Transcript Intermediate Accounting 19-1 Prepared by Coby Harmon University of California, Santa Barbara 19 Accounting for Income Taxes Intermediate Accounting 14th Edition Kieso, Weygandt, and Warfield 19-2

Intermediate
Accounting
19-1
Prepared by
Coby Harmon
University of California, Santa Barbara
19 Accounting for Income Taxes
Intermediate Accounting
14th Edition
Kieso, Weygandt, and Warfield
19-2
Learning Objectives
1.
Identify differences between pretax financial income and taxable income.
2.
Describe a temporary difference that results in future taxable amounts.
3.
Describe a temporary difference that results in future deductible amounts.
4.
Explain the purpose of a deferred tax asset valuation allowance.
5.
Describe the presentation of income tax expense in the income statement.
6.
Describe various temporary and permanent differences.
7.
Explain the effect of various tax rates and tax rate changes on deferred
income taxes.
8.
Apply accounting procedures for a loss carryback and a loss carryforward.
9.
Describe the presentation of deferred income taxes in financial statements.
10. Indicate the basic principles of the asset-liability method.
19-3
Accounting for Income Taxes
Fundamentals of
Accounting for
Income Taxes
Accounting for
Net Operating
Losses
Financial
Statement
Presentation
Future taxable
amounts and
deferred taxes
Loss carryback
Balance sheet
Loss
carryforward
Income
statement
Future deductible
amounts and
deferred taxes
Loss carryback
example
Uncertain tax
positions
Income
statement
presentation
Specific
differences
Rate
considerations
19-4
Loss
carryforward
example
Review of AssetLiability Method
Fundamentals of Accounting for Income Taxes
Corporations must file income tax returns following the
guidelines developed by the Internal Revenue Service (IRS),
thus they:

calculate taxes payable based upon IRS code,

calculate income tax expense based upon GAAP.
Amount reported as tax expense will often differ from the
amount of taxes payable to the IRS.
19-5
LO 1 Identify differences between pretax financial income and taxable income.
Fundamentals of Accounting for Income Taxes
Illustration 19-1
Financial Statements
Tax Return
vs.
Exchanges
Investors and Creditors
Pretax Financial Income
GAAP
Income Tax Expense
19-6

