accounting for taxation

8/14/2019 accounting for taxation

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Chapter 14: Accounting for Income Taxes

Fundamentals of Intermediate AccountingWeygandt, Keiso and Warfield

Prepared byBonnie Harrison, College of Southern Maryland,

LaPlata, Maryland


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Chapter 14

Accounting for Income TaxesAfter studying this chapter, you should be able to:Identify differences between pretax financial income

and taxable income.

Describe a temporary difference that results in futuretaxable amounts.

Describe a temporary difference that results in futuredeductible amounts.

Explain the purpose of a deferred tax asset valuationallowance.

Describe the presentation of income tax expense in theincome statement.

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Chapter 14

Accounting for Income TaxAfter studying this chapter, you should be able to:Describe the various temporary and permanent differences.

Explain the effect of various tax rates and tax rate changes on

deferred income taxes.Apply accounting procedures for a loss carryback and a loss

carryforward.

Describe the presentation of deferred income taxes in financialstatements.

Indicate the basic principles of the asset-liability method.

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Deferred Taxes: Basics

x Deferred taxes arise when income tax

expense differs from income tax liability

x The tax expense is determined underGAAPx The income tax liability is determined under

the Internal Revenue Code

x Some of these differences are temporary andreverse over time

x Others arepermanent and do not reverse


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Temporary Differences: Examples

Revenues and Gains, recognized in financial

income, are later taxed for income tax purposes

Expenses and losses, recognized in financial income,

are later deducted for income tax purposesRevenues and gains are taxed for income tax

purposesbefore they are recognized in financial

income

Expenses and losses are deducted for income tax

purposesbefore they are recognized in financial

income


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Summary of Temporary Differences

TransactionWhen recorded

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


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Permanent Differences: Examples

Items, recognized for financial accounting purposes,but not for income tax purposes:

interest income received on tax exempt securities

fines and expenses resulting from violations of law Premiums paid for life insurance on key

officers/employees

Items, recognized for tax purposes, but not for

financial accounting purposes: the dividends received deduction under the Code

percentage depletion of natural resources in excessof their cost


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Summary of Permanent Differences

Sources of PERMANENT DIFFERENCESSources of PERMANENT DIFFERENCES

No deferred tax effects

for permanent differences

No deferred tax effects

for permanent differences

Some itemsSome items are recordedin Books

are recordedin Books but NEVERon tax returnbut NEVERon tax return

Other itemsOther items are NEVER

recorded in books

are NEVER

recorded in books

but recorded

on tax return

but recorded

on tax return


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Deferred Tax Asset & Deferred Tax Liability:

Sources

y Deferred taxes may be a:

Deferred tax liability, or

Deferred tax assety Deferred tax liability arises due to net taxable

amounts in the future.

y Deferred tax asset arises due to net deductibleamounts in the future.


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Recording a Valuation Allowance

for Doubtful Deferred Tax Assets

x If the deferred tax asset appears doubtful, a Valuation

Allowance account is needed.

xJournal entry: Income Tax Expense $$ Allowance to Reduce Deferred Tax

Asset to Expected Realizable Value $

$

x

The entry records a potential future tax benefit that isnotexpected to be realized in the future.


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Deferred Taxes:

Applying Tax Rates

s Basic Rule:

Apply the yearly tax rate to calculate deferred tax

effects.

s If future tax rates change:use the enacted tax rate expected to apply in the

future year

s

If new rates are not yet enacted into law for futureyears, the current rate should be used

s The appropriate enacted rate for a year is the average

tax rate [based on graduated tax brackets].


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Revision of Future Tax Rates

s When a change in tax rate is enacted, itseffect should be recorded immediately

s The effect is reported as an adjustment to taxexpense in the period of change

s Changes in tax rates are treated just like anyother change in estimate, prospectively

s See example following slide


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Revision of Future Tax Rates: Example

xEnd of 2002, corporate tax rate is changed from 40%

to 35%

xThe new rate is effective January 1, 2004

xThe deferred tax account (1/1/2002) is as follows:

x Excess tax depreciation: $3 million

x Deferred tax liability: $1.2 million.

xRelated taxable amounts are expected to occur

equally over 2003, 2004, and 2005.

Provide the journal entry to reflect the change.


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Revision of Future Tax Rates: Example

xThe 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

liability $400,000 350,000 350,000

xEntry:

Deferred Tax Liability $100,000

Income Tax Expense $100,000*

*$1,200,000 - $1,100,000


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Financial Statement Presentation

xBalance Sheet Presentation:

The deferred tax classification relates to its

underlying asset or liability

Classify the deferred tax amounts as currentor

noncurrent

Sum the various deferred tax assets and liabilities

classified as currentSum the various deferred tax assets and liabilities

classified as noncurrent


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Financial Statement Presentation

xBalance Sheet Presentation:


classified as current:

If net result is an asset, report as current asset

If net result is a liability, report as current liability


classified as noncurrent

If net result is an asset, report as long-term asset

If net result is a liability, report as long-term liability


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Income Statement Presentation

x Income tax expense, as allocated to:

1. Continuing operations

2. Discontinued operations

3. Extraordinary items

4. Cumulative effect of an accounting change, and

5. Prior period adjustments

x Disclose other significant components, such as:current tax expense,

deferred tax expense/benefit,etc.


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Net Operating Losses [NOLs]:

Basic Terminology

qNet operating loss is a tax terminology

q A net operating loss occurs when tax

deductions for a year exceed taxable revenuesqNet loss or operating loss is a financial

accounting term

qNOL can be derived from net loss: but thesetwo amounts must be kept separately


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NOLs: Rules of Application

y NOL for each tax year is computed

y The NOL of one year can be applied to offset

taxable income of other years, possibly resulting

tax refunds

y NOLs can be:

carried back2 years and carried forward 20 years

(carryback option), or carried forward 20 years (carryforward only)


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Net Operating Loss: Carryback rules.

s If NOLs are carried back 2 years and carried

forward 20 years:

s NOL is applied to the earlierof the 2 year period,

then to the immediately preceding year etc

s Remaining NOLs are applied to the following 20

year period

s Any tax refunds are reported in the year of theoriginal net operating loss


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NOL Carryback Rules: continued

2001 2002 2003 2004 2005 2006 2007 2024

NOL2004

Tax years

Apply first

next

Loss carryforward

20 years forward

Expect

tax refund

hereRecord all

tax effects here

Expect

tax

shield

here


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NOL Carryforward Rules

2001 2002 2003 2004 2053 2006 2007 2024

NOL2004

Tax years

Loss carryforward

20 years forward

Record all

tax effects here

Expecttax

shield

here

Forgo 2

year rule


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Basic Principles of Asset-Liability

Methods A current tax liability or asset is recognized for the

estimated taxes payable or refundable on the tax return forcurrent year

s A deferred tax liability or asset is recognized for the

estimated future tax effects attributable to temporarydifferences and carryforwards

s The measurement of current and deferred tax liabilities andassets is based on provisions of enacted tax law, effects offuture changes in tax law or rates are not anticipated

s The measurement of deferred tax assets is reduced, ifnecessary, by the amount of any tax benefits that are notexpected to be realized


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Copyright 2003 John Wiley & Sons, Inc. All rightsreserved. Reproduction or translation of this workbeyond that named in Section 117 of the 1976United States Copyright Act without the express

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