Black Co., organized on January 2, year 1, had pretax accounting income of $500,000 and taxable income of $800,000 for the year ended December 31, year 1. The only temporary difference is accrued product warranty costs that are expected to be paid as follows:
Year 2 $100,000
Year 3 50,000
Year 4 50,000
Year 5 100,000
Black has never had any net operating losses (book or tax) and does not expect any in the future. There were no temporary differences in prior years. The enacted income tax rates are 35% for year 1, 30% for year 2 through year 4, and 25% for year 5. In Black�s December 31, year 1 balance sheet, the deferred income tax asset should be
$ 60,000
$ 70,000
$ 85,000
$105,000

$ 85,000

Explanation:

800,000 x 35% = 280,000 income tax payable

500,00 x 35% =   175,000 income tax expense

We solve for the deferred tax asset considering the tax-rates of each year:

Year 2:

warrant expense: $100,000

Tax Rate: 30%

Deferred Tax Asset: $30,000

Year 3:

warrant expense:  $50,000

Tax Rate: 30%

Deferred Tax Asset: $15,000

Year 4:

warrant expense:  $50,000

Tax Rate: 30%

Deferred Tax Asset:  $15,000

Year 5:

warrant expense: $100,000

Tax Rate: 25%

Deferred Tax Asset: $25,000

Total:

Future deductible amount: $300,000

Deferred Tax Asset: $85,000

the difference between the 85,000 deferred tax asset and the 105,000 generates a permanent difference in the order of 20,000 which decreases directly retained earnings as it is not an expense

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