Eciation e before tax rome tax 40 income 60 expense 50

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eciation . e before tax .................. ........ •. ro:>me tax (40%) ........ .................... income _ _. $200 50 150 60 [expense] $200 75 125 50 [cash paid] $ 90 $ 75 - company records income tax expense and a related deferred tax liability for the first year as - ted in the following financial statement effects template: - Modified Accelerated Cost Recovery System (MACRS) is the current method of accelerated asset depreciation - by the United States income tax code. Under MACRS, all assets are divided into classes that dictate the number :;= over which an asset's cost is "recovered" and the percentage of the asset cost that can be depreciated per year - ed by regulation. For a five-year asset, such as in our example, the MACRS depreciation percentages per year are - _32%, 19.2%, 11.52%, 11.52%, and 5.76%. MACRS assumes that assets are acquired in the middle of the year, a half-year depreciation in Year 1and a half-year depreciation in Year 6. The point at which straight-line deprecia- exceeds MACRS depreciation is after about 2.5 years as assumed in the example.
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5-21 Module 5 I Revenue Recognition and Operating Income Cash -+' TE 60 Record tax DTL 10 expense: Cash 50 -50 +10 -60 TE expense Deferred Retained 60 I Cash = DTL exceeds cash Tax Liability Earnings I 10 because of Cash deferral of tax 50 +60 -60 Tax = Expense The reduction in cash reflects the payment of taxes owed to the taxing authority. The increase in deferred tax liability represents an estimate of additional tax that will be payable in the second year (which is the tax liability deferred in the first year). This liability for a future tax paymenr arises because second-year depreciation expense for tax purposes will be only $25, resulting in taxes payable of $70, which is $10 more than the income tax expense the company reports in its income statement to shareholders in Year 2 (see Exhibit 5.4B). I EXHIBIT 5.4B Year 2 Income Statements: Financial Reporting vs Tax Reporting Income before depreciation . Depreciation. . . . . . . . . . . . . . .. . . Income before tax . . . • . . ... •. . . Income tax (40%) .... ' . $200 50 150 60 (expense] $200 25 175 70 (cash paid] Net income . $ 90 $105 ._--------- At the end of Year I, the company knows that this additional tax must be paid in Year 2 because the financial reporting and tax reporting depreciation schedules are set when the asset is placed in service. Given these known amounts, the company accrues the deferred tax liability in Year 1in the same manner as it would accrue any estimated future liability, say for wages payable, by recognizing a liability and the related expense. At the end of Year2, the additional income tax is paid and the company's deferred tax liability is now satisfied. Financial statement effects related to the tax payment and expense in Year 2 are reflected in the following template: TE 60 Record tax expense: DTL 10 Cash 70 cash exceeds -70 -10 -60 +60 -60 TE expense because Cash = Deferred Retained Tax 60 I - = DTL deferred taxes are Tax Liability Earnings Expense 10 I reversed Cash 70 The income tax expense for financial reporting purposes is $60 each year. However, the cash pay- ment for taxes is $70 in Year 2; the $10 excess reduces the deferred tax liability accrued in Year L
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