Milzan Co., which began operations on January 1, Year 2, recognizes revenue from long-term construction contracts using the input method based on costs incurred in its financial statements and under the completed-contract method for income tax reporting. Under the completed-contract method, revenue and gross profit are recognized only upon completion of the project. Income under each method follows:

$162,500

Explanation:

Notice that 2 things have happened to date due to the difference in the way net income is computed normally and how it is computed for tax purposes, which is the temporary difference the question is alluding to:

Step 1. Income to date based on percentage completion

Year 2 - $300,000

Year 3 - $600,000

Year 4 -  $850,000

Total       $1,750,000

Step 2. Taxable income to date based on completed contract

Year 3 - $400,000

Year 4 - $700,000

Total     $1,100,000

Step 3. Computation of Temporary Difference

The temporary difference = Net Income - Taxable Income.

Hence Temporary Difference = $1,750,000 - $1,100,000 = $650,000

Therefore, Deferred Income Tax liability = Tax rate x Temporary difference

Deferred Income Tax liability = 25% x $650,000 = $162,500

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