Taxable Income

Tax Code
Income Tax Payable
LO 1 Identify differences between pretax financial income and taxable income.
Fundamentals of Accounting for Income Taxes
Illustration: Chelsea, Inc. reported revenues of $130,000
and expenses of $60,000 in each of its first three years of
operations. For tax purposes, Chelsea reported the same
expenses to the IRS in each of the years. Chelsea reported
taxable revenues of $100,000 in 2012, $150,000 in 2013,
and $140,000 in 2014. What is the effect on the accounts of
reporting different amounts of revenue for GAAP versus tax?
19-7
LO 1 Identify differences between pretax financial income and taxable income.
Book vs. Tax Difference
Illustration 19-2
GAAP Reporting
2012
2013
2014
Total
Revenues
$130,000
$130,000
$130,000
$390,000
Expenses
60,000
60,000
60,000
180,000
Pretax financial income
$70,000
$70,000
$70,000
$210,000
Income tax expense (40%)
$28,000
$28,000
$28,000
$84,000
Illustration 19-3
Tax Reporting
2012
2013
2014
Total
Revenues
$100,000
$150,000
$140,000
$390,000
Expenses
60,000
60,000
60,000
180,000
Pretax financial income
$40,000
$90,000
$80,000
$210,000
Income tax payable (40%)
$16,000
$36,000
$32,000
$84,000
19-8
LO 1 Identify differences between pretax financial income and taxable income.
Book vs. Tax Difference
Illustration 19-2
Comparison
2012
2013
2014
Total
$28,000
$28,000
$28,000
$84,000
16,000
36,000
32,000
84,000
Difference
$12,000
$(8,000)
$(4,000)
Income tax expense (40%)
$28,000
$28,000
$28,000
Income tax expense (GAAP)
Income tax payable (IRS)
Are the differences accounted for in the financial statements?
Year
Reporting Requirement
2012
Deferred tax liability account increased to $12,000
2013
Deferred tax liability account reduced by $8,000
2014
Deferred tax liability account reduced by $4,000
19-9
$0
$84,000
Yes
LO 1 Identify differences between pretax financial income and taxable income.
Financial Reporting for 2010
Balance Sheet
Assets:
Income Statement
2012
2012
Revenues:
Expenses:
Liabilities:
Deferred taxes
Income tax payable
Equity:
12,000
16,000
Income tax expense
28,000
Net income (loss)
Where does the “deferred tax liability” get reported in the financial
statements?
19-10
LO 1 Identify differences between pretax financial income and taxable income.
Temporary Differences
A Temporary Difference is the difference between the tax basis of
an asset or liability and its reported (carrying or book) amount in the
financial statements that will result in taxable amounts or deductible
amounts in future years.
Future Taxable Amounts
Deferred Tax Liability represents
the increase in taxes payable in
future years as a result of taxable
temporary differences existing at
the end of the current year.
Future Deductible Amounts
Deferred Tax Asset represents the
increase in taxes refundable (or
saved) in future years as a result of
deductible temporary differences
existing at the end of the current
year.
Illustration 19-22 Examples of Temporary Differences
19-11
LO 2 Describe a temporary difference that results in future taxable amounts.
Future Taxable Amounts and Deferred Taxes
Illustration: In Chelsea’s situation, the only difference
between the book basis and tax basis of the assets and
liabilities relates to accounts receivable that arose from revenue
recognized for book purposes. Chelsea reports accounts
receivable at $30,000 in the December 31, 2012, GAAP-basis
balance sheet. However, the receivables have a zero tax
basis.
Illustration 19-5
19-12
LO 2 Describe a temporary difference that results in future taxable amounts.
Future Taxable Amounts and Deferred Taxes
Illustration: Reversal of Temporary Difference, Chelsea Inc.
Illustration 19-6
Chelsea assumes that it will collect the accounts receivable and report
the $30,000 collection as taxable revenues in future tax returns.
Chelsea does this by recording a deferred tax liability.
19-13
LO 2 Describe a temporary difference that results in future taxable amounts.
Future Taxable Amounts and Deferred Taxes
Deferred Tax Liability
A deferred tax liability represents the increase in taxes payable
in future years as a result of taxable temporary differences
existing at the end of the current year.
Illustration 19-4
Income tax expense (GAAP)
Income tax payable (IRS)
Difference
19-14
2012
2013
2014
Total
$28,000
$28,000
$28,000
$84,000
16,000
36,000
32,000
84,000
$12,000
$(8,000)
$(4,000)
$0
LO 2 Describe a temporary difference that results in future taxable amounts.
Future Taxable Amounts and Deferred Taxes
Deferred Tax Liability
Illustration: Because it is the first year of operations for
Chelsea, there is no deferred tax liability at the beginning of the
year. Chelsea computes the income tax expense for 2012 as
