_____ A Swiss subsidiary follows the practice of recording a liability for potential future losses at its manufacturing location (which is not insured). The offsetting debit to income is in accordance with Swiss GAAP and is deductible under Swiss tax laws. The liability account had a balance of 500,000 francs at the beginning of 2006. During 2006, 100,000 francs were added to the account, and 40,000 francs were charged against the liability account as a result of fire damage from an accident. The Swiss income tax rate is 40%. The worksheet entry required at 12/31/06 to restate to U.S. GAAP would result in which of the following?
A) A decrease in net income by 40,000 francs.
B) A decrease in net income by 24,000 francs.
C) An increase in net income by 60,000 francs.
D) An increase in net income by 36,000 francs.
E) None of the above.

Question

Quizplus · Accepted Answer

Under U.S. GAAP, companies cannot recognize a liability for general or unspecified business risks, so the reserve for potential future losses that is permissible under Swiss GAAP must be reversed. The initial liability was 500,000 francs, with 100,000 francs added and 40,000 francs used for actual losses. The net addition to the liability in 2006 is 60,000 francs (100,000 added - 40,000 used). This amount would be reversed, increasing net income by 60,000 francs before tax. However, since the tax rate is 40%, the net increase in income after tax would be 60,000 francs * (1 - 0.40) = 36,000 francs.

_____ a Swiss Subsidiary Follows the Practice of Recording a Liability