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Chapter 16. Accounting for Income Taxes. Deferred Tax Assets and Deferred Tax Liabilities. The Internal Revenue Code is the set of rules for preparing tax returns. GAAP is the set of rules for preparing financial statements. Results in. Results in. Usually.

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Accounting for income taxes

Chapter 16

Accounting for Income Taxes


Deferred tax assets and deferred tax liabilities
Deferred Tax Assets and Deferred Tax Liabilities

The Internal Revenue Code is the set of rules for preparing tax returns.

GAAP is the set of rules for preparing financial statements.

Results in . . .

Results in . . .

Usually. . .

Financial statement income tax expense.

IRS income taxes payable.

The objective of accounting for income taxes is to recognize a deferred tax liabilityordeferred tax assetforthe tax consequences of amounts that will become taxable or deductible in future years as a result of transactions or events that already have occurred.


Temporary differences
Temporary Differences

Often, the difference between pre-tax accounting income and taxable income results from items entering the income computations at different times.

These are called temporary differences.


Temporary differences1

Accounting Income>Taxable Income

Accounting Income<Taxable Income

Future Taxable Amounts

Future Deductible Amounts

Deferred Tax Liability

Deferred Tax Asset

Temporary Differences

Temporary differences will reverse out in one or more future periods.


Deferred tax assetsresult in deductible amounts in the future.

Deferred tax liabilitiesresult in taxable amounts in the future.


Deferred tax liabilities
Deferred Tax Liabilities

In 2009, Baxter reports $300,000 of pretax income. Included in this amount is $100,000 resulting from revenue earned from an installment sale for which no cash was collected. The revenue will be taxed as the cash is collected in 2010 and 2011. Baxter expects to collect $70,000 in 2010 and the remaining $30,000 in 2011. In 2010 and 2011, Baxter reports $200,000 of pretax income. The company is subject to a 32% tax rate.

There are no other temporary differences.


Deferred tax liabilities1
Deferred Tax Liabilities

2009 Income tax payable = $200,000 × 32% = $64,000

2009 Deferred tax liability change = ($100,000 × 32%) - $0 = $32,000


Deferred tax liabilities2
Deferred Tax Liabilities

The Deferred Tax Liability represents the future taxes Baxter will pay in 2010 and 2011.


Deferred tax liabilities3
Deferred Tax Liabilities

Recall this information for Baxter.

2010 Income tax payable = $270,000 × 32% = $86,400

2010 Deferred tax liability change = ($30,000 × 32%) - $32,000 = $22,400


Deferred tax liabilities4
Deferred Tax Liabilities

The Deferred Tax Liability represents the future taxes Baxter will pay in 2011.

Future Taxable Amount Schedule


Deferred tax liabilities5
Deferred Tax Liabilities

Recall this information for Baxter.

2011 Income tax payable = $230,000 × 32% = $73,600

2011 Deferred tax liability change = ($0 × 32%) - $9,600 = $9,600


Deferred tax liabilities6
Deferred Tax Liabilities

The Deferred Tax Liability represents the future taxes Baxter will pay.

Future Taxable Amount Schedule


Deferred tax assets
Deferred Tax Assets

Health Magazine received $150,000 of subscriptions in advance during 2009.

Subscription revenue will be earned equally in 2010, 2011 and 2012 for financial accounting purposes.

The entire $150,000 will be taxed in 2009.

There is additional income of $500,000 in each year. The company is subject to a 30% tax rate in each year.


Deferred tax assets1
Deferred Tax Assets

This is the computation for the Deferred Tax Asset.

Now, let’s record the income tax entry for 2009.


Deferred tax assets2
Deferred Tax Assets

2009 Income tax payable = $650,000 × 30% = $195,000

2009 Deferred tax asset change = [($150,000 × 30%] - $0 = $45,000


Deferred tax assets3
Deferred Tax Assets

After posting the entry, the Deferred Tax Asset account will have the desired ending balance of $45,000.


