Solution manual intermediate accounting 7th by nelson spiceland ch16

Question 16–11 Regarding deferred tax amounts reported in the balance sheet, disclosure notes should indicate a the total of all deferred tax liabilities, b the total of all deferred ta

Chapter 16 Accounting for Income Taxes

AACSB assurance of learning standards in accounting and business education require

documentation of outcomes assessment Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment To aid faculty in this endeavor, we have labeled each

question, exercise, and problem in Intermediate Accounting, 7e, with the following AACSB learning

skills:

Questions AACSB Tags Exercises (cont.) AACSB Tags

16–1 Reflective thinking 16–6 Reflective thinking

16–11 Reflective thinking 16–16 Analytic, Reflective thinking

16–15 Diversity, Reflective thinking 16–20 Analytic

QUESTIONS FOR REVIEW OF KEY TOPICS

deductible amounts in some future year(s) when the related assets are recovered or the related liabilities are settled (when the temporary differences reverse) An example is the liability created when estimated warranty expense is recognized for financial reporting purposes When this liability

is settled, deductible amounts are produced because the warranty cost is then deducted for tax purposes The deferred tax liability or asset each year is the tax rate times the temporary difference

between the financial statement carrying amount of the receivable or liability and its tax basis

Question 16–3

Future deductible amounts mean that taxable income will be decreased relative to pretax accounting income in one or more future years Two examples are (a) estimated expenses that are recognized on income statements when incurred, but deducted on tax returns in later years when actually paid and (b) revenues that are taxed when collected, but are recognized on income statements in later years when actually earned These situations have favorable tax consequences that are recognized as deferred tax assets.

Question 16–4

Deferred tax assets are recognized for all deductible temporary differences and operating loss carryforwards However, a deferred tax asset is then reduced by a valuation allowance if it is “more likely than not” that some portion or the entire deferred tax asset will not be realized The decision

as to whether a valuation allowance is needed should be based on the weight of all available evidence.

Nontemporary or “permanent” differences are caused by transactions and events that under existing tax law will never affect taxable income or taxes payable Some provisions of the tax laws exempt certain revenues from taxation and prohibit the deduction of certain expenses Provisions of the tax laws, in some other instances, dictate that the amount of a revenue that is taxable or expense that is deductible permanently differs from the amount reported in the income statement Permanent differences are disregarded when determining both the tax payable currently and the deferred tax effect

Question 16–6

Examples of nontemporary or “permanent” differences are:

• Interest received from investments in bonds issued by state and municipal governments (not taxable)

• Investment expenses incurred to obtain tax-exempt income (not tax deductible)

• Life insurance proceeds upon the death of an insured executive (not taxable)

• Premiums paid for life insurance policies (not tax deductible)

• Compensation expense pertaining to some employee stock option plans (not tax deductible)

• Expenses due to violations of the law (not tax deductible)

• Portion of dividends received from U.S corporations that is not taxable due to the

“dividends received deduction”

• Tax deduction for depletion of natural resources (percentage depletion) that permanently exceeds the income statement depletion expense (cost depletion)

Question 16–7

A deferred tax liability (or asset) is based on enacted tax rates and laws Hudson should use the 35% rate, the currently enacted tax rate that will be effective in the year(s) the temporary difference reverses Calculations are not based on anticipated legislation that would alter the company’s tax rate

Question 16–8

When a change in a tax law or rate occurs, a deferred tax liability or asset must be adjusted to reflect the amount to be paid or recovered in the future If a deferred tax liability was established with the expectation that the future taxable amount would be taxed at 34%, it would now be adjusted

to reflect taxation at 36% instead The usual practice of recalculating the desired balance in a deferred tax liability each period, and comparing that amount with any previously existing balance automatically takes into account tax rate changes The effect is reflected in operating income (adjustment to income tax expense) in the year of the enactment of the change in the tax law or rate

Question 16–9

The income tax benefit of either an operating loss carryback or an operating loss carryforward

is recognized for accounting purposes in the year the operating loss occurs The net after-tax

operating loss reflects the reduction of past taxes from the loss carryback or future tax savings that the loss carryforward is expected to create

An operating loss carryforward creates future deductible amounts, so a deferred tax asset is recognized for an operating loss carryforward The deferred tax asset is then reduced by a valuation allowance if it is “more likely than not” that some portion or all of the deferred tax asset will not be realized due to insufficient taxable income expected in the carryforward years

