Dexter Company appropriately uses the asset-liability method to record deferred income taxes. Dexter reports depreciation expense for certain machinery purchased this year using the modified accelerated cost recovery system (MACRS) for income tax purposes and the straight-line basis for financial reporting purposes. The tax deduction is the larger amount this year.Dexter received rent revenues in advance this year. These revenues are included in this year's taxable income. However, for financial reporting purposes, these revenues are reported as unearned revenues, a current liability.Instructionsa.    What are the principles of the asset-liability approach?b.    How would Dexter account for the temporary differences?c.    How should Dexter classify the deferred tax consequences of the temporary differences on its balance sheet?

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Asked Jan 27, 2020
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Dexter Company appropriately uses the asset-liability method to record deferred income taxes. Dexter reports depreciation expense for certain machinery purchased this year using the modified accelerated cost recovery system (MACRS) for income tax purposes and the straight-line basis for financial reporting purposes. The tax deduction is the larger amount this year.

Dexter received rent revenues in advance this year. These revenues are included in this year's taxable income. However, for financial reporting purposes, these revenues are reported as unearned revenues, a current liability.

Instructions

a.    What are the principles of the asset-liability approach?

b.    How would Dexter account for the temporary differences?

c.    How should Dexter classify the deferred tax consequences of the temporary differences on its balance sheet?

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Expert Answer

Step 1

a.

The following basic principles are applied in accounting for income taxes at the date of the financial statements:

  1. “A current tax liability or asset is recognized for the estimated taxes payable or refundable on the tax return for the current year”.
  2. “A deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and loss carry forwards using the enacted marginal tax rate.”
  3. “The measurement of current and deferred tax liabilities and assets is based on provisions of the enacted tax law; the effects of future changes in tax laws or rates are not anticipated.”
  4. “The measurement of deferred tax assets is adjusted, if necessary, to not recognize tax benefits that, based on available evidence, are not expected to be realized”.
Step 2

b.

Dexter should do the following in accounting for the temporary differences.

  1. Identify the types and amounts of existing temporary differences. The depreciation policies give rise to a temporary difference that will result in net future taxable amounts (because depreciation for tax purposes exceeds the depreciation for financial statements). Rents are taxed in the year they are received but reported on the income statement in the year earned. The collection of rent revenue in advance will cause fu...

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