1. Taxable income of a corporation differs from pretax financial income because of
Permanent Temporary
Differences Differences
a. No No
b. No Yes
c. Yes Yes
d. Yes No

2. Assuming a 40% statutory tax rate applies to all years involved, which of the following situations will give rise to reporting a deferred tax liability on the balance sheet?
I. A revenue is deferred for financial reporting purposes but not for tax purposes.
II. A revenue is deferred for tax purposes but not for financial reporting purposes.
III. An expense is deferred for financial reporting purposes but not for tax purposes.
IV. An expense is deferred for tax purposes but not for financial reporting purposes.
a. item II only
b. items I and II only
c. items II and III only
d. items I and IV only

3. Which of the following temporary differences results in a deferred tax asset in the year the temporary difference originates?
I. Accrual for product warranty liability.
II. Subscriptions received in advance.
III. Prepaid insurance expense.
a. I and II only.
b. II only.
c. III only.
d. I and III only.

4. When a change in the tax rate is enacted into law, its effect on existing deferred income tax accounts should be
a. handled retroactively in accordance with the guidance related to changes in accounting principles.
b. considered, but it should only be recorded in the accounts if it reduces a deferred tax liability or increases a deferred tax asset.
c. reported as an adjustment to income tax expense in the period of change.
d. applied to all temporary or permanent differences that arise prior to the date of the enactment of the tax rate change, but not subsequent to the date of the change.

5. Recognizing a valuation allowance for a deferred tax asset requires that a company
a. consider all positive and negative information in determining the need for a valuation allowance.
b. consider only the positive information in determining the need for a valuation allowance.
c. take an aggressive approach in its tax planning.
d. pass a recognition threshold, after assuming that it will be audited by taxing authorities.

Use the following information for questions 6 and 7.

At the beginning of 2015, Pitman Co. purchased an asset for $1,200,000 with an estimated useful life of 5 years and an estimated salvage value of $200,000. For financial reporting purposes the asset is being depreciated using the straight-line method; for tax purposes the double-declining-balance method is being used. Pitman Co.’s tax rate is 40% for 2015 and all future years.

6. At the end of 2015, what are the book basis and the tax basis of the asset?
Book basis Tax basis
a. $1,000,000 $620,000
b. $980,000 $620,000
c. $980,000 $720,000
d. $1,000,000 $720,000

7. At the end of 2015, which of the following deferred tax accounts and balances is reported on Pitman’s balance sheet?
Account _ Balance
a. Deferred tax asset $136,000
b. Deferred tax liability $136,000
c. Deferred tax asset $112,000
d. Deferred tax liability $112,000

Use the following information for questions 8 through 10.

Mathis Co. at the end of 2014, its first year of operations, prepared a reconciliation between pretax financial income and taxable income as follows:
Pretax financial income $ 800,000
Estimated litigation expense 2,000,000
Installment sales (1,600,000)
Taxable income $ 1,200,000

The estimated litigation expense of $2,000,000 will be deductible in 2016 when it is expected to be paid. The gross profit from the installment sales will be realized in the amount of $800,000 in each of the next two years. The estimated liability for litigation is classified as noncurrent and the installment accounts receivable are classified as $800,000 current and $800,000 noncurrent. The income tax rate is 40% for all years.

8. The income tax expense is
a. $240,000.
b. $320,000.
c. $360,000.
d. $400,000.

9. The deferred tax asset to be recognized is
a. $240,000 current
b. $240,000 noncurrent.
c. $800,000 current.
d. $800,000 noncurrent.

10. The deferred tax liability—current to be recognized is
a. $240,000.
b. $480,000.
c. $320,000.
d. $640,000.

Use the following information for questions 11 and 12.

Kraft Company made the following journal entry in late 2014 for rent on property it leases to Danford Corporation.
Cash 120,000
Unearned Rent Revenue 120,000

The payment represents rent for the years 2015 and 2016, the period covered by the lease. Kraft Company is a cash basis taxpayer. Kraft has income tax payable of $148,000 at the end of 2014, and its tax rate is 35%.

11. What amount of income tax expense should Kraft Company report at the end of 2014?
a. $106,000
b. $142,000
c. $163,000
d. $226,000

12. Assuming the income taxes payable at the end of 2015 is $225,000, what amount of income tax expense would Kraft Company record for 2015?
a. $162,000
b. $183,000
c. $225,000
d. $246,000

Use the following information for questions 13 and 14.

Rowen, Inc. had pre-tax accounting income of $1,672,000 and a tax rate of 40% in 2015, its first year of operations. During 2015 the company had the following transactions:

Received rent from Jane, Co. for 2016 $64,000
Municipal bond income $80,000
Depreciation for tax purposes in excess of book depreciation $40,000
Installment sales revenue to be collected in 2016 $108,000

13. For 2015, what is the amount of income taxes payable for Rowen, Inc?
a. $603,200
b. $654,400
c. $686,400
d. $772,800

14. At the end of 2015, which of the following deferred tax accounts and balances is reported on Rowen, Inc.’s balance sheet?
Account _ Balance
a. Deferred tax asset $32,000
b. Deferred tax liability $32,000
c. Deferred tax asset $59,200
d. Deferred tax liability $59,200

Use the following information for questions 15 and 16.

