Multiple Choice
1. A permanent difference is a difference between pretax financial income and taxable income in an accounting period that will never reverse in a later period. Which of the following is not an example of a permanent difference?
a. Fine for air pollution
b. Percentage depletion in excess of cost depletion on a wasting asset
c. Interest on municipal bonds
d. Rent received in advance

2. Prior to and during 2007, the Shadrach Company reported tax depreciation at an amount higher than the amount of financial depreciation, resulting in a book value of the depreciable assets of $24,500 for financial reporting purposes and of $20,000 for tax purposes at the end of 2007. In addition, the company recognized a $3,500 estimated liability for legal expenses in the financial statements during 2007; it expects to pay this liability (and deduct it for tax purposes) in 2011. The current tax rate is 30%, no change in the tax rate has been enacted, and the company expects to be profitable in future years. What is the amount of the net noncurrent deferred tax liability at the end of 2007?
a. $300
b. $450
c. $1,050
d. $1,350

3. Which of the following is an argument in favor of the asset/liability method of interperiod income tax allocation?
a. Deferred taxes are the result of historical transactions and should be reported in a similar manner.
b. Tax effects should be recorded in the same manner as all other revenue and expense transactions that involve changes in specific asset and liability accounts.
c. The predictive value of future cash flows, liquidity, and financial flexibility are increased when deferred taxes are reported based on enacted tax rates that will be in effect when the temporary differences reverse.
d. Historical tax rates are more verifiable and, therefore, the deferred tax amount is more reliable.

4. At the beginning of 2007, Conley Company purchased an asset at a cost of $10,000. For financial reporting purposes, the asset has a four-year life with no residual value, and is depreciated by the straight-line method beginning in 2007. For tax purposes, the asset is depreciated under MACRS using a five-year recovery period. Prior to 2007, the company had no deferred tax liability or asset. The difference between depreciation for financial reporting purposes and income tax purposes is the only temporary difference between pretax financial income and taxable income. The current income tax rate is 30% and no change in the tax rate has been enacted for future years. In 2007 and 2008, taxable income will be higher or lower than financial income by what amount?

5. Brooks Company reported a prior period adjustment of $12,000 in pretax financial €œincome€ and taxable income for 2008. The prior period adjustment was the result of an error in calculating bad debt expense for 2007. The current tax rate is 30% and no change in the tax rate has been enacted for future years. When the company applies intraperiod income tax allocation, the prior period adjustment will be
a. Shown on the income statement at $12,000
b. Shown on the income statement at $8,400 (net of $3,600 income taxes)
c. Shown on the retained earnings statement at $12,000
d. Shown on the retained earnings statement at $8,400 (net of $3,600 income taxes)

6. In 2007 Swope Company reports a pretax operating loss of $70,000 for both financial reporting and income tax purposes. Pretax financial income and taxable income for the previous three years had been: 2004€”$15,000 (tax rate 20%); 2005€”$24,000 (tax rate 25%); and 2006€”$49,000 (tax rate 30%). The current tax rate is 30% and no change in the tax rate has been enacted for future years. At the end of 2007 the journal entry recorded would contain an income tax benefit from an operating loss carryback of
a. $0
b. $18,300
c. $19,800
d. $19,950

7. FASB Statement No. 109 came to which of the following conclusions regarding interperiod income tax allocation?
a. The partial allocation approach should be applied.
b. The net-of-tax method of income tax allocation should be used.
c. Nonallocation of income tax expense is appropriate.
d. The asset/liability method of income tax allocation should be used.

8. Which of the following is not a cause of a difference between pretax financial income and taxable income in a given period?
a. Operating loss carrybacks and carryforwards
b. Permanent differences
c. Applicable tax rates
d. Temporary differences

9. Which component of current income is not disclosed on the income statement net of tax effects?
a. Extraordinary loss from flood
b. Gain on disposal of milling machine
c. Gain from sale of discontinued segment
d. Loss from operations of discontinued component

10. The Oliver Company earned taxable income of $7,500 during 2007, its first year of operations. A reconciliation of pretax financial income and taxable income indicated that an additional $2,500 of accelerated depreciation was deducted for tax purposes and that an estimated expense of $5,800 was deducted for financial reporting purposes. The estimated expense is not expected to be deductible for tax purposes until 2010, when the liability is paid. The current tax rate is 30% and no change in the tax rate has been enacted for future years. The resulting journal entry for 2007 wouldbe:

a. Income Tax Expense Deferred Tax Asset 1,260 1,740 Deferred Tax Liability 750 2,250 Income Taxes Payable Deferred Tax Asset Income Tax Expense b. Income Tax Expense 1,260 90 2,250 c. 3,240 Deferred Tax Liability Income Taxes Payable 2,250 d. Income Tax Expense 3,000 Deferred Tax Liability Income Taxes Payable 750 2,250