2.18 Interpreting Income Tax Disclosures. Prepaid Legal Services (PPD) is a company that sells insurance for legal expenses. Customers pay premiums in advance for coverage over some specified period. Thus, PPD obtains cash but has unearned revenue until the passage of time over the specified period of coverage. Also, the company pays various costs to acquire customers (such as sales materials, commissions, and prepayments to legal firms that provide services to customers). These upfront payments are expensed over the specified period that customers' contracts span. Exhibit 2.12 provides information from PPD's income tax note. REQUIRED a. Assuming that PPD had no significant permanent differences between book income and taxable income, did income before taxes for financial reporting exceed or fall short of tax- able income for 2007? For 2008? Explain. b. Will the adjustment to net income for deferred taxes to compute cash flow from opera- tions in the statement of cash flows result in an addition or a subtraction for 2007? For 2008? c. PPD must report as taxable income premiums collected from customers, although the company defers recognizing them as income for financial reporting purposes until they are earned over the contract period. Why are deferred taxes related to deferred revenue disclosed as a deferred tax asset instead of a deferred tax liability? Suggest reasons for the direction of the change in amounts for this deferred tax asset between 2007 and 2008. d. Firms are generally allowed to deduct cash costs on their tax returns, although they might defer some of these costs for financial reporting purposes. As noted above, PPD defers various costs associated with obtaining customers. Why are deferred taxes related to this item disclosed as a deferred tax liability? Suggest reasons for the direction of the change in amounts for this deferred tax asset between 2007 and 2008. e. Like most companies, PPD uses the straight-line depreciation method for financial report- ing and accelerated depreciation methods for income tax purposes. Why are deferred LO 2-3