Coop Incorporated owns 10 percent of Chicken Incorporated as an investment for trading. Coop's Chicken stock appreciated by $15,000 during the year. Both Coop and Chicken are corporations. Chicken pays Coop a dividend of $10,000 in the current year. Chicken also reports financial accounting earnings of $20,000 for that year. Assume Coop follows the general rule of accounting for investment in Chicken. What is the amount and nature of the book–tax difference to Coop associated with its investment in Chicken stock (ignoring the dividends received deduction)?

Question

BlackTom AI · Accepted Answer

We start by restating the scenario and all answer choices to ensure clarity about what is being evaluated.
Question: Coop Incorporated owns 10 percent of Chicken Incorporated as an investment for trading. Chicken stock appreciated by $15,000 during the year. Chicken pays Coop a dividend of $10,000 in the current year. Chicken reports financial accounting earnings of $20,000 for that year. Coop uses the general rule of accounting for investment in Chicken. Ignore the dividends received deduction. What is the amount and nature of the book–tax difference to Coop associated with its investment in Chicken stock?
Answer choices: "$1,000 unfavorable", "$10,000 favorable", "$15,000 unfavorable", "$15,000 favorable".

Now, analyze each option one by one.
Option 1: $1,000 unfavorable
To arrive at a $1,000 difference, one would have to combine some combination of current-year book income changes and tax effects that net to $1,000 and be of the opposite sign (unfavorable). However, the only explicit financial reporting event highlighted here that would create a book–tax timing difference is the unrealized gain on the trading securities ($15,000). There is no $1,000 figure in the data provided (no partial gain, no incremental effect drifting from the dividend or earnings that would create exactly $1,000). Therefore this option does not align with the given numbers.
Option 2: $10,000 favorable
The $10,000 figure corresponds to the dividend received from Chicken. Under many tax rules, dividends can create a tax effect, but we are instructed to ignore the dividends received deduction for this question. Since the dividend amount is explicitly stated and the problem asks specifically about the book–tax difference associated with the investment in Chicken stock under the general rule (and ignoring DRD), the $10,000 dividend does not drive the book–tax timing difference in this scenario. Therefore this option misattributes the source of the difference and is incorrect.
Option 3: $15,000 unfavorable
This option uses the $15,000 amount but labels the timing difference as unfavorable. When a trading investment’s unrealized gain is recorded in financial statements but not yet taxed for tax purposes, the book income is higher than taxable income in the current year, creating a taxable temporary difference. This difference, in most conventional corporate tax accounting, would be viewed as a deferred tax liability (a future tax cost), not an immediate unfavorable impact within the current year’s books. The labeling of the difference as unfavorable would imply current tax expense is higher or that the timing difference benefits the current year, which is not consistent with recognizing an unrealized gain on a trading investment that is not taxed until realization. Thus, the classification of $15,000 as unfavorable is not correct.
Option 4: $15,000 favorable
Here, the $15,000 figure corresponds exactly to the unrealized gain on the trading investment (the appreciation in Chicken stock). Under the general rule for investments in trading securities, such unrealized gains increase book income in the current year but do not increase taxable income until the gain is realized (sale). This creates a timing difference: higher book income now, lower current taxable income, and a deferred tax liability to be settled in a future period when the gain is taxed. In many introductory and intermediate tax contexts, this type of difference is described as a favorable book–tax difference for the current year because it reduces current taxes relative to book income (the tax consequence is deferred). Therefore, the $15,000 amount aligns with the described nature as a favorable timing difference.

Summary of reasoning for all options:
- The only numerical figure tied to the investment’s financial events is the $15,000 unrealized gain on Chicken stock.
- The $10,000 dividend is explicitly to be ignored for DRD purposes in this problem, so it does not drive the book–tax difference here.
- An unrealized gain on a trading security increases book income now but typically does not increase current year tax, creating a taxable (deferred) difference. This is conventionally characterized as favorable to the current year’s book–tax comparison, because taxes payable are lower now than book income would suggest, with recognition of the tax effect deferred to a future period.

As a result, among the given options, the one that matches both the amount ($15,000) and the described favorable timing nature is "$15,000 favorable".

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