporary Book-Tax Difference: $33 million - $20 million = $13 million
For 2013:
Book Depreciation: $20 million
Tax Depreciation: $15 million
Temporary Book-Tax Difference: $15 million - $20 million = -$5 million (reversal of temporary difference)
For 2014:
Book Depreciation: $20 million
Tax Depreciation: $7 million
Temporary Book-Tax Difference: $7 million - $20 million = -$13 million (reversal of temporary difference)
b) Balance to be Reported in the Deferred Tax Liability Account:
To calculate the balance to be reported in the deferred tax liability account, you need to multiply the temporary book-tax difference for each year by the enacted tax rate of 40%.
For 2011:
Deferred Tax Liability: $5 million * 40% = $2 million
For 2012:
Deferred Tax Liability: $13 million * 40% = $5.2 million
For 2013:
Deferred Tax Asset: -$5 million * 40% = -$2 million
For 2014:
Deferred Tax Asset: -$13 million * 40% = -$5.2 million
Note: A negative balance represents a deferred tax asset, while a positive balance represents a deferred tax liability.