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Accounting for Income Taxes

Accounting for Income Taxes. 16. Learning Objectives. Describe the types of temporary differences that cause deferred tax liabilities and determine the amounts needed to record periodic income taxes. LO1.

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Accounting for Income Taxes

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  1. Accounting for Income Taxes 16

  2. Learning Objectives Describe the types of temporary differences that cause deferred tax liabilities and determine the amounts needed to record periodic income taxes. LO1 Identify and describe the types of temporary differences that cause deferred tax assets. LO2

  3. 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.

  4. Deferred Tax Assets/Liabilities Examine the December 31, 2006, 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%. Compute X-Off’s income tax expense and income tax payable.

  5. The income tax amount computed based on financial statement income isincome tax expensefor the period. Deferred Tax Assets/Liabilities Compute X-Off’s income tax expense and income tax payable. Next, compute income taxes for the tax return.

  6. Income taxes based on tax return income are the taxes payable for the period. Deferred Tax Assets/Liabilities Compute X-Off’s income tax expense and income tax payable.

  7. Deferred Tax Assets/Liabilities 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. Let’s look at the journal entry to record the deferred taxes.

  8. Deferred Tax Assets/Liabilities The entry to record the deferred taxes would appear as follows:

  9. 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.

  10. 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.

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

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

  13. Deferred Tax Liabilities In 2006, 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 2007 and 2008. Baxter expects to collect $70,000 in 2007 and the remaining $30,000 in 2008. In 2007 and 2008, Baxter reports $200,000 of pretax income. The company is subject to a 32% tax rate. There are no other temporary differences.

  14. Deferred Tax Liabilities 2006 Deferred tax liability = ($100,000) × 32% = ($32,000) 2006 Income tax payable = $200,000 × 32% = $64,000

  15. Deferred Tax Liabilities The Deferred Tax Liability represents the future taxes Baxter will pay in 2007 and 2008.

  16. Deferred Tax Liabilities Recall this information for Baxter. 2007 Deferred tax liability = $70,000 × 32% = $22,400 2007 Income tax payable = $270,000 × 32% = $86,400

  17. Originating difference Reversing difference Deferred Tax Liabilities The Deferred Tax Liability represents the future taxes Baxter will pay in 2008. Future Taxable Amount Schedule

  18. Deferred Tax Liabilities Recall this information for Baxter. 2008 Deferred tax liability = $30,000 × 32% = $9,600 2008 Income tax payable = $230,000 × 32% = $73,600

  19. Reversing difference Deferred Tax Liabilities

  20. Deferred Tax Assets Health Magazine received $150,000 of subscriptions in advance during 2006. Subscription revenue will be earned equally in 2007, 2008 and 2009 for financial accounting purposes. The entire $150,000 will be taxed in 2006. There is additional income of $500,000 in each year. The company is subject to a 30% tax rate in each year.

  21. Deferred Tax Assets This is the computation for the Deferred Tax Asset. Now, let’s record the income tax entry for 2006.

  22. Deferred Tax Assets 2006 Deferred tax asset = $150,000 × 30% = $45,000 2006 Income tax payable = $650,000 × 30% = $195,000

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

  24. Deferred Tax Assets 2007 Deferred tax asset = ($50,000) × 30% = ($15,000) 2007 Income tax payable = $500,000 × 30% = $150,000

  25. In 2007, the balance in the Deferred Tax Asset should decrease to $30,000. Reversing difference Originating difference Deferred Tax Assets Can you prepare the entries for 2008 and 2009?

  26. At the end of 2009, the balance in the Deferred Tax Asset would be zero. Deferred Tax Assets This would be the entry for 2008 and 2009.

  27. Learning Objectives Describe when and how a valuation allowance is recorded for deferred tax assets. LO3

  28. 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 estimated net realizable value. Valuation Allowance

  29. Learning Objectives Explain why nontemporary differences have no deferred tax consequences. LO4

  30. Nontemporary 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 never included in taxable income.

  31. Nontemporary Differences Also called permanent differences. Disregarded when determining both taxes payable currently and the deferred tax asset or liability.

  32. Learning Objectives Explain how a change in tax rates affects the measurement of deferred tax amounts. LO5

  33. 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

  34. Learning Objectives Determine income tax amounts when multiple temporary differences exist. LO6

  35. 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.

  36. Learning Objectives Describe when and how an operating loss carryforward and an operating loss carryback are recognized in the financial statements. LO7

  37. When used to offset 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.

  38. Carryforward Period -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.

  39. In 2006 Garson, Inc. incurred an $85,000 net operating loss. The company is subject to a 30% tax rate. In 2004, Garson reported taxable income of $20,000, and in 2005, 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.

  40. Net Operating Losses (NOL)

  41. 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.

  42. Learning Objectives Explain how deferred tax assets and deferred tax liabilities are classified and reported in a classified balance sheet and describe related disclosures. LO8

  43. Balance Sheet Classification 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.

  44. 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.

  45. Learning Objectives Explain intraperiod tax allocation. LO9

  46. SFAS No. 109 requires intraperiod tax allocation for: Income from continuing operations. Discontinued operations. Extraordinary items. Intraperiod Tax Allocation

  47. End of Chapter 16

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