Transcript Accounting for Income Taxes Chapter Intermediate Accounting 12th Edition Kieso, Weygandt, and Warfield Prepared by Coby Harmon, University of California, Santa Barbara.

Accounting for
Income Taxes
Chapter
19
Intermediate Accounting
12th Edition
Kieso, Weygandt, and Warfield
1
Prepared by Coby Harmon, University of California, Santa Barbara
Fundamental Differences between
Financial and Tax Reporting
Background
• Deferral approach to tax allocation
(APB Opinion 11)
– Income tax expense = amount of taxes that
would be paid if income statement numbers
appeared on the current year's tax return.
• Deferred taxes was the plug figure (difference
between taxes payable and tax expense).
• The effect of subsequent changes in tax rates on
deferred tax account were essentially ignored.
Matching Approach
3
Background
• A method that was proposed theoretically
(but has never been GAAP in US)
– Assets and liabilities would be recorded NET of
any deferred tax related to the item
Net-of-Tax Approach
4
Background
• Liability approach to tax allocation
(FASB 96, 109)
– Income tax expense = taxes currently payable
plus change in deferred taxes.
• If tax rates change, the effect on deferred tax
amounts affect income tax expense in the year the
change is enacted.
• If there are no changes in tax rates, income tax
expense should be approximately the same as under
APB Opinion 11.
Asset/Liability
Measurement Approach
5
Fundamentals of Accounting for Income Taxes
Financial Statements
Tax Return
vs.
Exchanges
Investors and Creditors
Pretax Financial Income
GAAP
Income Tax Expense

Taxable Income

Tax Code
Income Tax Payable
LO 1 Identify differences between pretax financial income and taxable 6income.
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
Deferred Tax
Liability
Amounts
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
Deferred Tax
Asset represents
Amounts
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
LO 2 Describe a temporary difference that results in future taxable 11
amounts.
Example – Deferred Tax Liability
• Assume that Sales Company recognizes $15,000 gross profit
from installment sales for financial accounting in 2006. The
gross profit will be taxable at $3,000 each year for the next five
years. The company earns $10,000 additional income each year
and the tax rate is 40%. The following schedule shows taxable
income, income tax payable, financial income, and income tax
expense for the five year period.
12
Solution – Sales Company
For tax purposes, we are postponing recognition of
revenue until later years. This revenue will be
reported on future tax returns and the taxes will be
paid at that time (rather than immediately)
13
Sales Co. - Solution - continued
14
Example – Deferred Tax Asset
Financial Magazine Company received $15,000 of
subscriptions in advance for 2006. Subscription revenue
will be recognized equally in 2007, 2008, and 2009, for
financial accounting purposes but all of the $15,000 will be
recognized in 2006 for tax purposes. There is additional
income of $50,000 each year and the tax rate is 40%.
15
Financial Magazine Co.
Solution Continued
16
Financial Magazine Co.
Solution Continued
17
South Carolina Corporation
E19-1 South Carolina Corporation has one temporary
difference at the end of 2007 that will reverse and cause
taxable amounts of $55,000 in 2008, $60,000 in 2009, and
$65,000 in 2010. South Carolina’s pretax financial income
for 2007 is $300,000, and the tax rate is 30% for all years.
There are no deferred taxes at the beginning of 2007.
Instructions
a) Compute taxable income and income taxes payable for 2007.
b) Prepare the journal entry to record income tax expense,
deferred income taxes, and income taxes payable for 2007.
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South Carolina Corporation
Ex. 19-1
Current Yr.
INCOME:
2007
2008
2009
2010
Financial income (GAAP)
Temporary Diff.
Taxable income (IRS)
Tax rate
a.
Income tax
a.
b. Income tax expense (plug)
Income tax payable
Deferred tax liability
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South Carolina Corp. (Solution)
Ex. 19-1
Current Yr.
INCOME:
2007
Financial income (GAAP)
2009
2010
300,000
Temporary Diff.
(180,000)
55,000
60,000
65,000
120,000
55,000
60,000
65,000
Taxable income (IRS)
Tax rate
2008
30%
a.
Income tax
36,000
30%
16,500
30%
18,000
30%
19,500
a.
b. Income tax expense (plug)
90,000
Income tax payable
36,000
Deferred tax liability
54,000
LO 2 Describe a temporary difference that results in future taxable 20
amounts.
