Transcript Intangible Assets - University of Utah

Accounting for Income Taxes
ACCTG 5120
David Plumlee
1
Accounting for Income Taxes
Why do accountants record Deferred Taxes?
Income is measured in two
different ways, taxable income
and GAAP income. Deferred
taxes result from timing
differences between these two.
page2
Accounting Income = Taxable Income
Why are GAAP and tax income computed differently?

Tax income is intended to
raise sufficient tax revenues
 stimulate or depress certain sectors of the
economy

GAAP is intended to provide relevant, reliable
and representationally faithful

GAAP is full accrual, while tax is accrual
with some cash basis adjustments.

page3
Inter-period Tax Allocation
From an income statement perspective
what is the justification for inter-period tax
allocation?
It improves matching of tax expense
to related accounting income.
From a balance sheet perspective what is the
justification for inter-period tax allocation?
It allows recognition of deferred tax
assets and liabilities associated with
future deductible and future taxable
amounts.
page4
A Simple Example
Assume that $9,000 is received on day 1, year
1 in payment of year 1 and year 2 rent
($4,500/year). What is the taxable and
accounting income for each of these years?
Accounting Taxable
Income
Income
Year 1
Year 2
Total
$4,500
$4,500
$9,000
$9,000
$0
$9,000
page5
“Cash” Basis
Assume a tax rate
of 30%, then the
$2,700 of income
tax would be paid
in 2003.
Income before tax
Tax expense
Net income
Implied Effective Tax Rate
2003
2004
$4,500 $4,500
2,700
-$1,800 $4,500
60%
0%
What is wrong with this approach?
No matching of Tax Expense to
related accounting income.
page6
“Accrual” Basis
Using Interperiod Tax Allocation:
Income before tax
Tax expense
Net income
Implied Effective Tax Rate
2003
$4,500
1,350
$3,150
30%
2004
$4,500
1,350
$3,150
30%
Total tax expense is still $2,750, but:



net income better reflects “effort”
effective tax rate reflects statutory rate
less volatility in earnings
page7
Is a deferred tax really a liability?

Some say yes



eventually the timing difference will be reversed and the tax
recorded in the deferred tax liability account will become payable
future cash outflow in the amount of the deferred tax liability (asset)
will occur
Some say no




many reversing temporary differences continually replaced with new
originating temporary differences
in reality deferred income tax liabilities continually grow
net temporary differences do not require future cash outflows
not a legal obligation of the firm until tax return filed
page8
Permanent Differences
A difference arising from an item that
enters into accounting income but
never taxable income (interest on
state issued bonds)
or enters into taxable income but never
accounting income (excess depletion
on wasting assets)
page9
Examples of Permanent
Differences

Interest on state/municipal bonds

Proceeds from executive life insurance

Premiums paid on executive life insurance

Fines due to violations of the law

Dividend received deduction - 70% - 80% of
dividends received from U. S. corporations

Excess depletion on wasting assets
page10
Example: Interest Income on
State Bonds
A company receives $1,000 in interest
income on state bonds and tax rate is
45%. The company NEVER pays tax on
this income. What if we did this?
tax expense
deferred tax liability
450
450
Deferred tax would stay on the books forever!
page11
Temporary Differences
A difference between an asset or
liability’s tax basis and its amount for
accounting purposes that will result
in taxable or deductible amounts in
future years
Or, a difference between in the
financial and tax amounts for income
(or expense) in a given year (or
years)
page12
How do we get taxable income?


Start with GAAP/financial ‘books’
Make tax-related adjustments



permanent items that are in accounting income
but not taxable or vice versa
temporary/timing items that are included in
financial income at a different time than taxable
income
Complete tax return and pay required taxes
(taxes payable)
page13
Temporary Difference Example
A company purchases an asset for $100,000.
Depreciation expense:


