Crunchers Inc. reports Earnings Before Taxes of $100,000, a Deferred Tax Liability (DTL) at the beginning of the year of 3,000 and an ending DTL of 11,000. If the tax liability on the tax return is $25,000 and Crunchers' tax rate is 35%, how much Income Tax Expense will Crunchers report on its Income Statement?

the tax expense on the income statement will be $27, 000

Explanation:

Before we begin to answer the question, we need to establish that we have a clear understanding of what deferred taxation is.

Normally, taxation is regarded as an expense. However, deferred taxation {thereafter referred to as deferred tax] is a liability tax. This liability tax is the tax that has been assessed for the period, but has not been paid over to the tax authority or tax collector.

The reason why is it deferred is as a result of the timing difference between when the tax becomes accrued and when it is paid.

A general ledger account is then opened in order to record the liability. This account shows that the company will pay more income tax in the future, because of a transaction that took place in the current period.

Common examples of deferred tax:

• The most common deferred is the difference between how the company calculates depreciation, and how the tax authority calculates the wear and tear allowance of a business asset. Suppose a company has an asset that is valued at $100, 000. It is depreciated at 10% straight line basis over 10 years. Suppose also that the tax authority stated that it will calculate the wear and tear allowance at 20% annually.

In this instance, the company will record the depreciation expense at $100, 000 x 10% = $10, 000. The tax authority will record the wear and tear allowance at $100, 000 x 25% = $25, 000. The difference of $15, 000 between the two values is deferred tax.

• Another common deferred tax source is as a result of an instalment sale. The company recognises revenue of the full credit amount upon sale. The tax authority requires revenue to be recognised as and when instalments are received.

For Cruncher Inc., this is the tat expense on the income statement:

Deferred Tax liability

Tax expense $27, 000 Opening balance $3, 000

Current tax $35, 000*

Balance c/d $11, 000

$38, 000 $38, 000

Balance b/d $11, 000

*$100, 000 x 35% = $35, 000