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Chapter 16. Accounting for Income Taxes. Deferred Tax Assets/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.

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chapter 16

Chapter 16

Accounting for Income Taxes

deferred tax assets liabilities
Deferred Tax Assets/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 difference between tax expense and tax payable is referred to as deferred taxes.

deferred tax assets liabilities example
Deferred Tax Assets/LiabilitiesExample

Examine the December 31, 2003, information for X-Off Inc.

X-Off uses straight-line depreciation for financial reporting and accelerated depreciation for income tax reporting.

X-Off’s tax rate is 30%.

deferred tax assets liabilities example1
Deferred Tax Assets/LiabilitiesExample

Compute X-Off’s income tax expense and income tax payable.

deferred tax assets liabilities example2

The income tax amount computed based on financial statement income is income tax expense for the period.

Deferred Tax Assets/LiabilitiesExample

Compute X-Off’s income tax expense and income tax payable.

deferred tax assets liabilities example3
Deferred Tax Assets/LiabilitiesExample

Compute X-Off’s income tax expense and income tax payable.

Next, compute income taxes for the tax return.

deferred tax assets liabilities example4

Income taxes based on tax return income are the taxes payable for the period.

Deferred Tax Assets/LiabilitiesExample

Compute X-Off’s income tax expense and income tax payable.

deferred tax assets liabilities example5
Deferred Tax Assets/LiabilitiesExample

Compute X-Off’s income tax expense and income tax payable.

The deferred tax for the period of $36,000 is the difference between income tax expense of $45,000 and income tax payable of $9,000.

deferred tax assets liabilities example6
Deferred Tax Assets/LiabilitiesExample

The entry to record the deferred taxes would appear as follows:

temporary differences
Temporary Differences

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

These are called temporary differences.

temporary differences1

Financial Income > Taxable Income

Financial 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.

slide12

The temporary differences in the yellow boxes create deferred tax assets because they result in deductible amounts in the future.

slide13

The temporary differences in the gray boxes create deferred tax liabilities because they result in taxable amounts in the future.

deferred tax liabilities
Deferred Tax Liabilities

In 2001, Baxter records $100,000 on its books resulting from revenue earned. The revenue will be taxed as the cash is collected in 2002 and 2003. Baxter expects to collect $70,000 in 2002 and the remaining $30,000 in 2003.

The company is subject to a 32% tax rate.

There are no other temporary differences.

Let’s look at Baxter’s 2001 tax entry.

deferred tax liabilities1
Deferred Tax Liabilities

Income tax expense = $300,000 × 32% = $96,000

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

deferred tax liabilities2
Deferred Tax Liabilities

The Deferred Tax Liability represents the future taxes Baxter will pay in 2002 and 2003.

deferred tax liabilities3
Deferred Tax Liabilities

Recall this information for Baxter for 2002.

Income tax expense = $200,000 × 32% = $64,000

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

deferred tax liabilities5
Deferred Tax Liabilities

Future Taxable Amount Schedule

The Deferred Tax Liability represents the future taxes Baxter will pay in 2003.

deferred tax liabilities6
Deferred Tax Liabilities

Recall the information for Baxter, Inc. for 2003:

Income tax expense = $200,000 × 32% = $64,000

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

deferred tax assets
Deferred Tax Assets

Health Magazine received $150,000 of subscriptions in advance during 2001.

Subscription revenue will be earned equally in 2002, 2003 and 2004 for financial accounting purposes.

The entire $150,000 will be taxed in 2001.

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 2001.

deferred tax assets2
Deferred Tax Assets

Income tax expense = $500,000 × 30% = $150,000

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

deferred tax assets3
Deferred Tax Assets

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

deferred tax assets4

In 2002, Health Magazine earns $50,000 for financial reporting purposes.

In 2002, the balance in the Deferred Tax Asset should decrease to $30,000.

Deferred Tax Assets

Income tax expense = $550,000 × 30% = $165,000

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

Let’s see the income tax entry for 2002.

deferred tax assets5

Reversing difference

Originating difference

Deferred Tax Assets

Income tax expense = $550,000 × 30% = $165,000

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

deferred tax assets6
Deferred Tax Assets

This is the computation for the Deferred Tax Asset.

Can you finish Health Magazine’s income tax entries for 2003 and 2004?

deferred tax assets7
Deferred Tax Assets

This would be the entry for 2003 and 2004.

At the end of 2004, the balance in the Deferred Tax Asset would be zero.

valuation allowance
Valuation Allowance
  • A valuation allowance account is required when it is more likely than notthat some portion of the deferred tax assetwill not be realized.
  • The deferred tax asset is then reported at its net realizable value.
non temporary differences
Non-Temporary Differences
  • 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 excluded from taxable income

non temporary differences1
Non-Temporary Differences

Also called permanent differences.

Disregarded when determining both taxes payable and the deferred tax asset or liability.

tax rate considerations

IRC

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.
net operating losses nol

When used to offset earliertaxable income:

  • Called: operating loss carryback.
  • Result in a tax refund.
  • When used to offset future taxable income:
  • Called: operating loss carryforward.
  • Result in 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.

carryback and carryforward

Carryforward Period

-2

-1

+1

+2

+3

+4

+5

+20

. . .

CarrybackandCarryforward

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 nol1
Net Operating Losses (NOL)

In 2003 Garson, Inc. incurred an $85,000 net operating loss. The company is subject to a 30% tax rate. In 2001, Garson reported taxable income of $20,000, and in 2002, taxable income was $10,000. The company elects to carryback the NOL.

net operating losses nol2
Net Operating Losses (NOL)

In 2003, no taxes are paid and Garson claims a tax refund of $9,000 for taxes paid in 2001 and 2002.

net operating losses nol3
Net Operating Losses (NOL)

Garson’s Income Statement for 2003 looks like this . . .

Now let’s look at the treatment of the remaining NOL of $55,000 ($85,000 - $20,000 - $10,000).

net operating losses nol4
Net Operating Losses (NOL)

Garson prepares this estimate of taxable income based upon the best available evidence at 12/31/03.

The NOL carryforward will provide a tax benefit of $17,000.

net operating losses nol5
Net Operating Losses (NOL)

It is likely that Garson will receive the benefits of the NOL in future periods. As a result, the following journal entry is made . . .

Garson’s income statement for 2003 willlook like this . . .

net operating losses nol6
Net Operating Losses (NOL)

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

Disclose the following:

  • Total of all deferred tax liabilities and 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
  • 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.
intraperiod tax allocation
Intraperiod Tax Allocation
  • SFAS No. 109 requires intraperiod tax allocation for:
    • Income from continuing operations.
    • Discontinued operations.
    • Extraordinary items.
    • Changes in accounting principle.
    • Prior period adjustments (to the beginning retained earnings).
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