SOLUTIONS

1. C is correct. Because the differences between tax and financial accounting will correct over time, the resulting deferred tax liability, for which the expense was charged to the income statement but the tax authority has not yet been paid, will be a temporary difference. A valuation allowance would only arise if there was doubt over the company's ability to earn sufficient income in the future to require paying the tax.
2. A is correct. The taxes a company must pay in the immediate future are taxes payable.
3. C is correct. Higher reported tax expense relative to taxes paid will increase the deferred tax liability, whereas lower reported tax expense relative to taxes paid increases the deferred tax asset.
4. B is correct. If the liability is expected to reverse (and thus require a cash tax payment) the deferred tax represents a future liability.
5. A is correct. If the liability will not reverse, there will be no required tax payment in the future and the “liability” should be treated as equity.
6. C is correct. The deferred tax liability should be excluded from both debt and equity when both the amounts and timing of tax payments resulting from the reversals of temporary differences are uncertain.
7. C is correct. Accounting items that are not deductible for tax purposes will not be reversed and thus result in permanent differences.
8. C is correct. Tax credits that directly reduce taxes are a permanent difference, and permanent differences do not give rise to deferred tax.
9. A is correct. The capitalization will result in an asset with a positive tax base and zero carrying value. The amortization means the difference is temporary. Because there is a temporary difference on an asset resulting in a higher tax base than carrying value, a deferred tax asset is created.
10. B is correct. The difference is temporary, and the tax base will be lower (because of more rapid amortization) than the carrying value of the asset. The result will be a deferred tax liability.
11. A is correct. The advances represent a liability for the company. The carrying value of the liability exceeds the tax base (which is now zero). A deferred tax asset arises when the carrying value of a liability exceeds its tax base.
12. B is correct. The income tax provision in 2007 was $54,144, consisting of $58,772 in current income taxes, of which $4,628 were deferred.
13. B is correct. The effective tax rate of 30.1 percent ($56,860/$189,167) was higher than the effective rates in 2005 and 2007.
14. A is correct. In 2007 the effective tax rate on foreign operations was 24.2 percent [($28,140 + $124)/$116,704] and the effective US tax rate was [($30,632 − $4,752)/$88,157] = 29.4 percent. In 2006 the effective tax rate on foreign operations was 26.2 percent and the US rate was 35.9 percent. In 2005 the foreign rate was 24.1 percent and the US rate was 35.5 percent.
15. B is correct. The valuation allowance is taken against deferred tax assets to represent uncertainty that future taxable income will be sufficient to fully utilize the assets. By decreasing the allowance, Zimt is signaling greater likelihood that future earnings will be offset by the deferred tax asset.
16. C is correct. The valuation allowance is taken when the company will “more likely than not” fail to earn sufficient income to offset the deferred tax asset. Because the valuation allowance equals the asset, by extension the company expects no taxable income prior to the expiration of the deferred tax assets.
17. A is correct. A lower tax rate would increase net income on the income statement, and because the company has a net deferred tax liability, the net liability position on the balance sheet would also improve (be smaller).
18. C is correct. The reduction in the valuation allowance resulted in a corresponding reduction in the income tax provision.
19. B is correct. The net deferred tax liability was smaller in 2007 than it was in 2006, indicating that in addition to meeting the tax payments provided for in 2007 the company also paid taxes that had been deferred in prior periods.
20. C is correct. The income tax provision at the statutory rate of 34 percent is a benefit of $112,000, suggesting that the pre-tax income was a loss of $112,000/0.34 = ($329,412). The income tax provision was $227,000. ($329,412) − $227,000 = ($556,412).
21. C is correct. Accounting expenses that are not deductible for tax purposes result in a permanent difference, and thus do not give rise to deferred taxes.
22. B is correct. Over the three-year period, changes in the valuation allowance reduced cumulative income taxes by $1,670,000. The reductions to the valuation allowance were a result of the company being “more likely than not” to earn sufficient taxable income to offset the deferred tax assets.