Wilcox Corporation reported the following results for its first three years of operation:
2014 income (before income taxes) $ 1,000,000
2015 loss (before income taxes) (1,800,000)
2016 income (before income taxes) 2,000,000
There were no permanent or temporary differences during these three years. Assume a corporate tax rate of 30% for 2014 and 2015, and 35% for 2016.

15. Assuming that Wilcox elects to use the carryback provision, what income (loss) is reported in 2015? (Assume that any deferred tax asset recognized is more likely than not to be realized.)
a. $(1,800,000)
b. $ -0-
c. $(1,220,000)
d. $(800,000)

16. Assuming that Wilcox elects to use the carryforward provision and not the carryback provision, what income (loss) is reported in 2015?
a. $(1,800,000)
b. $(1,740,000)
c. $ -0-
d. $(1,170,000)

Use the following information for questions 17 and 18.

Operating income and tax rates for C.J. Company’s first three years of operations
were as follows:
Income _ Enacted tax rate
2014 $300,000 35%
2015 ($850,000) 30%
2016 $1,060,000 40%

17. Assuming that C.J. Company opts to carryback its 2015 NOL, what is the amount of income taxes payable at December 31, 2016?
a. $204,000
b. $504,000
c. $369,000
d. $324,000

18. Assuming that C.J. Company opts only to carryforward its 2015 NOL, what is the amount of deferred tax asset or liability that C.J. Company would report on its December 31, 2015 balance sheet?
Amount _ Deferred tax asset or liability
a. $325,000 Deferred tax liability
b. $340,000 Deferred tax liability
c. $325,000 Deferred tax asset
d. $340,000 Deferred tax asset

19. Horner Corporation has a deferred tax asset at December 31, 2015 of $80,000 due to the recognition of potential tax benefits of an operating loss carryforward. The enacted tax rates are as follows: 40% for 2012–2014; 35% for 2015; and 30% for 2016 and thereafter. Assuming that management expects that only 60% of the related benefits will actually be realized, a valuation account should be established in the amount of:
a. $80,000
b. $32,000
c. $28,000
d. $24,000

20. At December 31, 2014 Raymond Corporation reported a deferred tax liability of $120,000 which was attributable to a taxable type temporary difference of $400,000. The temporary difference is scheduled to reverse in 2018. During 2015, a new tax law increased the corporate tax rate from 30% to 35%. Raymond should record this change by debiting
a. Retained Earnings for $20,000.
b. Retained Earnings for $6,000.
c. Income Tax Expense for $20,000.
d. Income Tax Expense for $6,000.

21. What impact does a bargain purchase option have on the present value of the minimum lease payments computed by the lessee?
a. There is no impact as the option does not enter into the transaction until the end of the lease term.
b. The lessee must increase the present value of the minimum lease payments by the present value of the option price.
c. The lessee must decrease the present value of the minimum lease payments by the present value of the option price.
d. The minimum lease payments would be increased by the present value of the option price if, at the time of the lease agreement, it appeared certain that the lessee would exercise the option at the end of the lease and purchase the asset at the option price.

22. From the lessee’s perspective, in the earlier years of a lease, the use of the
a. capital method will enable the lessee to report higher income, compared to the operating method.
b. capital method will cause debt to increase, compared to the operating method.
c. operating method will cause income to decrease, compared to the capital method.
d. operating method will cause debt to increase, compared to the capital method.

23. Based solely upon the following sets of circumstances indicated below, which set gives rise to a sales-type or direct-financing lease of a lessor?
Transfers Ownership Contains Bargain Collectibility of Lease Any Important
By End Of Lease? Purchase Option? Payments Assured? Uncertainties?
a. No Yes Yes No
b. Yes No No No
c. Yes No No Yes
d. No Yes Yes Yes

24. To avoid leased asset capitalization, companies can devise lease agreements that fail to satisfy any of the four leasing criteria. Which of the following is not one of the ways to accomplish this goal?
a. Lessee uses a higher interest rate than that used by lessor.
b. Set the lease term at something less than 75% of the estimated useful life of the property.
c. Write in a bargain purchase option.
d. Use a third party to guarantee the asset’s residual value.

25. The primary difference between a direct-financing lease and a sales-type lease is the
a. manner in which rental receipts are recorded as rental income.
b. amount of the depreciation recorded each year by the lessor.
c. recognition of the manufacturer’s or dealer’s profit at (or loss) the inception of the lease.
d. allocation of initial direct costs by the lessor to periods benefited by the lease arrangements.

26. When a company sells property and then leases it back, any gain on the sale should usually be
a. recognized in the current year.
b. recognized as a prior period adjustment.
c. recognized at the end of the lease.
d. deferred and recognized as income over the term of the lease.

Use the following Annuity Table for questions 27 through 32.