follows:
Illustration 19-9
19-15
LO 2 Describe a temporary difference that results in future taxable amounts.
Future Taxable Amounts and Deferred Taxes
Deferred Tax Liability
Illustration: Chelsea makes the following entry at the end of
2012 to record income taxes.
Income Tax Expense
19-16
28,000
Income Tax Payable
16,000
Deferred Tax Liability
12,000
LO 2 Describe a temporary difference that results in future taxable amounts.
Future Taxable Amounts and Deferred Taxes
Deferred Tax Liability
Illustration: Computation of Income Tax Expense for 2013.
Illustration 19-10
19-17
LO 2 Describe a temporary difference that results in future taxable amounts.
Future Taxable Amounts and Deferred Taxes
Deferred Tax Liability
Illustration: Chelsea makes the following entry at the end of
2013 to record income taxes.
Income Tax Expense
28,000
Deferred Tax Liability
8,000
Income Tax Payable
19-18
36,000
LO 2 Describe a temporary difference that results in future taxable amounts.
Future Taxable Amounts and Deferred Taxes
Deferred Tax Liability
Illustration: The entry to record income taxes at the end of
2014 reduces the Deferred Tax Liability by $4,000. The Deferred
Tax Liability account appears as follows at the end of 2014.
Illustration 19-11
19-19
LO 2 Describe a temporary difference that results in future taxable amounts.
Future Taxable Amounts and Deferred Taxes
E19-1: Starfleet Corporation has one temporary difference at
the end of 2012 that will reverse and cause taxable amounts of
$55,000 in 2013, $60,000 in 2014, and $75,000 in 2015.
Starfleet’s pretax financial income for 2012 is $400,000, and the
tax rate is 30% for all years. There are no deferred taxes at the
beginning of 2012.
Instructions
a) Compute taxable income and income taxes payable for
2012.
b) Prepare the journal entry to record income tax expense,
deferred income taxes, and income taxes payable for 2012.
19-20
LO 2 Describe a temporary difference that results in future taxable amounts.
Future Taxable Amounts and Deferred Taxes
Ex. 19-1:
Current Yr.
INCOME:
2012
Financial income (GAAP)
400,000
Temporary Diff.
Taxable income (IRS)
b.
19-21
2014
2015
(190,000)
55,000
60,000
75,000
210,000
55,000
60,000
75,000
a.
Tax rate
Income tax
2013
30%
a.
Income tax expense (plug)
63,000
30%
16,500
30%
18,000
30%
22,500
120,000
Income tax payable
63,000
Deferred tax liability
57,000
LO 2 Describe a temporary difference that results in future taxable amounts.
Future Deductible Amounts and Deferred Taxes
Illustration: During 2012, Cunningham Inc. estimated its
warranty costs related to the sale of microwave ovens to be
$500,000, paid evenly over the next two years. For book
purposes, in 2012 Cunningham reported warranty expense and
a related estimated liability for warranties of $500,000 in its
financial statements. For tax purposes, the warranty tax
deduction is not allowed until paid.
Illustration 19-12
19-22
LO 3 Describe a temporary difference that results in future deductible amounts.
Future Deductible Amounts and Deferred Taxes
Illustration: Reversal of Temporary Difference.
Illustration 19-13
When Cunningham pays the warranty liability, it reports an expense
(deductible amount) for tax purposes. Cunningham reports this future
tax benefit in the December 31, 2012, balance sheet as a deferred tax
asset.
19-23
LO 3 Describe a temporary difference that results in future deductible amounts.
Future Deductible Amounts and Deferred Taxes
Deferred Tax Asset
A deferred tax asset represents the increase in taxes
refundable (or saved) in future years as a result of deductible
temporary differences existing at the end of the current year.
19-24
LO 3 Describe a temporary difference that results in future deductible amounts.
Future Deductible Amounts and Deferred Taxes
Deferred Tax Asset
Illustration: Hunt Co. accrues a loss and a related liability of
$50,000 in 2012 for financial reporting purposes because of
pending litigation. Hunt cannot deduct this amount for tax
purposes until the period it pays the liability, expected in 2013.
Illustration 19-14
19-25
LO 3 Describe a temporary difference that results in future deductible amounts.
Future Deductible Amounts and Deferred Taxes
Deferred Tax Asset
Illustration: Assuming that 2012 is Hunt’s first year of
operations, and income tax payable is $100,000, Hunt computes
its income tax expense as follows.
Illustration 19-16
19-26
LO 3 Describe a temporary difference that results in future deductible amounts.
Future Deductible Amounts and Deferred Taxes
Deferred Tax Asset
Illustration: Hunt makes the following entry at the end of 2012
to record income taxes.
Income Tax Expense
80,000
Deferred Tax Asset
20,000
Income Tax Payable
19-27
100,000
