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    Identify Temporary or Permanent Differences for Financial Reporting Purposes

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    Listed below are items that are commonly accounted for differently for financial reporting purposes than they are for tax purposes.

    INSTRUCTIONS:

    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 above (namely 1, 2 or 3) to indicate your answers for each.

    a) ____ The MACRS depreciation system issued 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 purposes.

    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 reporting purposes.

    j)_____Estimated losses on pending lawsuits and claims are accrued for books. These losses are tax deductible in period(s) when the related liabilities are settled.

    k)_____Expenses on stock options are accrued for financial reporting purposes.

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    Solution Preview

    A future deductible amount generates a deferred tax asset (we pay more tax now as compared to tax expense since taxable income is higher), a future taxable amount generates a deferred tax liability (we pay less tax now as compared to tax expense as the taxable income is lower) and if the amount is not liable for tax it is a permanent difference.

    a) The MACRS depreciation system issued for tax purposes, and the straight-line depreciation method is used for financial reporting purposes for some plant assets.

    (2) Deferred income tax liability (lower taxable income). The MACRS has a high depreciation initially and so would have future taxable ...

    Solution Summary

    The solution explains whether the given differences are temporary or permanent.

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