Intermediate accounting 17e stice skousen cengage chapter 16

Income Taxes Payable continues Example 1: Simple Deferred Tax Liability... Permanent and Temporary Differences Temporary differences are caused by differences between pretax financial

Intermediate Accounting,17E

Stice | Stice | Skousen

Income Taxes

• The primary goal of financial accounting is

to provide useful information to

management, stockholders, creditors, and

others properly interested

• The primary goal of the income tax system is

the equitable collection of revenue

Deferred Income Tax Overview

Two basic considerations in U.S

corporations’ computed net income:

1 How to account for revenues and expenses

that have already been recognized and reported to shareholders in a company’s financial statements but will not affect taxable income until subsequent years

Deferred Income Tax Overview

Deferred Income Tax Overview

2 How to account for revenues and expenses

that have already been reported to the IRS

but will not be recognized in the financial

statements until subsequent years

In 2011, Ibanez Company earned revenues of

$30,000 Ibanez has no expenses other than

income taxes In this case, Ibanez is taxed on cash received The company received $10,000

in 2011 and $20,000 in 2012 The income tax rate is 40% and it is expected to remain the

same into the foreseeable future

Example 1: Simple Deferred Tax

Liability

Income Taxes Payable

(continues)

Example 1: Simple Deferred Tax

Liability

Ibanez Company

Income Statement For the Year Ended December 31, 2011

In 2011, Gupta Company generated service

revenues totaling $60,000, all taxable in 2011

No warranty claims were made in 2011, but

Gupta estimates that in 2012 warranty costs of

$10,000 will be incurred for claims related to

2011 service revenues Assume a 40% tax rate

(continues)

Example 2: Simple Deferred Tax

Liability

Income Tax Expense 20,000

Deferred Tax Asset 4,000

Income Taxes Payable

Gupta Company

Income Statement For the Year Ended December 31, 2011

Permanent differences are caused by specific provisions of the tax law that exempt certain

types of revenues from taxation and prohibit the deduction of certain types of expenses

 Nontaxable revenue—proceeds from insurance

policies; interest received on municipal bonds

 Nondeductible expenses—fines for violations of laws; payment of insurance premiums

Permanent and Temporary Differences

Permanent and Temporary Differences

Temporary differences are caused by

differences between pretax financial income

and taxable income that arises from business

events that are recognized for both financial

reporting and tax purposes but in different time periods

 Using ACRS for tax purposes and straight-line

depreciation for accounting purposes

For the year ended December 31, 2011,

Monroe Corporation reported net income

before taxes of $420,000 This amount

includes $20,000 of nontaxable revenues and

$5,000 of nondeductible expenses The

depreciation method used for tax purposes

allowed a deduction that exceeded the book

approach by $30,000

Illustration of Permanent and

Temporary Differences

Add (deduct) temporary differences:

Excess of tax depreciation over

Illustration of Permanent and

Temporary Differences

• The permanent differences are not included in

either the financial income subject to tax or

the taxable income

• In general, the accounting for temporary

differences is referred to as interperiod tax

allocation

Annual Computation of Deferred Tax

Liabilities and Assets

• FASB Statement No 109 reflects the Board’s

preference for the asset and liability method

of interperiod tax allocation, which

emphasizes the measurement and reporting

of balance sheet amounts

• One drawback of this method is that it is too

complicated

Annual Computation of Deferred Tax

Liabilities and Assets

Advantages of the asset and liability method:

with FASB definitions of financial statement elements.

circumstances and adjusts the reported amounts accordingly.

Establish valuation allowance account if more

likely than not some portion or all of the deferred tax asset will not be realized.

Measure the deferred tax

liability for taxable temporary differences (use

enacted rates).

Measure the deferred tax asset for deductible temporary differences (use

enacted rates).

Annual Computation of Deferred Tax

Liabilities and Assets

Identify type and amounts of existing

temporary differences.