LO 3 Describe a temporary difference that results in future deductible amounts.
Future Deductible Amounts and Deferred Taxes
Deferred Tax Asset
Illustration: Computation of Income Tax Expense for 2013.
Illustration 19-17
19-28
LO 3 Describe a temporary difference that results in future deductible amounts.
Future Deductible Amounts and Deferred Taxes
Deferred Tax Asset
Illustration: Hunt makes the following entry at the end of 2013
to record income taxes.
Income Tax Expense
19-29
160,000
Deferred Tax Asset
20,000
Income Tax Payable
140,000
LO 3 Describe a temporary difference that results in future deductible amounts.
Future Deductible Amounts and Deferred Taxes
Deferred Tax Asset
Illustration: The entry to record income taxes at the end of
2013 reduces the Deferred Tax Asset by $20,000.
Illustration 19-18
19-30
LO 3 Describe a temporary difference that results in future deductible amounts.
Future Deductible Amounts and Deferred Taxes
Illustration: Columbia Corporation has one temporary difference
at the end of 2012 that will reverse and cause deductible amounts
of $50,000 in 2013, $65,000 in 2014, and $40,000 in 2015.
Columbia’s pretax financial income for 2012 is $200,000 and the
tax rate is 34% for all years. There are no deferred taxes at the
beginning of 2012. Columbia expects to be profitable in the future.
Instructions
a) Compute taxable income and income taxes payable for 2012.
b) Prepare the journal entry to record income tax expense,
deferred income taxes, and income taxes payable for 2012.
19-31
LO 3 Describe a temporary difference that results in future deductible amounts.
Future Deductible Amounts and Deferred Taxes
Illustration
Current Yr.
INCOME:
2012
Financial income (GAAP)
200,000
Temporary Diff.
Taxable income (IRS)
a.
Tax rate
Income tax
b.
2014
2015
155,000
(50,000)
(65,000)
(40,000)
355,000
(50,000)
(65,000)
(40,000)
34%
34%
34%
(17,000)
(22,100)
(13,600)
34%
a.
120,700
Income tax expense
68,000
Deferred tax asset
52,700
Income tax payable
19-32
2013
120,700
LO 3 Describe a temporary difference that results in future deductible amounts.
Future Deductible Amounts and Deferred Taxes
Deferred Tax Asset—Valuation Allowance
A company should reduce a deferred tax asset by a valuation
allowance if it is more likely than not that it will not realize
some portion or all of the deferred tax asset.
“More likely than not” means a level of likelihood of at least
slightly more than 50 percent.
19-33
LO 4 Explain the purpose of a deferred tax asset valuation allowance.
Future Deductible Amounts and Deferred Taxes
E19-14: Callaway Corp. has a deferred tax asset balance of
$150,000 at the end of 2012 due to a single cumulative
temporary difference of $375,000. At the end of 2013 this same
temporary difference has increased to a cumulative amount of
$500,000. Taxable income for 2013 is $850,000. The tax rate is
40% for all years. No valuation account is in existence at the end
of 2012.
Instructions
Assuming that it is more likely than not that $30,000 of the
deferred tax asset will not be realized, prepare the journal entries
required for 2013.
19-34
LO 4 Explain the purpose of a deferred tax asset valuation allowance.
Future Deductible Amounts and Deferred Taxes
E19-14:
Current Yr.
INCOME:
2011
Financial income (GAAP)
2012
2013
725,000
Temporary difference
375,000
125,000
(500,000)
Taxable income (IRS)
375,000
850,000
(500,000)
Tax rate
40%
Income tax
150,000
Income tax expense
Deferred tax asset
40%
340,000
Allowance for deferred tax asset
19-35
(200,000)
40%
-
290,000
50,000
Income tax payable
Income tax expense
40%
-
340,000
30,000
30,000
LO 4 Explain the purpose of a deferred tax asset valuation allowance.
Future Deductible Amounts and Deferred Taxes
Deferred Tax Asset—Valuation Allowance
E19-14 Balance Sheet Presentation
Assets:
2012
Deferred tax asset
19-36
$ 200,000
Allowance for deferred tax
(30,000)
Deferred tax asset, net
170,000
LO 4 Explain the purpose of a deferred tax asset valuation allowance.
Income Statement Presentation
Formula to Compute Income Tax Expense
Income tax
payable or
refundable
+
-
Change in
deferred income
tax
=
Illustration 19-20
Income tax
expense or
benefit
In the income statement or in the notes to the financial
statements, a company should disclose the significant
components of income tax expense (current and deferred).
19-37
LO 5 Describe the presentation of income tax expense in the income statement.
Income Statement Presentation
Given the previous information related to Chelsea Inc.,
Chelsea reports its income statement as follows.
Illustration 19-21
19-38
LO 5 Describe the presentation of income tax expense in the income statement.
Specific Differences
Temporary Differences

