If an overstatement of depreciation by 100 and an understatement of accounts receivables by 40 causes a firm's net income to be understated by 70, the firm's tax rate is ________.
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A. B. C. D.D
An overstatement of depreciation by 100 causes the income to be understated by 100*(1-tax rate). Hence, tax rate = 30%.
To solve this problem, let's break it down step by step:
Start with the given information:
First, let's consider the effect of the overstatement of depreciation. Depreciation is a non-cash expense that reduces net income and taxable income. An overstatement of depreciation will decrease net income and, consequently, the amount of taxes paid.
In this case, since the overstatement of depreciation is 100 and it caused a net income understatement of 70, we can infer that the tax savings due to the overstatement of depreciation is 70. This means that the tax savings per dollar of overstatement is 70/100 = 0.7.
Next, let's consider the effect of the understatement of accounts receivables. An understatement of accounts receivables implies that revenue was not recognized or recorded properly, leading to a decrease in reported net income. However, this adjustment does not affect the taxable income since revenue is recognized for tax purposes when earned, regardless of whether it has been collected or not. Therefore, the understatement of accounts receivables does not have any impact on taxes.
Now, we can determine the tax rate. Since the overstatement of depreciation results in a tax savings of 0.7 per dollar of overstatement, we can set up the following equation:
Tax savings due to overstatement of depreciation = Overstatement of depreciation × Tax rate
Substituting the values: 0.7 = 100 × Tax rate
Solving for the tax rate: Tax rate = 0.7 / 100 = 0.007 = 0.7%
Therefore, the tax rate is 0.7%, which is not among the answer choices provided.
Based on the options given, it appears that there might be a typographical error in the original question or the answer choices. None of the answer choices align with the calculated tax rate.