For 2011, Roland computes pretax financial income of

$75,000 The only difference between financial and taxable income is depreciation Roland uses the straight-line method

of depreciation for financial reporting purposes and ACRS on its tax return The depreciation amounts for 2011 through

2014 are:

Example 3: Deferred Tax Liability

The enacted tax rate for 2011 and future years is

40% Roland’s taxable income is $60,000, computed

as follows:

Financial income subject to tax

$75,000

Deduct temporary difference:

Excess of tax depreciation ($40,000)

over book depreciation ($25,000) (15,000)

Taxable income

Example 3: Deferred Tax Liability

Income Tax Expense 30,000

Income Taxes Payable

Roland earns financial income of $75,000 in each of

the years 2012 through 2014 Roland reports taxable income of $70,000, computed as follows:

Financial income subject to tax

$75,000

Deduct temporary difference:

Excess of tax depreciation ($30,000)

over book depreciation ($25,000) (5,000)

Income Tax Expense 30,000

Income Taxes Payable

Tax Liability—

Noncurrent

Journal Entry for 2012

Journal Entry for 2012

$28,000 current + $2,000 deferred

Example 3: Deferred Tax Liability

Depreciation expense in 2013 is the same for both financial and tax, so the entry is simple

Income Tax Expense 30,000

Income Taxes Payable

For 2014, Roland earns income of $75,000 and the

taxable income is $95,000, computed as follows:

Financial income subject to tax

$75,000

Add temporary difference:

Excess of book depreciation

($25,000) over tax depreciation

20,000Tax ($95,000 × 0.40)

Example 3: Deferred Tax Liability

Income Tax Expense 30,000

Deferred Tax Liability—Noncurrent 8,000

Income Taxes Payable

38,000

Journal Entry for 2014

Journal Entry for 2014

Example 3: Deferred Tax Liability

Example 4: Deferred Tax Asset

For 2011, Sandusky Inc computes pretax financial income of $22,000 The only difference between

financial and taxable income is Sandusky accruing

warranty expense in the year of the sale for financial reporting For tax purpose, it deducts only actual

expenditures Actual warranty expense for 2011 was

$18,000; no actual warranty expenditures were

made in 2011.

(continues)

Example 4: Deferred Tax Asset

Taxable income for 2011 is computed as

follows:

Financial income subject to tax

$22,000

Add temporary difference:

Excess of warranty expense over

warranty deductions

18,000

Taxable incomeTaxable income ($40,000 × 0.40)$16,000

Example 4: Deferred Tax Asset

Deferred Tax Asset—

Income Taxes Payable

Journal Entry for 2011

Journal Entry for 2011

2/3 × $7,200

$16,000 current – $7,200 deferred benefits

(continues)

Income before income taxes

$22,000

Deferred Tax Asset—

8,800

Sandusky’s 2011 income statement would

present income tax expense as follows:

Example 4: Deferred Tax Asset

Reversal of temporary difference:

Excess of warranty deductions

Example 4: Deferred Tax Asset

The following table illustrates the journal

entries that would be made each year:

For 2011, Hsieh reported pretax financial

income of $38,000 As of December 31, 2011,

the actual depreciation expense was $25,000

and the actual warranty expense was $18,000

For income tax reporting, these expenses were

$40,000 and $0, respectively The table on

Slide 16-35 summarizes 2012 through 2014.

(continues)

Example 5: Deferred Tax Liabilities

and Assets

Example 5: Deferred Tax Liabilities

and Assets

Add (deduct) temporary differences:

Excess of warranty expense

18,000

Excess of tax depreciation over

book depreciation (15,000)

Income Tax Expense 16,400

Income Taxes Payable

16,400

Journal Entry for 2011 Journal Entry for 2011

Deferred Tax Asset—Current 2,400

Deferred Tax Asset—Noncurrent 4,800

Income Tax Benefit

1,200

Deferred Tax Liability—

Example 5: Deferred Tax Liabilities

and Assets

A subtraction from

• The tax benefit will be realized only if there is

sufficient taxable income from which the deductible amount can be deducted.

• Statement No 109 requires that the deferred tax

asset be reduced by a valuation allowance, a contra asset account that reduces the asset to its expected realizable value.

Valuation Allowance for Deferred Tax

Assets

Some possible sources of taxable income to be

considered in evaluating the realizable value of a

deferred tax asset are as follows:

Valuation Allowance Under

IAS 12

Under the provisions of IAS 12, there is no

valuation allowance Instead, deferred tax assets are recognized only “to the extent that it is

probable that taxable profit will be available

against which the deductible temporary

difference can be utilized.”

