Question

Dexter Company appropriately uses the asset-liability method to record deferred income taxes. Dexter reports depreciation expense for certain machinery purchased this year using the modified accelerated cost recovery system (MACRS) for income tax purposes and the straight-line basis for financial reporting purposes. The tax deduction is the larger amount this year. Dexter received rent revenues in advance this year. These revenues are included in this year’s taxable income. However, for financial reporting purposes, these revenues are reported as unearned revenues, a current liability. Instructions (a) What are the principles of the asset-liability approach?

Short answer

MACRS, i.e., Modified Accelerated Cost Recovery System, is the type of depreciation system used forfixed assets like machinery so that its purchase cost can be realized upon its depreciation expense.

Step-by-step solution

Introduction

The asset-liability approach under the income tax deals with the following principles while calculating the amount of income tax expense.

Principles of the asset-liability approach

1. The amount of tax expense for the current year will be recognized under the estimated income tax payable.
2. Organizations should recognize their deferred tax assets and liabilities.
3. The amount of deferred tax assets should be reduced to recognize the income tax.