Phyllis, Inc., earns book net income before tax of $600,000. Phyllis puts into service a depreciable asset this year, and first year tax depreciation exceeds book depreciation by $120,000. Phyllis has recorded no other temporary or permanent book-tax differences. Assuming that the U.S. tax rate is 21%, what is Phyllis's deferred income tax liability reported on its GAAP financial statements?

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BlackTom AI · Accepted Answer

We start by restating the scenario to keep the numbers straight: Phyllis, Inc. has book net income before tax of 600,000. First-year tax depreciation exceeds book depreciation by 120,000. The effect is a temporary difference of 120,000 between tax and book depreciation, with the tax rate at 21%. Now evaluate each answer option by tracing current tax effect and the deferred tax consequence.

Option A: 151,200. To see if this could be a deferred tax liability, convert the 120,000 timing difference to a tax amount using 21%: 120,000 × 0.21 = 25,200. This is the typical deferred tax liability amount, not 151,200. The figure 151,200 would imply a much larger impact than the given 120,000 timing difference or miscalculation of current tax, so this option is inconsistent with the described timing difference.

Option B: 126,000. This would correspond to applying 21% to 6,000, or some other misapplied base; however, the only stated timing difference is 120,000, and the proper deferred tax on that difference is 25,200. There is no justification for 126,000 in this context because it does not align with 21% × 120,000. Therefore this option is incorrect.

Option C: 100,800. This value matches the current-year income tax payable if you apply 21% to the taxable income (600,000 − 120,000 = 480,000; 480,000 × 0.21 = 100,800). But this figure represents the current tax payable, not the deferred tax liability. The question asks for the deferred income tax liability to be reported on GAAP financial statements, not the current tax payable, so this option mixes up concepts and is incorrect in context.

Option D: 25,200. This is 21% × 120,000, which corresponds exactly to the deferred tax liability arising from the temporary taxable difference where tax depreciation exceeds book depreciation by 120,000. In other words, the difference will reverse in future periods, creating a liability for future taxes; the amount to reflect that liability on the GAAP balance sheet is 25,200. This aligns with standard practice for recognizing deferred tax liabilities on taxable temporary differences.

In summary, the key reasoning hinges on identifying the correct category of tax effect: the 120,000 timing difference creates a deferred tax liability, calculated as 0.21 × 120,000 = 25,200. The other options either represent current tax payable (not deferred), misrepresent the magnitude, or blur the distinction between current tax and deferred tax.

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