Question: (Identify Temporary Differences and Classification Criteria) The asset-liability approach for recording deferred income taxes is an integral part of generally accepted accounting principles.

Instructions: (a) Indicate whether each of the following independent situations should be treated as a temporary difference or as a permanent difference, and explain why.

(1) Estimated warranty costs (covering a 3-year warranty) are expensed for financial reporting purposes at the time of sale but deducted for income tax purposes when paid.

(2) Depreciation for book and income tax purposes differs because of different bases of carrying the related property, which was acquired in a trade-in. The different bases are a result of different rules used for book and tax purposes to compute the basis of property acquired in a trade-in.

(3) A company properly uses the equity method to account for its 30% investment in another company. The investee pays dividends that are about 10% of its annual earnings.

(4) A company reports a gain on an involuntary conversion of a nonmonetary asset to a monetary asset. The company elects to replace the property within the statutory period using the total proceeds so the gain is not reported on the current year's tax return.

(b) Discuss the nature of the deferred income tax accounts and possible classifications in a company's balance sheet. Indicate the manner in which these accounts are to be reported.