Columbia Corporation
Columbia Corporation has one temporary difference
at the end of 2007 that will reverse and cause
deductible amounts of $50,000 in 2008, $65,000 in
2009, and $40,000 in 2010. Columbia’s pretax
financial income for 2007 is $200,000 and the tax
rate is 34% for all years. There are no deferred
taxes at the beginning of 2007. Columbia expects
to be profitable in the future.
Instructions
a) Compute taxable income and income taxes payable for 2007.
b) Prepare the journal entry to record income tax expense,
deferred income taxes, and income taxes payable for 2007.
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Columbia Corporation
Columbia Corp.
Current Yr.
INCOME:
2007
2008
2009
2010
Financial income (GAAP)
Temporary Diff.
Taxable income (IRS)
Tax rate
Income tax
a.
a.
b. Income tax expense
Income tax payable
Deferred tax asset
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Temporary Differences (1)
• Revenues and gains, recognized in
financial income, are later taxed for
income tax purposes.
– Installment sales
• Expenses and losses are deducted for
income tax purposes before they are
recognized in financial income.
– MACRS depreciation
– Goodwill deduction on tax return
Called “taxable temporary differences”
Temporary Differences (2)
• Revenues and gains are taxed for
income tax purposes before they are
recognized in financial income.
– Subscription revenue
– Prepaid rent
• Expenses and losses, recognized in
financial income, are later deducted for
income tax purposes.
– Warranty expense
Called “deductible temporary differences”
Summary of Temporary Differences
When recorded
Transaction
in books
When recorded
on tax return
Deferred
tax effect
Rev or Gain
Earlier
Later
Liability
Rev or Gain
Later
Earlier
Asset
Exp or Loss
Earlier
Later
Asset
Exp or Loss
Later
Earlier
Liability
Permanent Differences
Sources of Permanent Differences
Some items
are recorded
in Books
Other items
are NEVER
recorded in books
but NEVER
on tax return
but recorded
on tax return
No deferred tax effects
for permanent differences
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Permanent Differences: Examples
• Items, recognized for financial accounting
purposes, but not for income tax purposes:
– Interest revenue on Municipal Bonds
– Life insurance premiums and proceeds when corporation is
beneficiary
– Fines and penalties
• Items, recognized for tax purposes, but not
for financial accounting purposes:
– Dividend exclusion
– Statutory depletion
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Deferred Tax Asset & Deferred
Tax Liability: Sources
• Deferred taxes may be a:
– Deferred tax liability, or
– Deferred tax asset
• Deferred tax liability arises due to net
taxable amounts in the future.
• Deferred tax asset arises due to net
deductible amounts in the future.
Valuation Allowance
for Deferred Tax Assets
If the deferred tax asset appears doubtful, a
Valuation Allowance account is needed.
Journal entry:
Income Tax Expense
$$
Allowance to Reduce
Deferred Tax Asset to
Expected Realizable Value
$$
The entry records a potential future tax benefit that
is not expected to be realized in the future.
Balance Sheet Presentation
• The deferred tax classification relates to its
underlying asset or liability.
– Classify the deferred tax amounts as current or
non-current.
• Presentation is
– NET amount related to current items
• If DR>CR, current deferred tax asset
• If DR<CR, current deferred tax liability
– NET amount related to noncurrent items
• If DR>CR, noncurrent deferred tax asset
• If DR<CR, noncurrent deferred tax liability
What Tax Rate to Apply
• Basic Rule: Apply the yearly tax rate to calculate
deferred tax effects.
– If future tax rates change: use the enacted tax rate
expected to apply in the future year.
– If new rates are not yet enacted into law for future
years, the current rate should be used.
• The appropriate enacted rate for a year is the
average tax rate [based on graduated tax
brackets].
Let’s do an example
• Second Best Company
– Working paper style – working paper blank
will be provided on Exam 2
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33
Net Operating Loss (NOL)
Net operating loss is tax terminology.
A net operating loss occurs when tax
deductions for a year exceed taxable
revenues.
Net loss or operating loss is a financial
accounting term.
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NOL Rule (subject to change)
• NOL for each tax year is computed.