Taxable temporary differences - Deferred tax
liability

Deductible temporary differences - Deferred tax
Asset
Text Illustration 19-22 Examples of Temporary Differences
19-39
LO 6 Describe various temporary and permanent differences.
Specific Differences
Permanent differences are caused by items that (1) enter into
pretax financial income but never into taxable income or (2)
enter into taxable income but never into pretax financial
income.
Permanent differences affect only the period in which they
occur. They do not give rise to future taxable or deductible
amounts. There are no deferred tax consequences to be
recognized.
Text Illustration 19-24 Examples of Permanent Differences
19-40
LO 6 Describe various temporary and permanent differences.
Specific Differences
Do the following generate:
 Future Deductible Amount = Deferred Tax Asset
 Future Taxable Amount = Deferred Tax Liability
 Permanent Difference
E19-6
1. The MACRS depreciation system is used for tax purposes,
and the straight-line depreciation method is used for financial
reporting purposes.
Future
Taxable
Amount
2. A landlord collects some rents in advance. Rents received
are taxable in the period when they are received.
Future
Deductible
Amount
3. Expenses are incurred in obtaining tax-exempt income.
Permanent
Difference
4. Costs of guarantees and warranties are estimated and
accrued for financial reporting purposes.
Future
Deductible
Amount
19-41
LO 6 Describe various temporary and permanent differences.
Specific Differences
Do the following generate:
 Future Deductible Amount = Deferred Tax Asset
 Future Taxable Amount = Deferred Tax Liability
 Permanent Difference
E19-6
5. Installment sales of investments are accounted for by the
accrual method for financial reporting purposes and the
installment-sales method for tax purposes.
Future
Taxable
Amount
6. Proceeds are received from a life insurance company
because of the death of a key officer (the company carries a
policy on key officers).
Permanent
Difference
7. Estimated losses on pending lawsuits and claims are
accrued for books. These losses are tax deductible in the
period(s) when the related liabilities are settled.
Future
Deductible
Amount
19-42
LO 6 Describe various temporary and permanent differences.
Permanent Differences
E19-4: Havaci Company reports pretax financial income of $80,000
for 2012. The following items cause taxable income to be different
than pretax financial income.
1. Depreciation on the tax return is greater than depreciation on
the income statement by $16,000.
2. Rent collected on the tax return is greater than rent earned on
the income statement by $27,000.
3. Fines for pollution appear as an expense of $11,000 on the
income statement.
Havaci’s tax rate is 30% for all years, and the company expects to
report taxable income in all future years. There are no deferred taxes
at the beginning of 2012.
19-43
LO 6 Describe various temporary and permanent differences.
Permanent Differences
E19-4:
Current Yr.
Deferred
Deferred
INCOME:
2012
Asset
Liability
Financial income (GAAP)
$
Excess tax depreciation
80,000
(16,000)
Excess rent collected
27,000
Fines (permanent)
11,000
Taxable income (IRS)
$
102,000
Tax rate
$
Income tax expense
30,600
30%
$
16,000
(27,000)
(27,000)
30%
Income tax
(8,100) $
16,000
-
30%
4,800
-
27,300
Deferred tax asset
8,100
Deferred tax liability
Income tax payable
19-44
$
4,800
30,600
LO 6 Describe various temporary and permanent differences.
Tax Rate Considerations
Future Tax Rates
A company must consider presently enacted changes in the
tax rate that become effective for a particular future year(s)
when determining the tax rate to apply to existing temporary
differences.
Revision of Future Tax Rates
When a change in the tax rate is enacted, companies should
record its effect on the existing deferred income tax accounts
immediately.
19-45
LO 7 Explain the effect of various tax rates and tax
rate changes on deferred income taxes.
Accounting for Net Operating Losses
Net operating loss (NOL) = tax-deductible expenses
exceed taxable revenues.
The federal tax laws permit taxpayers to use the losses of
one year to offset the profits of other years (carryback and
carryforward).
19-46
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.
Accounting for Net Operating Losses
Loss Carryback

Back 2 years and forward 20 years

Losses must be applied to earliest year first
Illustration 19-29
19-47
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.
Accounting for Net Operating Losses
Loss Carryforward

