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CFA Level I · CFA Level I Exam · Analysis of Income Taxes

A company has a deferred tax liability of 90,000 measured at a 30% tax rate. Legislation enacted during the year lowers the future tax rate to 25%, with no change in the temporary differences. The effect on the company's reported results is most likely:

The underlying temporary difference is 300,000, so at 25% the liability falls from 90,000 to 75,000. The 15,000 reduction is recognized through income tax expense, which lowers expense and raises net income in the period the rate change is enacted.

  1. Aa 15,000 decrease in the deferred tax liability and a lower income tax expenseCorrect
  2. Ba 15,000 increase in the deferred tax liability and a higher income tax expense
  3. Ca 15,000 decrease in the deferred tax liability with no effect on income tax expense

Explanation

Temporary difference = 90,000 / 0.30 = 300,000. Revised liability = 300,000 x 25% = 75,000, a decrease of 15,000. The adjustment runs through income tax expense, reducing it and raising net income. The option claiming no expense effect ignores that the remeasurement is recognized in profit or loss.

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