• The NOL of one year can be applied to
offset taxable income of other years,
possibly resulting in tax refunds
• Current rule: NOLs can be:
– carried back 2 years and carried forward
20 years (carryback option),
– or carried forward 20 years (carryforward
only)
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NOL Carryback
Tax years
2001
2002
2003
2004
2005
2006
2007
next
Apply first
NOL
2004
Loss carryforward
20 years forward
Expect
tax refund
Record all
here
tax effects here
Expect
tax
shield
here
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NOL Carryforward
Tax years
2001 2002
2003
2004
NOL
2004
Forgo 2
year rule
2053
2006
2007
Loss carryforward
20 years forward
Record all
tax effects here
Expect
tax
shield
here
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Zoop Inc. (NOL)
Zoop Inc. incurred a net operating loss of
$500,000 in 2007. Taxable income was
$200,000 for 2005 and $200,000 for 2006.
The tax rate for all years is 40%. Zoop elects
the carryback option. Prepare the journal
entries to record the benefits of the loss
carryback and the loss carryforward.
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LO 8 Apply accounting procedures for a loss carryback and a loss carryforward
.
Zoop Inc. (NOL)
Zoop Inc.
2005
2006
2007
2008
Financial income
Difference
Taxable income (loss)
Rate
Income tax
NOL Schedule
Taxable income
Carryback from 2007
Taxable income
Rate
Income tax (revised)
Refund
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Zoop Inc. (NOL) - Solution
Zoop Inc.
Financial income
2005
2006
$ 200,000
$ 200,000
200,000
200,000
2007
2008
Difference
Taxable income (loss)
Rate
Income tax
40%
$
80,000
40%
$
(500,000)
40%
80,000
NOL Schedule
Taxable income
$ 200,000
Carryback from 2007
(200,000)
$ 200,000
(200,000)
Taxable income
-
-
Rate
40%
40%
Income tax (revised)
$
-
$
-
Refund
$
80,000
$
80,000
$160,000
(500,000)
400,000
(100,000)
40%
(40,000)
Deferred Tax Asset
40
Zoop Inc. (NOL) - Solution
Zoop’s Journal Entries for 2007
Income tax refund receivable
160,000
Benefit due to loss carryback
Deferred tax asset
Benefit due to loss carryforward
160,000
40,000
40,000
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LO 8 Apply accounting procedures for a loss carryback and a loss carryforward
.
Zoop Inc. (Variation)
Now assume that it is more likely than not
that the entire net operating loss
carryforward will not be realized by Zoop
Inc. in future years. Prepare all the
journal entries necessary at the end of
2007.
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.
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Zoop Inc. (Variation) - Solution
Zoop Inc. - Journal Entries for 2007
Income tax refund receivable
160,000
Benefit due to loss carryback
Deferred tax asset
160,000
40,000
Benefit due to loss carryforward
Benefit due to loss carryforward
Allowance for deferred tax asset
40,000
40,000
40,000
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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
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Valis Corporation (NOL)
Valis Corporation had the following tax information.
Year
Taxable
Income
Tax
Rate
Taxes
Paid
2004
$ 300,000
35%
$ 105,000
2005
325,000
30%
97,500
2006
400,000
30%
120,000
In 2007 Valis suffered a net operating loss of
$450,000, which it elected to carry back. The
2007 enacted tax rate is 29%. Prepare Valis’s entry
to record the effect of the loss carryback.
LO 8 Apply procedures for a loss carryback and a loss carryforward.
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Valis Corporation – Solution (NOL)
Valis Corp.
2004
2005
2006
2007
Financial income
Difference
Taxable income (loss)
Rate
Income tax
NOL Schedule
Taxable income
Carryback from 2007
Taxable income
Rate
Income tax (revised)
Refund
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Valis Corporation – Solution (NOL)
Valis Corp - Journal Entry for 2007
Income tax refund receivable
Benefit due to loss carryback
135,000
135,000
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Example:
Revision of Future Tax Rate
At the end of 2002, the corporate tax rate is
changed from 40% to 35%. The new rate is
effective January 1, 2004.
The deferred tax account (1/1/2002) is as
follows:
Excess tax depreciation:
$3 million
Deferred tax liability:
$1.2 million
Related taxable amounts are expected to occur
equally over 2003, 2004, and 2005.
Provide the journal entry to reflect the change.
