LESSON 5 INCOME TAX

Tax CodeSEC Investors and Creditors FINANCIAL REPORTING Pretax Financial Income GAAP Income Tax Expense Taxable Income Income Tax Payable TAX REPORTING vs... INCOME COMPUTATION:Two sets

ACCOUNTING FOR INCOME TAXES

CHAPTER 16 INCOME TAXES

The concept of deferred taxes

 Permanent differences:

 Temporary differences.

Apply the concept & compute:

 Changes in Enacted Tax rates

 Use of Valuation Allowance

The Provisions of Tax loss carry-backs/forwards Financial statement presentation and disclosure

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Learning Objectives

FUNDAMENTAL REPORTING

Financial & Tax Reporting

FINANCIAL REPORTING

- Useful Information INCOME TAX SYSTEM: Equitable collection of revenue

Tax Code

SEC Investors and Creditors

FINANCIAL REPORTING

Pretax Financial Income

GAAP

Income Tax Expense

Taxable Income

Income Tax Payable

TAX REPORTING

vs.

≠

≠

Fundamentals of Accounting for Income Taxes

INCOME COMPUTATION:

Two sets of rules

 Pretax Financial (Accounting) Income:

– according to GAAP (FASB 109)

is income before income taxes for financial reporting purposes

 Taxable Income:

- according to IRS rules

is the amount of income on which the income tax is based

Therefore the above two income differ

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Depreciation GAAP: (based on estimated amount)

IRS: The Modified Accelerated Cost Recovery System (MACRS)

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DIFFERENT TAXABLE

A temporary difference

corporation’s pretax financial income & taxable income that “originates” in one or

more years and “reverses” in later years

Temporary Differences TIMMING DIFFERENCES

HOW IS ADVANCED SUBSCRIPTION

RECORDING ACCORDING TO:

 GAAP?

IRS?

For recording expense we need GAAP reporting For Income tax payment we need IRS rule

Is it possible for a company to have both deferred tax assets and deferred tax liability at the same time?

If so, How? Give Example!

Let’s Illustrate

STOP & THINK!

Types of Temporary Differences

Deferred tax liabilities

result in taxable amounts

in the future.

Deferred tax liabilities

result in taxable amounts

in the future.

Deferred tax assets

result in deductible

amounts in the future.

Deferred tax assets

result in deductible

amounts in the future.

Some items of revenue and expense that a corporation reports for financial accounting purposes are never reported for income tax

purposes These permanent differences never

reverse in a later accounting period.

Permanent Differences

∗ Examples of permanent book-tax differences

∗ Tax-exempt state and local bond interest

income

∗ Nondeductible expenses incurred to generate state and local bond interest income

∗ Life insurance proceeds (death benefits)

∗ 50% of meals and entertainment

∗ Political contributions

∗ Fines and penalties

∗ Bribes, kickbacks and illegal payments

∗ Dividends-received deduction: Certain

deductions

Professor Vedd

Book-Tax Differences – Permanent

CONT… PART II CHANGES IN TAX RATES

Professor Vedd

ACCOUNTING FOR INCOME

TAXES

CHAPTER 16 PART II

INCOME TAXES DEFERED TAX: WITH CHANGES IN

ENACTED TAX RATES

Tax Rate Considerations

 Deferred tax assets and liabilities should be determined using the future tax rates, if known

 The deferred tax asset or liability must be adjusted if a change in a tax law or rate occurs

∗ When a change in tax rate is enacted, its effect should be

recorded immediately

∗ The effect is reported as an adjustment to tax expense in the

period of change

∗ Changes in tax rates are treated just like any other change in estimate, prospectively

∗ See example following slide

16 Revision of Future Tax Rates

Net Operating Losses (NOL)

Tax laws often allow a company to use tax NOLs

to offset taxable income in earlier or subsequent

periods.

When used to offset earlier taxable

income:

 Called: operating loss carryback.

 Result: tax refund.

When used to offset future taxable

income:

 Called: operating loss

carryforward.

 Result: reduced tax payable.

Accounting for Net Operating Losses

Loss Carryback

Back 2 years and forward 20 years

Losses must be applied to earliest year first

Loss Carryforward

May elect to forgo loss carryback and

Carryforward losses 20 years

A company would most likely choose the carry-forward option for a net operating loss if the company expected higher tax rates in the future compared to the past

Disclose the following:

 Total of all deferred tax liabilities

 Total of all deferred tax assets

 Total valuation allowance recognized

 Net change in valuation account

 Approximate tax effect of each type of temporary difference (and carryforward)

Balance Sheet Classification

Deferred tax

assets/liabilities are

classified as current

or noncurrent based

on the classification

of the related asset

or liability.

is to recognize an asset or liability for the tax consequences of temporary differences that exist at the balance sheet date.

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INTERPERIOD/INTRAPERIOD INCOME TAX ALLOCATION

INTRAPERIOD:

The total income tax expense for a reporting period is allocated among

the financial statement items that gave rise to the income tax expense

The following items should be reported net of their respective income tax

effects:

• Income (or loss) from continuing operations

• Discontinued operations

• Extraordinary items

• Changes in accounting principle

• Prior period adjustments (to the beginning retained earnings balance)