CFA Level IFinancial Statement AnalysisMedium
A company depreciates a machine using the straight-line method for financial reporting purposes, recording $100,000 of depreciation expense this year. For tax purposes, it uses an accelerated method, deducting $150,000 of tax depreciation this year. The company's tax rate is 30%. Assuming this is the only temporary difference, what deferred tax liability is created this year?
- A$5,000
- B$50,000
- C$15,000
- D$45,000
Show answer & explanationAnswer & explanation
Correct answer: C. $15,000
Because tax depreciation ($150,000) exceeds book depreciation ($100,000), taxable income is lower than pretax financial income, creating a temporary difference of $50,000 that will reverse in future years. The deferred tax liability equals the temporary difference times the tax rate: $50,000 × 30% = $15,000.
Why the other options are wrong
- A. Results from mistakenly applying a 10% rate instead of 30%.
- B. This is the temporary difference itself, not multiplied by the tax rate.
- D. Incorrectly applies the tax rate to total tax depreciation ($150,000) rather than the difference.
Deferred Tax Liability (Depreciation)
A deferred tax liability arises when tax depreciation exceeds book depreciation, causing taxable income to be temporarily lower than pretax financial income; it represents taxes that will be paid in future periods.
- DTL = Temporary difference × Tax rate
- Accelerated tax depreciation vs. straight-line book depreciation is a common source of DTLs
- The temporary difference reverses over the asset's life as book depreciation eventually exceeds tax depreciation
Memory trick: Tax deducts fast, liability grows last.