May elect to forgo loss carryback and

Carryforward losses 20 years
Illustration 19-30
19-48
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.
Accounting for Net Operating Losses
BE19-12: (Carryback) Conlin Corporation had the following tax
information.
Year
Taxable
Income
Tax
Rate
Taxes
Paid
2010
2011
2012
$ 300,000
325,000
400,000
35%
30%
30%
$ 105,000
97,500
120,000
In 2013 Conlin suffered a net operating loss of $480,000, which it
elected to carry back. The 2013 enacted tax rate is 29%.
Prepare Valis’s entry to record the effect of the loss carryback.
19-49
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.
Accounting for Net Operating Losses
BE19-12
Financial income
2010
$
300,000
2011
$
2012
325,000
$
2013
400,000
Difference
Taxable income (loss)
300,000
Rate
325,000
35%
Income tax
400,000
30%
30%
(480,000)
29%
$
105,000
$
97,500
$
120,000
$
300,000
$
325,000
$
400,000
(480,000)
(155,000)
480,000
NOL Schedule
Taxable income
Carryback
(325,000)
Taxable income
300,000
Rate
35%
Income tax (revised)
Refund
19-50
-
$
105,000
245,000
30%
$
$
-
97,500
30%
29%
$
73,500
-
$
46,500
$144,000
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.
Accounting for Net Operating Losses
E19-12: Journal Entry for 2013
Income tax refund receivable
Benefit due to loss carryback
19-51
144,000
144,000
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.
Accounting for Net Operating Losses
BE19-13: Rode Inc. incurred a net operating loss of
$500,000 in 2012. Combined income for 2010 and 2011
was $350,000. The tax rate for all years is 40%. Rode
elects the carryback option. Prepare the journal entries to
record the benefits of the loss carryback and the loss
carryforward.
19-52
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.
Accounting for Net Operating Losses
BE19-13
2010-2011
Financial income
$
2012
2013
350,000
Difference
Taxable income (loss)
350,000
Rate
Income tax
40%
(500,000)
40%
$
140,000
$
350,000
(500,000)
(350,000)
350,000
NOL Schedule
Taxable income
Carryback
Taxable income
-
Rate
40%
Income tax (revised)
19-53
$
-
(150,000)
40%
(60,000)
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.
Accounting for Net Operating Losses
E19-13: Journal Entries for 2012
Income tax refund receivable
140,000
Benefit due to loss carryback
Deferred tax asset
Benefit due to loss carryforward
19-54
140,000
60,000
60,000
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.
Accounting for Net Operating Losses
BE19-14 (Carryback and Carryforward with Valuation
Allowance): Use the information for Rode Inc. given in BE1913. Assume that it is more likely than not that the entire net
operating loss carryforward will not be realized in future years.
Prepare all the journal entries necessary at the end of 2012.
19-55
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.
Accounting for Net Operating Losses
E19-14: Journal Entries for 2012
Income tax refund receivable
Benefit due to loss carryback
19-56
140,000
140,000
Deferred tax asset
Benefit due to loss carryforward
60,000
Benefit due to loss carryforward
Allowance for deferred tax asset
60,000
60,000
60,000
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.
Valuation Allowance Revisited
Whether the company will realize a deferred tax asset
depends on whether sufficient taxable income exists or will
exist within the carryforward period.
Text Illustration 19-37 Possible Sources of Taxable Income
If any one of these sources is sufficient to support a
conclusion that a valuation allowance is unnecessary, a
company need not consider other sources.
Text Illustration 19-38 Evidence to Consider in Evaluating the need
for a Valuation Account
19-57
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.
Financial Statement Presentation
Balance Sheet Presentation
An individual deferred tax liability or asset is classified as
current or noncurrent based on the classification of the
related asset or liability for financial reporting purposes.
Companies should classify deferred tax accounts on the
balance sheet in two categories:
19-58