Deferred tax assets and deferred tax liabilities are classified as either current or noncurrent

according to how the related assets or liabilities are classified for financial reporting For instance, a deferred tax liability arising from estimated warranty expenses would be classified as current if the warranty liability is classified as current A deferred tax asset or liability that is not related to a specific asset or liability should be classified according to when the underlying temporary difference

is expected to reverse

Question 16–11

Regarding deferred tax amounts reported in the balance sheet, disclosure notes should indicate (a) the total of all deferred tax liabilities, (b) the total of all deferred tax assets, (c) the total valuation allowance recognized for deferred tax assets, (d) the net change in the valuation allowance, and (e) the approximate tax effect of each type of temporary difference (and carryforward)

Question 16–12

Pertaining to the income tax expense reported in the income statement, disclosure notes should indicate (a) the current portion of the tax expense (or tax benefit), (b) the deferred portion of the tax expense (or tax benefit), with separate disclosure of amounts attributable to (c) the portion that does not include the effect of the following separately disclosed amounts, (d) operating loss carryforwards, (e) adjustments due to changes in tax laws or rates, (f) adjustments to the beginning- of-the-year valuation allowance due to revised estimates, and (g) investment tax credits.

GAAP creates a higher standard that tax benefits must meet before they can be recognized in a company’s financial statements The identified tax position must have a "more-likely-than-not" likelihood—a more than 50 percent chance—of being sustained on examination The concept of

"being sustained" means being capable of making it through the final level of appeal or litigation on the tax position's technical merits, assuming the examining jurisdictions have full knowledge of all facts and circumstances

Once a company concludes that a particular tax position has a "more likely than not" chance of being sustained, it should deal with step two in the FASB's model by measuring the dollar amount of benefit to recognize Specifically, it should follow the Board's "cumulative probability"

methodology under which companies will record in the financial statements the largest benefit that

cumulatively is greater than 50 percent likely to be sustained

Question 16–14

Intraperiod tax allocation means the total income tax obligation for a reporting period is

allocated among the income statement items that gave rise to the income tax The following items should be reported net of their respective income tax effects:

• Income (or loss) from continuing operations

• Discontinued operations

• Extraordinary items

Question 16–15

Despite the similar approaches for accounting for taxation under IAS No 12, “Income Tax,”

and U.S GAAP, differences in reported amounts for deferred taxes are among the most frequent between the two reporting approaches The reason is that a great many of the nontax differences between IFRS and U.S GAAP affect deferred taxes as well

BRIEF EXERCISES

Brief Exercise 16–1

Since taxable income is less than pretax accounting income, a future taxable amount will occur when the temporary difference reverses This means a deferred tax liability should be recorded to reflect the future tax consequences of the temporary difference:

Since tax depreciation to date has been $100,000 more than depreciation for financial reporting purposes, a future taxable amount will occur when the temporary difference reverses This means a deferred tax liability should be reported to reflect the future tax consequences of the temporary difference At this point, that amount is

$100,000 times 40%, or $40,000

If the balance was $32,000 last year, we need an increase of $8,000 The entry to record income taxes is:

Brief Exercise 16–3

Since taxable income is more than pretax accounting income, a future deductible amount will occur when the temporary difference reverses This means a deferred tax asset should be recorded to reflect the future tax savings from the temporary difference:

Brief Exercise 16–4

Brief Exercise 16–5

Brief Exercise 16–6

($ in millions)

Valuation allowance – deferred tax asset ( 1/4 x $12) 3

Brief Exercise 16–7

Deferred tax assets are recognized for all deductible temporary differences and operating loss carryforwards Deferred tax assets are then reduced by a valuation allowance if it is “more likely than not” that some portion or all of the deferred tax assets will not be realized That would be the case if management feels taxable income will not be sufficient in future years to permit gaining the benefit of reducing taxable income by the future deductible amounts This apparently is the case with Hypercom, which reported large losses in 2012 and years prior to 2012, perhaps indicative of insufficient taxable income in coming years to benefit from the tax savings

Brief Exercise 16–8

Since taxable income to date has been $40 million less than pretax accounting income because of the temporary difference, a future taxable amount of $40 million will occur when the temporary difference reverses This means a deferred tax liability should be reported to reflect the future tax consequences of the temporary difference That amount is $40 million times 40%, or $16 million (The $18 million temporary