Deferred tax assets4
Deferred Tax Assets

2010 Income tax payable = $500,000 × 30% = $150,000

2010 Deferred tax asset change = [($100,000) × 30%] - $45,000 = ($15,000)


Deferred tax assets5
Deferred Tax Assets

In 2010, the balance in the Deferred Tax Asset should decrease to $30,000.

Can you prepare the entries for 2011 and 2012?


Deferred tax assets6

At the end of 2012, the balance in the Deferred Tax Asset would be zero.

Deferred Tax Assets

This would be the entry for 2011 and 2012.


Valuation allowance

A valuation allowance account is required when it is would be zero.more likely than notthat some portion of the deferred tax assetwill not be realized.

The deferred tax asset is then reported at its estimated net realizable value.

Valuation Allowance


Nontemporary differences
Nontemporary Differences would be zero.

  • Created when an income item is included in taxable income oraccounting income but will never be included in the computation of the other.

    Example: Interest on tax-free municipal bonds is included in accounting income but is never included in taxable income.

Also called permanent differences.


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.

InternalRevenueCode

Tax Rate Considerations


Multiple temporary differences

Categorize all temporary differences according to whether they create …

Future taxable amounts

Future deductible amounts

Multiple Temporary Differences

It would be unusual for any but a very small company to have only a single temporary difference in any given year.


Net operating losses nol

  • When used to offset they create …earliertaxable income:

  • Called: operating loss carryback.

  • Result: tax refund.

  • When used to offsetfuturetaxable income:

  • Called:operating loss carryforward.

  • Result: reduced tax payable.

Net Operating Losses (NOL)

Tax laws often allow a company to use tax NOLs to offset taxable income in earlier or subsequent periods.


Net operating losses nol1

Carryforward Period they create …

-2

-1

+1

+2

+3

+4

+5

+20

. . .

Net Operating Losses (NOL)

Carryback Period

Current Year

The NOL may first be applied against taxable income from two previous years.

Unused NOL may be carried forward for 20 years.


Net operating losses nol2

In they create …2009 Garson, Inc. incurred an $85,000 net operating loss. The company is subject to a 30% tax rate. In 2007, Garson reported taxable income of $20,000, and in 2008, taxable income was $10,000. The company elects to carryback the NOL.

Net Operating Losses (NOL)

Let’s look at the tax benefits of the operating loss carryback and carryforward.



Net operating losses nol4
Net Operating Losses (NOL) they create …

The deferred tax asset account created by the benefit of the carryforward will be used to lower income taxes payable in future years.


Balance sheet classification
Balance Sheet Classification they create …

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).

Deferred tax assets/liabilities are classified as current or noncurrent based on the classification of the related asset or liability.


Additional disclosures
Additional Disclosures they create …

  • Current portion of tax expense (benefit)

  • Deferred portion of tax expense (benefit), with separate disclosure for

    • Portion that does not include the effect of the following separately disclosed amounts.

    • Operating loss carryforwards.

    • Adjustments due to changes in tax laws or rates.

    • Adjustments to the beginning-of-the-year valuation allowance due to revised estimates.

    • Investment tax credits.


Coping with uncertainty in income taxes
Coping with Uncertainty in Income Taxes they create …

FASB Interpretation No. 48

Step 1. A tax benefit may be reflected in the financial statements only if it is “more likely than not” that the company will be able to sustain the tax return position, based on its technical merits.

Step 2. A tax benefit should be measured as the largest amount of benefit that is cumulatively greater than 50-percent likely to be realized.

Not “more likely than not” = none of the tax benefit is allowed to be recorded


Intraperiod tax allocation

SFAS they create …No. 109 requires intraperiod tax allocation for:

Income from continuing operations.

Discontinued operations.

Extraordinary items.

Intraperiod Tax Allocation


Conceptual concerns
Conceptual Concerns they create …

Some accountants disagree with the FASB’s approach to accounting for income taxes.

Should deferred taxes be recognized?

Should deferred taxes be recognized for only some items?

Should deferred taxes be discounted?

Should classification be based on the timing of temporary difference reversals?


End of Chapter 16 they create …


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