one for the net current amount, and

one for the net noncurrent amount.
LO 9 Describe the presentation of deferred
income taxes in financial statements.
Financial Statement Presentation
Income Statement Presentation
Companies should allocate income tax expense (or benefit)
to continuing operations, discontinued operations,
extraordinary items, and prior period adjustments.
Companies should disclose the significant components of
income tax expense attributable to continuing operations
(current tax expense, deferred tax expense, etc.).
19-59
LO 9 Describe the presentation of deferred
income taxes in financial statements.
Review of the Asset-Liability Method
Companies apply the following basic principles:
19-60
a.
A current tax liability or asset is recognized for the estimated taxes
payable or refundable on the tax return for the current year.
b.
A deferred tax liability or asset is recognized for the estimated
future tax effects attributable to temporary differences and
carryforwards.
c.
The measurement of current and deferred tax liabilities and assets
is based on provisions of the enacted tax law; the effects of future
changes in tax laws or rates are not anticipated.
d.
The measurement of deferred tax assets is reduced, if necessary,
by the amount of any tax benefits that, based on available
evidence, are not expected to be realized.
LO 10 Indicate the basic principles of the asset-liability method.
Review of the Asset-Liability Method
Illustration 19-43
Procedures for Computing
and Reporting Deferred
Income Taxes
19-61
LO 10 Indicate the basic principles of the asset-liability method.
APPENDIX
19A
COMPREHENSIVE EXAMPLE OF INTERPERIOD
TAX ALLOCATION
Fiscal Year-2011
Allman Company, which began operations at the beginning of 2011,
produces various products on a contract basis. Each contract
generates a gross profit of $80,000. Some of Allman’s contracts provide
for the customer to pay on an installment basis. Under these contracts,
Allman collects one-fifth of the contract revenue in each of the following
four years. For financial reporting purposes, the company recognizes
gross profit in the year of completion (accrual basis); for tax purposes,
Allman recognizes gross profit in the year cash is collected (installment
basis).
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LO 11 Understand and apply the concepts and
procedures of interperiod tax allocation.
APPENDIX
19A
COMPREHENSIVE EXAMPLE OF INTERPERIOD
TAX ALLOCATION
Fiscal Year-2011
Presented below is information related to Allman’s operations for 2011.
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1.
In 2011, the company completed seven contracts that allow for the
customer to pay on an installment basis. Allman recognized the related
gross profit of $560,000 for financial reporting purposes. It reported only
$112,000 of gross profit on installment sales on the 2011 tax return. The
company expects future collections on the related installment
receivables to result in taxable amounts of $112,000 in each of the next
four years.
2.
At the beginning of 2011, Allman Company purchased depreciable
assets with a cost of $540,000. For financial reporting purposes, Allman
depreciates these assets using the straight-line method over a six-year
service life. For tax purposes, the assets fall in the five-year recovery
class, and Allman uses the MACRS system.
LO 11
APPENDIX
19A
COMPREHENSIVE EXAMPLE OF INTERPERIOD
TAX ALLOCATION
Fiscal Year-2011
3.
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The company warrants its product for two years from the date of
completion of a contract. During 2011, the product warranty liability
accrued for financial reporting purposes was $200,000, and the amount
paid for the satisfaction of warranty liability was $44,000. Allman expects
to settle the remaining $156,000 by expenditures of $56,000 in 2012 and
$100,000 in 2013.
LO 11
APPENDIX
19A
COMPREHENSIVE EXAMPLE OF INTERPERIOD
TAX ALLOCATION
Fiscal Year-2011
19-65
4.
In 2011 nontaxable municipal bond interest revenue was $28,000.
5.
During 2011 nondeductible fines and penalties of $26,000 were paid.
6.
Pretax financial income for 2011 amounts to $412,000.
7.
Tax rates enacted before the end of 2011 were:

