Here's the problem;

Cahn Co. applies straight-line amortization to its organization costs for income tax purposes, but expenses all costs as incurred for financial statement reporting. For tax purposes a 15-year period is used. Cahn has no other temporary differences, has an operating cycle of less than 1 year, and has taxable income in all years. Cahn should report both current and noncurrent deferred income tax assets at the end of:

Answer:

YR1.................YR2

YES................NO

This is the explanation:

Yes - Year 1; No - Year 14. Since there is no related balance sheet account the deferred income tax asset is classified based upon its expected reversal date. In Year 1 a portion of the deferred income tax asset will reverse during the year, therefore it must be classified, as current while the balance will reverse in subsequent years. In Year 14 the remaining deferred income tax asset is classified as current since no deferred income tax asset will reverse in more than one year.

My view:

This really threw me off just because I never heard of straight line amortization for tax purposes. I suppose it does not matter how a company wishes to assess their tax expense; the Tax Return remains at cash basis.

So if expenses are recognized when incurred on the I/S and when paid in the tax Return, it could result in both a DTA or a DTL

A DTA from warraty liability (recognized as expense on I/S)

OR

DTL that could be related to the amortization of equipment i.e. Amortization Expense.

However, i do not understant how the reversal of the DTA works out here

Please help...

For tax purposes organizational costs must be amortized over 180 months (15 years). For financial reporting purposes such costs would be expensed in the same year they were incurred.

The DTA exists because right now your income tax liability is higher than your income tax expense (because your expenses under financial reporting are higher than under tax). So it's this entry:

Income tax expense DR xxx

DTA DR xxx

Income tax liability CR xxx

Over time this DTA will reverse and income tax expense will be higher than income tax liability (because that big fat expense you would have incurred in year 1 under financial reporting would not be recognized in the F/S in subsequent years, but would be recognized in the tax filings). The reversal is as follows:

Income tax expense DR xxx

DTA CR xxx

Income tax liability CR xxx

That is much more clear cut, thank you!

Now I'm just left wondering about the question asking when to record the DTA as current and noncurrent.

My understanding is costs are expenses, and expenses are current for the period in which they are incurred. 

In this example, the organization costs are not related to an asset or liability on the B/S. The costs are related to a current expense. With that in mind, shouldn't the DTA be classified also current throughout the 15 years?

The current portion would be the portion which is expected to reverse within one year (or the operating cycle, whichever is longer).

The noncurrent portion is the remainder.

In year 14, there is no noncurrent portion because in year 15 the organizational expenses will have been fully amortized for tax purposes.

I'm starting to see it now, it's a little challenging to do so without numbers

Something in a smaller scale. What if the costs were $600 and say a 4yr period was allowed to amortize the costs:

...............YR1..........YR2............YR3.........YR4

DTA.........600..........(200)......... (200).......(200)

Current ....200..........200.............200...........0

Non-C .....400...........200..............0

Would this be what the flow out of the DTA look like?

Thank you for your help