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Wall Street Prep: Advanced Accounting Exam
Questions & Correct Answers ||Verified Exam!!|| 100%
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Why is the effective and marginal tax rate often different? -
Answer-Effective and marginal tax rates differ because the
effective tax rate calculation uses pre-tax income from the
accrual-based income statement. Since there's a
difference between the taxable income on the income
statement and taxable income shown on the tax filing, the
tax rates will nearly always be different. Thus, the "Tax
Provision" line item on the income statement rarely
matches the actual cash taxes paid to the IRS.
Could you give specific examples of why the effective and
marginal tax rates might differ? - Answer-Under GAAP,
many companies follow different accounting standards and
rules for tax and financial reporting.
i. Most companies use straight-line depreciation (i.e.,
equal allocation of the expenditure over the useful life) for
reporting purposes, but the IRS requires accelerated
depreciation for tax purposes - meaning, book
depreciation is lower than tax depreciation for earlier
periods until the DTLs reverse.
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ii. Companies that incurred substantial losses in earlier
years could apply tax credits (i.e., NOL carryforwards) to
reduce the amount of taxes due in later periods.
iii. When debt or accounts receivable is determined to be
uncollectible (i.e., "Bad Debt" and "Bad AR"), this can
create DTAs and tax differences. The expense can be
reflected on the income statement as a write-off but not be
deducted in the tax returns.
What are deferred tax liabilities (DTLs)? - Answer-
Deferred tax liabilities ("DTLs") are created when a
company recognizes a tax expense on its GAAP income
statement that, because of a temporary timing difference
between GAAP and IRS accounting, is not actually paid to
the IRS that period but is expected to be paid in the future.
DTLs are often related to depreciation. Companies can
use accelerated depreciation methods for tax purposes
but elect to use straight-line depreciation for GAAP
reporting. This means that for a given depreciable asset,
the amount of depreciation recognized in the earlier years
for tax purposes will be greater than under GAAP.
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Those temporary timing differences are recognized as
DTLs. Since these differences are just temporary - under
both book and tax reporting, the same cumulative
depreciation will be recognized over the life of the asset -
at a certain point into the asset 's useful life, an inflection
point will be reached where the depreciation expense for
tax reporting will become lower than for GAAP.
What are deferred tax assets (DTAs)? - Answer-Deferred
tax assets ("DTAs") are created when a company
recognizes a tax expense on its GAAP income statement
that, due to a temporary timing difference between GAAP
and IRS accounting rules, is lower than what must be paid
to the IRS for that period. These net operating losses
("NOLs") that a company can carry forward against future
income create DTAs.
For example, a company that reported a pre-tax loss of
$10 million will not get an immediate tax refund. Instead,
it'll carry forward these losses and apply them against
future profits.
Wall Street Prep: Advanced Accounting Exam
Questions & Correct Answers ||Verified Exam!!|| 100%
Verified Solutions | Already Graded A+ | Newest Exam
| Newest Exam!!!
Why is the effective and marginal tax rate often different? -
Answer-Effective and marginal tax rates differ because the
effective tax rate calculation uses pre-tax income from the
accrual-based income statement. Since there's a
difference between the taxable income on the income
statement and taxable income shown on the tax filing, the
tax rates will nearly always be different. Thus, the "Tax
Provision" line item on the income statement rarely
matches the actual cash taxes paid to the IRS.
Could you give specific examples of why the effective and
marginal tax rates might differ? - Answer-Under GAAP,
many companies follow different accounting standards and
rules for tax and financial reporting.
i. Most companies use straight-line depreciation (i.e.,
equal allocation of the expenditure over the useful life) for
reporting purposes, but the IRS requires accelerated
depreciation for tax purposes - meaning, book
depreciation is lower than tax depreciation for earlier
periods until the DTLs reverse.
,2|Page
ii. Companies that incurred substantial losses in earlier
years could apply tax credits (i.e., NOL carryforwards) to
reduce the amount of taxes due in later periods.
iii. When debt or accounts receivable is determined to be
uncollectible (i.e., "Bad Debt" and "Bad AR"), this can
create DTAs and tax differences. The expense can be
reflected on the income statement as a write-off but not be
deducted in the tax returns.
What are deferred tax liabilities (DTLs)? - Answer-
Deferred tax liabilities ("DTLs") are created when a
company recognizes a tax expense on its GAAP income
statement that, because of a temporary timing difference
between GAAP and IRS accounting, is not actually paid to
the IRS that period but is expected to be paid in the future.
DTLs are often related to depreciation. Companies can
use accelerated depreciation methods for tax purposes
but elect to use straight-line depreciation for GAAP
reporting. This means that for a given depreciable asset,
the amount of depreciation recognized in the earlier years
for tax purposes will be greater than under GAAP.
, 3|Page
Those temporary timing differences are recognized as
DTLs. Since these differences are just temporary - under
both book and tax reporting, the same cumulative
depreciation will be recognized over the life of the asset -
at a certain point into the asset 's useful life, an inflection
point will be reached where the depreciation expense for
tax reporting will become lower than for GAAP.
What are deferred tax assets (DTAs)? - Answer-Deferred
tax assets ("DTAs") are created when a company
recognizes a tax expense on its GAAP income statement
that, due to a temporary timing difference between GAAP
and IRS accounting rules, is lower than what must be paid
to the IRS for that period. These net operating losses
("NOLs") that a company can carry forward against future
income create DTAs.
For example, a company that reported a pre-tax loss of
$10 million will not get an immediate tax refund. Instead,
it'll carry forward these losses and apply them against
future profits.
