Question

Klapper Company claimed a tax deduction which was uncertain when it was deducted in 2018 but is relatively certain of receiving the deduction over a five-year period. Which of the following is not correct in accounting for the uncertain tax item?
a. A contingency reserve will be set up at the same amount as the deferred tax asset if the firm is certain it may claim 100% of the deduction over time.
b. Income tax expense in the first year is the current portion of income tax expense minus the increase in the deferred tax asset.
c. The contingency reserve is reduced each year with the offset to the deferred tax account.
d. As the company will ultimately get 100% of the deduction, no contingency reserve is required.

Answer 1

Answer: d. As the company will ultimately get 100% of the deduction, no contingency reserve is required.

Explanation:

Just because the company will eventually get 100% of the deduction does not mean that no contingency reserve is required.

A contingency reserve needs to be created that is the same amount as the deferred tax asset which arises from the claimed deduction and deducted from every year to offset the deduction for that particular year until the 5 years have elapsed.