accounting - straight-line over 4 years
tax - straight-line over 2 years
Tax Expense
Book Value
Temporary
Book
Tax
Book
Tax
Difference
$25,000 $50,000 $ 75,000 $ 50,000 $ 25,000
$25,000 $50,000
50,000
50,000
$25,000
25,000
25,000
page14
Reconciliation - Year 1
Account ing
Revenues
$
Expenses*
Pret ax book income
T ax
T emp Diff
575,000
375000
$
200,000
$
200,000
Depreciat ion:
Add back book depr
Subt ract t ax depr
$
@ 40% rat e-t ax
200,000
$
25,000
(25,000)
(50,000)
50,000
175,000
$
25,000
T ax Expense
T ax Payable Deferred t axes
$
$
80,000
70,000
$
10,000
* includes book depreciation expense!
page15
AJE to Record Tax Expense
What is adjusting entry at the end of year 1?
tax expense
$80,000
tax payable
$70,000
deferred tax liability
$10,000
page16
Reconciliation - Year 2
Revenues
Expenses*
Pretax income
Accounting
T ax
Accounting
Taxable
$Income
400,000
Income
300000 $ 100,000
$ 100,000
Pretax
book income $
Depreciation:
100,000
$
T emp Diff
Temporary
Difference
100,000
Depreciation:
accounting
25,000
(25,000)
Add
back book depr
25,000
(25,000)
taxable
(50,000)
50,000
Subtract tax depr $ 100,000 $
(50,000)
50,000
75,000 $
25,000
$ Tax
100,000 $ Tax
75,000 $Deferred
25,000
TExpense
ax Expense TPayable
ax Payable Deferred
Taxestaxes
@ 40%
$
40,000 $
30,000 $
10,000
@
40%rate-tax
rate of
$ 40,000
$ 30,000 $
10,000
*income
includestax
book depreciation
expense!
page17
AJE to Record Tax Expense
What is the balance in Deferred Tax Liability
at the end of year 2?
($25,000+25,000) x 40% = $20,000
What is adjusting entry at the end of year 2?
tax expense
$40,000
tax payable
deferred tax liability
$30,000
$10,000
page18
Reconciliation - Year 3
Accounting
Revenues
T ax
T emp Diff
$ 400,000
Expenses*
300000
Pretax book income $
180,000
$
180,000
Depreciation:
Add back book depr
25,000
Subtract tax depr
(25,000)
$
180,000
$
205,000
$
(25,000)
T ax Expense T ax Payable Deferred taxes
@ 40% rate-tax
$
72,000
$
82,000
$
(10,000)
* includes book depreciation expense!
page19
AJE to Record Tax Expense
What is the balance in Deferred Tax Liability at
the end of year 3?
($25,000+25,000-25,000) x 40% = $10,000
What is the entry to record tax expense for year
3?
Tax Expense
$72,000
Deferred Tax Liability $10,000
Tax Payable
$82,000
page20
Changes in tax rates across time?
Revenues
T emp Diff
T ax
Accounting
$ 250,000
Expenses*
180000
Pretax book income $
70,000
$
70,000
Depreciation:
(25,000)
25,000
Add back book depr
-
-
Subtract tax depr
$
70,000
$
95,000
$
(25,000)
T ax Expense T ax Payable Deferred taxes
but, @ 30% rate-tax $
21,000
$
28,500
$
(7,500)
page21
AJE to Record Tax Expense
What is the balance in Deferred Tax
Liability at the end of year 4?
Should be $0, but ($25,000+25000-25000)
x 40% +(-25,000)x 30% = 2500
What is the entry to record tax expense for
year 4?
Tax Expense
Deferred Tax Liability
Tax Payable
$21,000
$ 7,500
$28,500
page22
Computing Tax Expense
Find cumulative temp. basis
differences = book - tax *
Compute ending deferred tax balance.
Prepare a schedule of anticipated reversals
and applying appropriate enacted tax rates
Compute change in Deferred Tax balance
*differences that
will reverse in
the future. If
differences are
permanent,
ignore!
Compute
taxes
payable
Tax Expense = tax payable +/- change in Deferred Tax balance
page23
Example





Year 2000 pretax accounting income = $500,000
Current tax rate = 40%
Deferred Tax liability (Jan 1, 2000) = $320,000
Year 2000 depreciation
 accounting = $200,000
 tax = $400,000
Municipal Bond Interest $10,000
page24
Example (continued)
As at the end of year 2000:
Book basis of depreciable assets
Tax basis of depreciable assets
Cumulative temporary difference
$1,000,000
0
$1,000,000
Additional information:
 enacted tax rates as shown in schedule
 temporary differences expected to reverse as
shown in schedule
page25
Change in Deferred Tax Balance
2000
Reversal
$
200,000 $
Enacted tax rates
40%
Deferred tax liability$
80,000 $
2001
200,000 $
40%
80,000 $
2002
2003 2004 Total
200,000 $ 200,000 $ 200,000 $ 1,000,000
35%
30% 30%
70,000 $ 60,000 $ 60,000 $ 350,000
Closing deferred tax liability
Opening deferred tax liability
Net increase in deferred tax liability
$350,000
320,000
$ 30,000
page26
Compute Taxes Payable
Pre-tax accounting income
add accounting depr.
subtract tax depr.
subtract non-taxable interest
Taxable income
tax rate
Tax Payable (per tax return)
$500,000
200,000
(400,000)
( 10,000)
$290,000
x 40%
$ 116,000
page27
Journal Entry
tax expense (plug)
tax payable
deferred tax liability*
146,000
116,000
30,000
*since we have a starting balance in DTL account,
need to adjust to correct balance
page28
Net Operating Losses (NOL)
Carry
Forward
Carry
Back
2 years
If a carryback then
• receive a refund of
previous tax paid
•record tax receivable
based on prior year
rate
20 years
NOL
Year
If a carryforward then
•future deductible item
•record deferred tax asset
based on future enacted
rate
page29
Deferred Tax Asset
Valuation Allowance


Based on all available evidence it is
more likely than not that some portion
will not be realized
Intended to adjust Deferred Tax asset
to expected net realizable value
tax expense
valuation allowance

xx
xx
Adjust to required ending balance each
period
page30
Deferred Tax Asset
Valuation Allowance
In year of expected reversal future
deductible amounts > future taxable
amounts
 Will there be sufficient future taxable
income to absorb the excess?
 Could the excess be carried back to
prior years?
if answer is NO - valuation allowance required
page31
Balance Sheet Presentation

Classify deferred tax balances based on



classification of related asset/liability
expected reversal date if not related
For reporting purposes



net current deferred tax balance
net non-current deferred tax balance
show deferred tax assets net of valuation
allowance
page32
Intraperiod Tax Allocation
Allocation of tax across different sources of
income/loss within a given period including:





income from continuing operations
discontinued operations
extraordinary items
cumulative changes in accounting policy
items charged directly to retained earnings, for
example
 prior period adjustments
 mark-to-market adjustments under FAS 115
page33
Intraperiod Tax Allocation
A company has ordinary income of
$50,000 and extraordinary income of
$100,000



tax rate is 45%
no permanent or temporary differences
tax payable


on ordinary income = $22,500
on extraordinary income = $45,000
page34
Intraperiod Tax Allocation
Intraperiod Tax
Allocation
Without
With
Operating income
50,000
50,000
Tax expense
67.500
22,500
(17,500)
27,500
100,000
55,000
82,500
82,500
Extraordinary Gain
Net income
page35