2011
50%

2012 and later years
40%
8.
The accounting period is the calendar year.
9.
The company is expected to have taxable income in all future years.
LO 11
APPENDIX
19A
COMPREHENSIVE EXAMPLE OF INTERPERIOD
TAX ALLOCATION
Taxable Income and Income Tax Payable-2011
The first step is to determine Allman Company’s income tax
payable for 2011 by calculating its taxable income.
Illustration 19A-1
Illustration 19A-2
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LO 11
APPENDIX
19A
COMPREHENSIVE EXAMPLE OF INTERPERIOD
TAX ALLOCATION
Computing Deferred Income Taxes – End of 2011
Illustration 19A-3
Illustration 19A-4
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LO 11
APPENDIX
19A
COMPREHENSIVE EXAMPLE OF INTERPERIOD
TAX ALLOCATION
Deferred Tax Expense (Benefit) and the Journal
Entry to Record Income Taxes - 2011
Computation of Deferred Tax Expense (Benefit), 2011
Illustration 19A-5
Computation of Net Deferred Tax Expense, 2011
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Illustration 19A-6
LO 11
APPENDIX
19A
COMPREHENSIVE EXAMPLE OF INTERPERIOD
TAX ALLOCATION
Deferred Tax Expense (Benefit) and the Journal
Entry to Record Income Taxes - 2011
Computation of Total Income Tax Expense, 2011
Illustration 19A-7
Journal Entry for Income Tax Expense, 2011
Income Tax Expense
Deferred Tax Asset
Income Tax Payable
Deferred Tax Liability
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174,000
62,400
50,000
186,400
LO 11
APPENDIX
19A
COMPREHENSIVE EXAMPLE OF INTERPERIOD
TAX ALLOCATION
Financial Statement Presentation - 2011
Companies should classify deferred tax assets and liabilities as
current and noncurrent on the balance sheet based on the
classifications of related assets and liabilities.
Illustration 19A-8
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LO 11
APPENDIX
19A
COMPREHENSIVE EXAMPLE OF INTERPERIOD
TAX ALLOCATION
Financial Statement Presentation - 2011
Balance Sheet Presentation of Deferred Taxes, 2011
Illustration 19A-9
Illustration 19A-10
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LO 11
RELEVANT FACTS
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
The classification of deferred taxes under IFRS is always noncurrent. As indicated in the chapter, GAAP classifies deferred taxes
based on the classification of the asset or liability to which it relates.

Under IFRS, an affirmative judgment approach is used, by which a
deferred tax asset is recognized up to the amount that is probable to
be realized. GAAP uses an impairment approach. In this approach,
the deferred tax asset is recognized in full. It is then reduced by a
valuation account if it is more likely than not that all or a portion of
the deferred tax asset will not be realized.

IFRS uses the enacted tax rate or substantially enacted tax rate.
(“Substantially enacted” means virtually certain.) For GAAP, the
enacted tax rate must be used.
RELEVANT FACTS
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
The tax effects related to certain items are reported in equity under
IFRS. That is not the case under GAAP, which charges or credits the
tax effects to income.

GAAP requires companies to assess the likelihood of uncertain tax
positions being sustainable upon audit. Potential liabilities must be
accrued and disclosed if the position is “more likely than not” to be
disallowed. Under IFRS, all potential liabilities must be recognized.
With respect to measurement, IFRS uses an expected-value
approach to measure the tax liability, which differs from GAAP.
IFRS SELF-TEST QUESTION
Which of the following is false?
a. Under GAAP, deferred taxes are reported based on the
classification of the asset or liability to which it relates.
b. Under IFRS, some potential liabilities are not recognized.
c.
Under GAAP, the enacted tax rate is used to measure deferred
tax assets and liabilities.
d. Under IFRS, all deferred tax assets and liabilities are classified
as non-current.
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IFRS SELF-TEST QUESTION
Which of the following statements is correct with regard to IFRS and GAAP?
a.
Under GAAP, all potential liabilities related to uncertain tax positions
must be recognized.
b.
The tax effects related to certain items are reported in equity under
GAAP; under IFRS, the tax effects are charged or credited to income.
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c.
IFRS uses an affirmative judgment approach for deferred tax assets,
whereas GAAP uses an impairment approach for deferred tax assets.
d.
IFRS classifies deferred taxes based on the classification of the asset
or liability to which it relates.
IFRS SELF-TEST QUESTION
Under IFRS:
a. “probable” is defined as a level of likelihood of at least slightly
more than 60%.
b. a company should reduce a deferred tax asset when it is likely
that some or all of it will not be realized by using a valuation
allowance.
c.
a company considers only positive evidence when determining
whether to recognize a deferred tax asset.
d. deferred tax assets must be evaluated at the end of each
accounting period.
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