CHAPTER 10
EXPENDITURE CYCLE:
OTHER OPERATING ITEMS
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PAYROLL TAXES
• Employee payroll
taxes:
– Federal income
tax
– State income tax
– FICA taxes
• Employer payroll
taxes:
– FICA taxes
– Federal
unemployment
taxes
– State
unemployment
taxes
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BONUSES
• Bonus plans allow employees to
receive additional compensation if
certain earnings objectives are met
• These plans are usually restricted
to top management
• One possible danger is that
managers will attempt to
manipulate reported earnings
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1
INCOME TAXES
• Income tax expense and the
amount paid for income tax are
different for two reasons:
– Income taxes are not totally paid in
the same year in which they are
incurred
– One accounting method may be used
for tax purposes and another for
financial reporting purposes
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INCOME TAXES
• Differences in financial statement
income and taxable income are
due to two types of differences
• Differences can be
– Permanent or
– Temporary
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PERMANENT DIFFERENCES
– Enter into accounting income, but
never into taxable income
– These are differences between GAAP
and the Internal Revenue Code
– For example, interest on state and
local bonds is included in financial
income, but not in taxable income
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2
TIMING DIFFERENCES
• Temporary differences
– Some transactions affect taxable
income in a different period from
financial accounting income
• Depreciation methods
• Rent received in advance
– The affects of these differences are
recorded as deferred tax assets or
liabilities and shown on the balance
sheet
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DEFERRED TAXES
• Deferred Tax Liability
– Requires a payment in the future
– Is the expected income tax on
income earned but not yet taxed
• Income Taxes Payable
– Tax due within the next 12 months
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DEFERRED TAXES
Entry for recording income taxes
with a Deferred Tax Liability would
be
Income Tax Expense
Income Taxes Payable
Deferred Tax Liability
12,000
4,000
8,000
• Income Tax Expense is an expense on the
income statement
• Income Taxes Payable and Deferred Tax
Liability are reported on the balance sheet
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3
DEFERRED TAXES
• Deferred Tax Asset
The expected benefit of a future tax
deduction for an expense that has
already been incurred but is not yet
deductible for tax purposes
– It can only be recognized if it is
“more likely than not” that future
income will be realized against which
the deduction can be offset
10
DEFERRED TAXES
• A typical entry for recording
income taxes with a Deferred Tax
Asset would be
Income Tax Expense
Deferred Tax Asset
Income Taxes Payable
20,000
4,000
24,000
• Income Tax Expense is an expense on the
income statement
• Income Taxes Payable and Deferred Tax
Asset are reported on the balance sheet
11
CAPITALIZE VERSUS EXPENSE
• An expenditure that is expected to
benefit future periods is capitalized
as an asset
• All other expenditures are treated
as expenses
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4
CAPITALIZE VERSUS EXPENSE
• Research and development costs
– Research is defined as
• Those activities undertaken to
discover new knowledge that will
be useful in developing new
products, services, or processes or
that will result in significant
improvement of existing products or
processes
– Development
• Applies the research findings to
develop a plan or design for new or
improved products and processes
13
CAPITALIZE VERSUS EXPENSE
• Research and development costs
are expensed in the period
incurred due to the uncertainty
surrounding the future economic
benefits of R&D activities
14
CAPITALIZE VERSUS EXPENSE
• Software development requires
special treatment
– All costs incurred up to the point
where technological feasibility is
established are to be expensed as
research and development
– After technological feasibility is
established, costs incurred are
capitalized
– Determining technological feasibility
is a matter of judgement
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5
CAPITALIZE VERSUS EXPENSE
• Advertising costs
– Generally, advertising costs are
expensed due to the uncertainty of
their future economic benefits
– In selected cases where the future
benefits are more certain, advertising
costs should be capitalized
16
CONTINGENCIES
• A contingency is an uncertain
circumstance involving a potential
gain or loss that will not be
resolved until some future event
occurs
17
CONTINGENCIES
• Three important definitions:
– Probable
• Likely to occur
– Remote
• Not likely to occur
– Reasonably possible
• More than remote but less than likely
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6
CONTINGENT LOSSES
Likelihood
Probable
Accounting Action
Recognize a probable liability if
the amount can be reasonably
estimated.
Reasonably possible
Disclose a possible liability in a
note.
Remote
No recognition or disclosure
unless contingency represents
a guarantee. Then, note
disclosure is required.
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CONTINGENT GAINS
Likelihood
Probable
Reasonably possible
Remote
Accounting Action
Recognize a probable asset if
the amount can be reasonably
estimated. If not estimable,
disclose facts in a note.
Disclose a possible asset in a
note, but be careful to avoid
misleading implications. In
practice, possible contingent
gains are often not disclosed.
No recognition or disclosure.
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ACCOUNTING FOR LAWSUITS
• If the facts of the case indicate that
a loss is probable and the amount
of the loss can be estimated, a
loss should be reported on the
income statement and a liability
should be reported on the balance
sheet
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