All of the following are examples of items that may create temporary book-tax differences except __.
A Depreciation
B Dividend received deduction
C Product warranty
D Installment sales
The correct answer and explanation is:
Correct Answer: B. Dividend received deduction
Explanation (300 words):
In accounting, book-tax differences refer to the differences between the income reported on financial statements (book income) and the income reported on tax returns (taxable income). These differences can be temporary or permanent.
- Temporary differences arise when income or expenses are recognized in different periods for book purposes and tax purposes but will eventually reverse over time.
- Permanent differences, on the other hand, never reverse because they result from items that are either included in book income and never in taxable income (or vice versa).
Let’s evaluate the options:
A. Depreciation
This is a classic example of a temporary difference. For book purposes, companies often use straight-line depreciation, whereas for tax purposes, accelerated methods (like MACRS) may be used. This results in temporary timing differences that reverse over the life of the asset.
B. Dividend received deduction (DRD)
This is a permanent difference. The DRD allows corporations to deduct a portion of dividends received from other domestic corporations (usually 50%, 65%, or 100%, depending on ownership). This deduction does not affect book income, only taxable income, and never reverses, making it a permanent difference.
→ Thus, this is NOT an example of a temporary difference.
C. Product warranty
Warranty expenses are estimated and recorded for book purposes when the sale occurs (based on matching principle), but they are only deductible for tax purposes when paid. This timing difference is temporary and will reverse when the actual payments are made.
D. Installment sales
Revenue from installment sales may be recognized for book purposes when the sale occurs, but for tax purposes, it may be recognized as payments are received. This again is a temporary difference.
✅ Conclusion:
The only permanent difference here is the dividend received deduction, making B the correct answer.