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Tax liability is an amount that a company or individual owes to the government as a result of the income earned. In the case of Rosty Co., to calculate the tax liability, one must look at the taxable income which is different from the pre-tax income reported on financial statements. The taxable income considers adjustments such as tax and book depreciation.

For instance, in 2000, the calculation involved determining the tax base income, which is found by adjusting the pre-tax income with book and tax depreciation. The formula can be expressed as:

• Tax base income = Pre-tax income + Book depreciation - Tax depreciation.

In this example, the tax base income for 2000 was calculated as 5 million dollars. Applying the tax rate of 30%, the tax liability was found to be 1.5 million dollars. This represents the firm's obligation for that year in terms of immediate taxes payable to the government.

Income tax expense reflects the total tax cost attributable to the year reported in the income statement. It includes more than just the immediate tax liability, as it also takes into account future tax impacts shown by deferred tax liabilities or assets from differences in book and taxable income.

For Rosty Co., income tax expense for 2000 was derived by summing up the current tax liability with the change in deferred tax amounts. The key consideration here is that deferred taxes account for future impacts due to temporary differences in financial versus tax reporting, such as depreciation. The income tax expense can be expressed as:

• Income Tax Expense = Tax Liability + Change in Deferred Tax Liability.

In Rosty's situation, the calculated tax expense for 2000 was 7.5 million dollars, combining 1.5 million dollars of tax liability and a 6 million adjustment related to the deferred tax asset.

The book-tax basis difference arises from using different rules for financial reporting and tax reporting. These differences affect how assets and liabilities are valued on financial statements compared to how they are represented on tax returns. For companies like Rosty Co., this often revolves around the varying treatment of depreciation.

Such differences may be temporary and lead to either deferred tax liabilities or assets, impacting future tax obligations. In Rosty's 2000 financials, the book depreciation was 30 million dollars, while for tax purposes, the depreciation was 50 million dollars. This resulted in a negative book-tax basis difference of -20 million dollars. This negative difference was significant as it introduced a potential tax benefit to be recognized in future periods, hence identifying a deferred tax asset.

The use of a book-tax basis difference is pivotal as it helps in understanding the timing differences that affect the computation of both current and future tax expenses, guiding better financial planning and reporting.