Pretax accounting income $ 900,000

Journal entry

straight-line depreciation: $800,000 ÷ 4 years 200,000

Brief Exercise 16–10

Current Future Year Deductible

Taxable income (tax return) 300

Journal entry at the end of 2013

unavailable The loss is carried forward

Journal entry

Brief Exercise 16–13

Because the operating loss is less than the previous two years taxable income, AirParts cannot get back all taxes paid those two years It can reduce taxable income from two years ago by $15 million (to zero) and last year’s taxable income

by $10 million and get a refund of $10 million of the taxes paid those years

Journal entry

Receivable – income tax refund ($25 million x 40%) 10,000,000

Brief Exercise 16–14

Taxable income reflects the benefit of the interest being tax-free, so the tax

currently payable is $55 million x 40% or $22 million But, since it’s more likely than not that the interest isn’t tax-free, that benefit can’t be recognized in the tax expense

So, First Bank would record tax expense as if the interest is fully taxable, income tax payable that reflects its tax-free benefits, and a liability that represents the potential obligation to pay the additional taxes if the tax-free status is not ultimately upheld:

($ in millions)

The $2 million difference is the tax benefit not recognized in the income statement, but potentially due if the deduction is not upheld Because the ultimate outcome

probably won’t be known within the upcoming year, the Liability—Projected

additional tax likely will be reported as a long-term liability

Intraperiod tax allocation means the total income tax obligation for a reporting period is allocated among the income statement items that gave rise to the income tax The following items should be reported net of their respective income tax effects:

• Income (or loss) from ordinary, continuing operations

• Discontinued operations

• Extraordinary items

Southeast Airlines had pretax earnings of $55 million before the extraordinary gain

of $10 million Since the company’s tax rate is 40%, the amount of income tax expense that Southeast should report is $55 million x 40%, or $22 million The extraordinary gain should be reported net of the tax on the gain: $10 million less 40% of $10 million, or $6 million So, the total income tax obligation of $26 million ($65 million x 40%) is allocated between the income statement items that gave rise to the income tax:

$26 million There would be no intraperiod tax allocation because extraordinary items

are not reported separately under IFRS IAS No 1, “Presentation of Financial

Statements,” states that neither the income statement nor any notes may contain any items called “extraordinary.” As a result, the only income statement item reported separately net of tax using IFRS is discontinued operations

As a result, net income is $260,000:

Requirement 2

In its balance sheet, Alvis will report the $52,500 deferred tax liability among either its current or long-term liabilities depending on the cause of the temporary difference and the $87,500 income tax payable as a current liability

Deferred tax liability:

Ending balance (balance currently needed) $ 6

Less: beginning balance ($30 – $20) x 40% (4)

Change needed to achieve desired balance $ 2

Journal entry at the end of 2013

Income tax expense (to balance) 830,000

Exercise 16–5

Exercise 16–6

D 1 Accrual of loss contingency; tax-deductible when paid

D 2 Newspaper subscriptions: taxable when received; recognized for

financial reporting when earned

T 3 Prepaid rent; tax-deductible when paid

D 4 Accrued bond interest expense; tax-deductible when paid

T 5 Prepaid insurance; tax-deductible when paid

D 6 Unrealized loss from recording investments at fair value (tax-deductible

when investments are sold)

D 7 Warranty expense; estimated for financial reporting when products are

sold; deducted for tax purposes when paid

D 8 Advance rent receipts on an operating lease (as the lessor); taxable

when received

T 9 Straight-line depreciation for financial reporting; accelerated

depreciation for tax purposes

D 10 Accrued expense for employee postretirement benefits; tax-deductible

when subsequent payments are made

8 Liability—unearned rent revenue

9 Accumulated depreciation; and thus depreciable assets (net)

10 Liability—postretirement benefits

e Deferred tax liability:(dr) cr $ 0 $ 4 $ 4 $12

Deferred tax asset:

Less: beginning balance ($75 x 40%) (30)

Change needed to achieve desired balance $( 2)

Journal entry at the end of 2013

Requirement 2

($ in millions)

Valuation allowance—Deferred tax asset ( 1/2 x $28) 14

Of course, these two entries can be combined

Deferred tax asset:

Less: beginning balance ($75 x 40%) (30)

Change needed to achieve desired balance $( 2)

Journal entries at the end of 2013

Of course, these two entries can be combined

Exercise 16–11 (concluded)

Requirement 2

($ in millions)

Valuation allowance—Deferred tax asset ([ 1/2 x $28] – $10) 4

Of course, these two entries can be combined

Requirement 1

The specific citation that specifies how a firm should determine whether a valuation allowance for deferred tax assets is needed is FASB ASC 740–10–30–17: “Income Taxes–Overall–Initial Measurement–Establishment of a Valuation Allowance for

Deferred Tax Assets.”