Accounting for Uncertain Tax

Positions

Case 1: Highly Certain Tax Position

Case 1: Highly Certain Tax Position

If the probability that the tax benefit of $100 would be greater than 50%, this would be

deemed a “highly certain” position In other words, it is more likely than not that the

position taken and the amount in question

would be upheld if reviewed

Accounting for Uncertain Tax

Positions

Case 2: Uncertain Tax Position—

More Likely Than Not

Case 2: Uncertain Tax Position—

More Likely Than Not

Assume the following assessment of

probabilities:

(continues)

Accounting for Uncertain Tax

Positions

If Company A determines that the technical merits of its

position exceed the more-than-not threshold (cumulative

probability becomes greater than 50%), the amount of tax

benefit to be recognize for financial statement purposes is $60.

Accounting for Uncertain Tax

Positions

The required journal entry is as follows:

Unrecognized Tax Benefit

Accounting for Uncertain Tax

Positions

Case 3: Uncertain Tax Position—

NOT More Likely Than Not

Case 3: Uncertain Tax Position—

NOT More Likely Than Not

If the company determines that it is not more

likely than not that the tax position will be

sustained, then the entire amount of the position

must be recognized as a liability

Unrecognized Tax Benefit

Carryback and Carryforward of

Operating Losses

Loss Year

Year

–2

Year +20

Carryback Election

Carryforward Election

Net operating loss carryback is applied to the preceding two years in

reverse order

Net operating loss carryforward

is applied to income over the

next 20 years

Net Operating Loss (NOL)

Carryback

Journal Entry in 2012:

Income Tax Benefit from NOL

Carryback

Prairie Company had the following pattern of income and losses for 2010 through 2012:

Net Operating Loss (NOL)

Carryforward

Continuing with the Prairie Company illustration from Slide

16-47 , assume that in 2013 the firm incurred an operating loss of

$35,000

Year

Income (Loss) Tax Rate

Income Tax

The only loss remaining against which operating income can

be applied is $5,000 from 2011 This leaves $30,000 to be

carried forward from 2013 as a future tax benefit of $9,000

($30,000 × 30).

(continues)

Accounting for NOL Carryforward

Income Tax Refund Receivable 1,500

Deferred Tax Asset—NOL

Income Tax Benefit from NOL Carryback

1,500

Income Tax Benefit from NOL

The journal entry for 2013 to record the tax

benefits:

Current asset if

Journal Entry in 2014:

Income Taxes Payable

Accounting for NOL Carryforward

(continues)

• If, however, it is more likely than not that some

portion or all of the deferred tax asset will not be

realized, a valuation allowance account is needed.

• To illustrate, assume that Prairie Company’s

management believes that losses will continue in

the future and the tax benefit will not be realized

As a result, management believes it is more likely than not that none of the asset will be realized.

Accounting for NOL Carryforward

Income Tax Refund Receivable 1,500

Deferred Tax Asset—NOL

Accounting for NOL Carryforward

The journal entry to record the carryback and carryforward would be as follows:

Scheduling for Enacted Future

Tax Rates

• Proper recognition of deferred tax assets and

liabilities is required when future tax rates are

expected to differ from current tax rates.

• The firm must determine the temporary differences

that will reverse.

scheduling through the “more-likely-than-not”

criterion for future income.

Financial Statement Presentation and

Disclosure

The income statement must show, either in the

body of the statement or in a note, the following components of income taxes related to continuing operations.

(continues)

5 Benefits of operating loss carryforwards

for enacted changes in tax laws or rates or a

change in the tax status of an enterprise

allowance because of a change in circumstancesFinancial Statement Presentation and

Disclosure

International Accounting for Deferred

Taxes

differences are ignored Income tax expense

equal to the amount of tax payable for the year is reported.

taxes are included in the computation of income tax expense and reported on the balance sheet.

(continues)

International Accounting for Deferred

Taxes

liability is recorded only to the extent that the

deferred taxes are actually expected to be paid in the future.