Future Value of Ordinary Annuity of 1
Period 5% 6% 8% 10% 12%
1 1.00000 1.00000 1.00000 1.00000 1.00000
2 2.05000 2.06000 2.08000 2.10000 2.12000
3 3.15250 3.18360 3.24640 3.31000 3.37440
4 4.31013 4.37462 4.50611 4.64100 4.77933
5 5.52563 5.63709 5.86660 6.10510 6.35285
6 6.80191 6.97532 7.33592 7.71561 8.11519
7 8.14201 8.39384 8.92280 9.48717 10.08901
8 9.54911 9.89747 10.63663 11.43589 12.29969
9 11.02656 11.49132 12.48756 13.57948 14.77566
10 12.57789 13.18079 14.48656 15.93743 17.54874

Present Value of an Ordinary Annuity of 1
Period 5% 6% 8% 10% 12%
1 .95238 .94340 .92593 .90909 .89286
2 1.85941 1.83339 1.78326 1.73554 1.69005
3 2.72325 2.67301 2.57710 2.48685 2.40183
4 3.54595 3.46511 3.31213 3.16986 3.03735
5 4.32948 4.21236 3.99271 3.79079 3.60478
6 5.07569 4.91732 4.62288 4.35526 4.11141
7 5.78637 5.58238 5.20637 4.86842 4.56376
8 6.46321 6.20979 5.74664 5.33493 4.96764
9 7.10782 6.80169 6.24689 5.75902 5.32825
10 7.72173 7.36009 6.71008 6.14457 5.65022

Use the following information for questions 27 through 32.

On January 1, 2015, Yancey, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Holt Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement.
(a) The agreement requires equal rental payments at the beginning each year.
(b) The fair value of the building on January 1, 2015 is $3,000,000; the book value to Holt is also $3,000,000.
(c) The building has an estimated economic life of 10 years, with no residual value. Yancey depreciates similar buildings on the straight-line method.
(d) At the termination of the lease, the title to the building will be transferred to the lessee.
(e) Yancey’s incremental borrowing rate is 11% per year. Holt Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Yancey, Inc.
(f) The yearly rental payment includes $8,000 of executory costs related to taxes on the property.

27. What is the amount of the minimum annual lease payment?
a. $443,851
b. $451,851
c. $488,236
d. $591,801

28. What is the amount of the total annual lease payment?
a. $443,851
b. $451,851
c. $488,236
d. $591,801

29. From the lessee’s viewpoint, what type of lease exists in this case?
a. Sales-type lease
b. Sale-leaseback
c. Capital lease
d. Operating lease
30. From the lessor’s viewpoint, what type of lease is involved?
a. Sales-type lease
b. Sale-leaseback
c. Direct-financing lease
d. Operating lease

31. Yancey, Inc. would record depreciation expense on this storage building in 2015 of (Rounded to the nearest dollar.)
a. $0.
b. $300,000.
c. $400,000.
d. $451,851.

32. If the lease were nonrenewable, there was no purchase option, title to the building does not pass to the lessee at termination of the lease and the lease were only for seven years, what type of lease would this be for the lessee?
a. Sales-type lease
b. Direct-financing lease
c. Operating lease
d. Capital lease

Use the following information for questions 33 and 34.
Metro Company, a dealer in machinery and equipment, leased equipment to Sands, Inc., on July 1, 2015. The lease is appropriately accounted for as a sales-type lease by Metro and as a capital lease by Sands. The lease is for a 8-year period (the useful life of the asset) expiring June 30, 2023. The first of 8 equal annual payments of $552,000 was made on July 1, 2015. Metro had purchased the equipment for $3,500,000 on January 1, 2015, and established a list selling price of $4,800,000 on the equipment. Assume that the present value at July 1, 2015, of the rent payments over the lease term discounted at 6% (the appropriate interest rate) was $4,000,000.

33. Assuming that Sands, Inc. uses straight-line depreciation, what is the amount of depreciation and interest expense that Sands should record for the year ended December 31, 2015?
a. $400,000 and $206,880
b. $250,000 and $103,440
c. $250,000 and $206,880
d. $240,000 and $103,440
34. What is the amount of profit on the sale and the amount of interest revenue that Metro should record for the year ended December 31, 2015?
a. $500,000 and $206,880
b. $500,000 and $103,440
c. $1,300,000 and $206,880
d. $1,300,000 and $103,440

35. Roman Company leased equipment from Koenig Company on July 1, 2015, for an eight-year period expiring June 30, 2023. Equal annual payments under the lease are $600,000 and are due on July 1 of each year. The first payment was made on July 1, 2015. The rate of interest contemplated by Roman and Koenig is 6%. The cash selling price of the equipment is $3,723,750 and the cost of the equipment on Koenig’s accounting records was $3,300,000. Assuming that the lease is appropriately recorded as a sale for accounting purposes by Koenig, what is the amount of profit on the sale and the interest income that Koenig would record for the year ended December 31, 2015?
a. $0 and $0
b. $0 and $187,425
c. $423,750 and $187,425
d. $423,750 and $93,712.50

1. Taxable income of a corporation differs from pretax financial in...