Requirement 2

Specifically, the guidelines are:

740–10–30-17: All available evidence, both positive and negative, is

considered to determine whether, based on the weight of that evidence, a

valuation allowance for deferred tax assets is needed Information about an

entity's current financial position and its results of operations for the current

and preceding years ordinarily is readily available That historical

information is supplemented by all currently available information about

future years Sometimes, however, historical information may not be

available (for example, start-up operations) or it may not be as relevant (for

example, if there has been a significant, recent change in circumstances)

and special attention is required

Tax payable currently 100

Deferred tax liability:

Ending balance (balance currently needed) $ 4

Change needed to achieve desired balance $ 4

Journal entry at the end of 2013

Income tax payable (determined above) 100

Requirement 1

($ in thousands)

Tax payable currently 360

Deferred tax Deferred tax liability asset

Ending balances (balances currently needed): $34 $ 4

Change needed to achieve desired balances $22 $ 4

Journal entry at the end of 2013

Deferred tax liability (determined above) 22

Deferred tax asset:

Change needed to achieve desired balance $1.7 Journal entry at the end of 2013

Income tax payable (determined above) 7.0

Requirement 1

($ in millions)

2014 2015 2016 2017 [total]

Temporary difference:

Taxable income (income tax return) 25

Deferred tax liability:

Change needed to achieve desired balance $3.2

Journal entry at the end of 2013

Deferred tax liability (determined above) 3.2

Exercise 16–16 (continued)

Requirement 2

($ in millions)

2015 2016 2017 [total]

Temporary difference:

Taxable income (income tax return) 52

Deferred tax liability:

Change needed to achieve desired balance $(0.8)

Journal entry at the end of 2014

Deferred tax liability (determined above) 0.8

($ in millions)

2015 2016 2017 [total]

Temporary difference:

Taxable income (income tax return) 52

Deferred tax liability:

Change needed to achieve desired balance $(1.4)

Journal entry at the end of 2014

Deferred tax liability (determined above) 1.4

Exercise 16–17

A deferred tax liability is established using the currently enacted tax rate for the year(s) a temporary difference is expected to reverse In this case that rate was 40% The change in the tax law in 2014 constitutes a change in estimate The deferred tax liability is simply revised to reflect the new rate

Income tax expense (to balance) 10

Deferred tax liability ($20 million x [40% – 30%]) 2

Income tax payable ($30 million x 40%) 12

When a company revises a previous estimate, prior financial statements are not

revised No adjustment is made to existing accounts A disclosure note should describe the effect of a change in estimate on income before extraordinary items, net income, and related per share amounts for the current period

Exercise 16–18

Income tax expense (to balance) 32,000

Deferred tax asset ($12,000 x 40%) 4,800

Deferred tax liability ($77,000 x 40%) 30,800

Income tax payable ($15,000 x 40%) 6,000

($ in millions)

Income tax expense (to balance) 80

Deferred tax asset ($25 million x 40%) 10

Deferred tax liability ($80 million x 40%) 32

Income tax payable ($145 million x 40%) 58

Deferred tax asset:

Change needed to achieve desired balance $150

Journal entry at the end of 2013

Since the weight of available evidence suggests future taxable income sufficient

to benefit from future deductible amounts from the operating loss carryforward, no valuation allowance is needed

Requirement 2

($ in thousands)

Journal entry at the end of 2013

Requirement 2

($ in thousands)

Less: Income tax benefit from loss carryback (41)

Tax payable (refundable) (32) (27) 0

Deferred tax asset:

Change needed to achieve desired balance $8

Journal entry at the end of 2013

Receivable—Income tax refund ($32 + 27) 59

Requirement 2

($ in thousands)

Less: Income tax benefit:

A 2 Estimated warranty costs; tax-deductible when paid

A 3 Rent revenue collected in advance; cash basis for tax purposes

N 4 Interest received from investments in municipal bonds

L 5 Prepaid expenses; tax-deductible when paid

A 6 Operating loss carryforward

N 7 Operating loss carryback

L 8 Straight-line depreciation for financial reporting; MACRS for tax

purposes

A 9 Organization costs expensed when incurred; tax-deductible over 15 years

N 10 Life insurance proceeds received upon the death of the company

president

Exercise 16–24

($ in millions)

Related Balance current-C (Deductible) Tax Liability Sheet Account noncurrent-NC Amounts Rate C NC

Current Assets:

Long-Term Liabilities:

Note: Before offsetting assets and liabilities within the current and noncurrent

categories, the total deferred tax assets is $16 ($6 + 10) and the total deferred

tax liabilities is $68 ($4 + 48 + 16)

Taxable income (tax return) 200

Deferred tax liability:

Change needed to achieve desired balance $225

Journal entry at the end of 2013

Deferred tax liability (determined above) 225