E19-6 (Identify Temporary or Permanent Differences) Listed below are items that are commonly
accounted for differently for financial reporting purposes than they are for tax purposes.
For each item below, indicate whether it involves:
(1) A temporary difference that will result in future deductible amounts and, therefore, will usually
give rise to a deferred income tax asset.
(2) A temporary difference that will result in future taxable amounts and, therefore, will usually give
rise to a deferred income tax liability.
(3) A permanent difference.
Use the appropriate number to indicate your answer for each.
(a) ______ The MACRS depreciation system is used for tax purposes, and the straight-line depreciation
method is used for financial reporting purposes for some plant assets.
(b) ______ A landlord collects some rents in advance. Rents received are taxable in the period when
they are received.
(c) ______ Expenses are incurred in obtaining tax-exempt income.
(d) ______ Costs of guarantees and warranties are estimated and accrued for financial reporting
(e) ______ Installment sales of investments are accounted for by the accrual method for financial
reporting purposes and the installment method for tax purposes.
(f) ______ For some assets, straight-line depreciation is used for both financial reporting purposes
and tax purposes but the assets' lives are shorter for tax purposes.
(g) ______ Interest is received on an investment in tax-exempt municipal obligations.
(h) ______ Proceeds are received from a life insurance company because of the death of a key officer.
(The company carries a policy on key officers.)
(i) ______ The tax return reports a deduction for 80% of the dividends received from U.S. corporations.
The cost method is used in accounting for the related investments for financial
(j) ______ Estimated losses on pending lawsuits and claims are accrued for books. These losses are
tax deductible in the period(s) when the related liabilities are settled.
(k) ______ Expenses on stock options are accrued for financial reporting purposes.
While this exercise claims that there are two temporary situations, future deductions and future taxable amounts. There are actually four possible scenarios for timing differences (see below). So, I answered based on whether it is a deferred tax liability or deferred tax asset.
1. Revenue reported first to IRS then later on GAAP statements= Deferred tax asset
Rationale: Paid taxes to IRS already and will "use it up" when report revenue in GAAP financials
Example: Unearned revenue (customers pay in advance so taxed but not earned for GAAP yet)
2. Revenue reported first on GAAP statements then to IRS = Deferred tax liability
Rationale: Revenue is in GAAP financials so liability is recorded in GAAP financials but not due to IRS until reported later.
Example: Revenue on ...
Your tutorial explains how to handle revenues when they are reported to the IRS before or after GAAP accrues them. The response also explains how to handle expenses when they are reported to the IRS before or after GAAP accrues them. The answers requested are then given.