A company overstated its liability for warranties by $200,000. Its tax rate is 30%.

As a result of this error, income tax expense is:

a. Unaffected

b. Overstated by $60,000

c. Overstated by $140,000

d. Understated by $60,000

The income tax expense would have been understated by $60,000 (D)

Explanation:

Since the liability has been overstated by $200,000, certainly its warranty expense has equally been overstated by the same amount.

The higher the expenses, the lower the tax base and the lower the tax expense or liability.

Understatement = 30% * $200,000 = $60,000

Hence, the tax liability of the company will increased by $60,000.

Option (a) False. This will be so if the warranty liability is accurately predicted i. e warranties liability is neither understated nor overstated.

Option (b) False. This will be so if the warranties liability has been understated.

Option (c) False.

Option (d) True