With what method, companies are required to estimate the amount and effect of the yearend cumulative temporary differences including any amount of valuation allowance to be recorded against deferred…

Question

Options

• Aliability method
• BDeferred tax method
• CExpense method
• DPre-tax income method

• A
  82% (50)
• B
  2% (1)
• C
  5% (3)
• D
  11% (7)

Explanation

Option A (liability method) is correct because it is the approach prescribed under ASC 740 (US GAAP) where companies measure deferred tax assets and liabilities based on the enacted tax rates expected to apply when the temporary differences reverse - and it requires estimating year-end cumulative temporary differences and assessing whether a valuation allowance is needed against deferred tax assets if it is "more likely than not" they won't be realized.

Option B (Deferred tax method) is a distractor - while it sounds plausible, the "deferred method" is an older approach (APB 11) that used historical tax rates rather than enacted future rates and did not require reassessment of valuation allowances the same way; it has been superseded.

Option C (Expense method) is not a recognized formal standard for accounting for income taxes; it conflates the concept of tax expense with the measurement methodology.

Option D (Pre-tax income method) is not a standard tax accounting method; it describes an income line on the financial statements, not a procedure for calculating deferred taxes.

Memory tip: Think "L for Law" - the Liability method uses currently enacted law (tax rates) to measure what you legally owe or can recover in the future, which is why it governs valuation allowance assessments at year-end.

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