Example:
Revision of Future Tax Rate
The deferred tax liability end of 2005 is as follows:
2003
2004
2005
Future tax inc $1,000,000 1,000,000 1,000,000
Tax rate
40%
35%
35%
Deferred tax
$400,000
350,000
350,000
liability
Entry:
Deferred Tax Liability
$100,000
Income Tax Expense
$100,000*
*$1,200,000 – $1,100,000
Let’s return to Second Best
• In the third year:
– A change in enacted tax rates
– A net operating loss
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Intraperiod Tax Allocation
Income tax expense, is allocated to:
•
•
•
•
Continuing operations
Discontinued operations
Extraordinary items
Cumulative effect of an accounting change,–
•
Prior period adjustments
we won’t see this one any more after FAS154
Disclose other significant components,
such as:
•
•
current tax expense,
deferred tax expense/benefit, etc.
Other Items Affected
• Comprehensive income items
– Holding gain/loss on AFS securities
– Certain gains/losses related to foreign currency
and derivatives
– Pension & post-retirement benefit amounts not yet
recognized on income statement
• Correction of error/change in accounting
principle that affects beginning retained
earnings
• Expenses for employee stock-based
compensation
• Existing deferred amounts in quasireorganization
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First Place Example
• Go to Excel and work the problem
– Identify temporary and permanent
differences
– Compute tax payable (or refund)
– Compute change in deferred taxes and
income tax expense
– Show where deferred tax will be reported
on the balance sheet
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55
Deferred Taxes
IAS 12 vs FAS 109
versu
s
Which Tax Rate to Use
IFRS
• Enacted or
substantively
enacted tax rat
US GAAP
• Enacted tax rates
Deferred Tax Assets
IFRS
US GAAP
• Don’t recognize at • Use an allowance
all unless it is
account to reduce
“more likely than
to net realizable
not” to be usable in
value
the future
• Uses same “more
likely than not”
criteria
Balance Sheet Presentation
IFRS
• Always is
noncurrent
• Plans to revise to
do it the FASB way
US GAAP
• Current items
netted
• Noncurrent items
netted
Essential Knowledge
• Be able to tell a permanent difference from
a temporary difference
• Know the impact of temporary differences:
– Is it a future deductible item?
– Is it a future taxable item?
• Textbook Illustrations 19-22 & 19-24:
– If all else fails, memorize!
– I’ll also provide a “study guide” for Exam 2
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Review – Basic Principles
• A current tax liability or asset is recognized for the
estimated taxes payable or refundable on the tax
return for current year.
• A deferred tax liability or asset is recognized for the
estimated future tax effects attributable to
temporary differences and carryforwards.
• The measurement of current and deferred tax
liabilities and assets is based on provisions of
enacted tax law, effects of future changes in tax
law or rates are not anticipated.
• The measurement of deferred tax assets is
reduced, if necessary, by the amount of any tax
benefits that are not expected to be realized.
Specific Differences
Do the following generate:
• Future Deductible Amount = Deferred Tax Asset
• Future Taxable Amount = Deferred Tax Liability
• A Permanent Difference
1. The MACRS depreciation system is used for tax
purposes, and the straight-line depreciation method
is used for financial reporting purposes.
2. A landlord collects some rents in advance. Rents
received are taxable in the period when they are
received.
3. Expenses are incurred in obtaining tax-exempt
income.
4. Costs of guarantees and warranties are estimated
and accrued for financial reporting purposes.
LO 6 Describe various temporary and permanent differences.
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Specific Differences
Do the following generate:
• Future Deductible Amount = Deferred Tax Asset
• Future Taxable Amount = Deferred Tax Liability
• A Permanent Difference
5. Sales of investments are accounted for by the
accrual method for financial reporting purposes and
the installment method for tax purposes.
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).
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..
LO 6 Describe various temporary and permanent differences.
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Review Problem
Zurich Company reports pretax financial income of $70,000 for
2007. 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 $22,000. (3) Fines for
pollution appear as an expense of $11,000 on the income
statement.
Zurich’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 2007.
Instructions Prepare the journal entry to record income tax
expense, deferred income taxes, and income taxes payable for
2007.
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Review Problem – Abbreviated Working Paper
Current Yr.
Deferred
Deferred
2007
Asset
Liability
INCOME:
Financial income (GAAP)
Permanent diff
Book TI
Temp diff
Temp diff
Taxable income (IRS)
Tax rate
Income tax
Income tax expense
Deferred tax asset
Deferred tax liability
Income tax payable
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