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Intermediate Accounting,17E
Income Taxes
PowerPoint presented by: Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
© 2010 Cengage Learning
16-1
Deferred Income Tax Overview
• The primary goal of financial
accounting is to provide useful
information to management,
stockholders, creditors, and others
properly interested.
• The primary goal of the income tax
system is the equitable collection of
revenue.
16-2
Deferred Income Tax Overview
Two basic considerations in U.S.
corporations’ computed net income:
1. How to account for revenues and
expenses that have already been
recognized and reported to
shareholders in a company’s
financial statements but will not
affect taxable income until
subsequent years.
(continues)
16-3
Deferred Income Tax Overview
2. How to account for revenues and
expenses that have already been
reported to the IRS but will not be
recognized in the financial
statements until subsequent years.
16-4
Example 1: Simple Deferred
Tax Liability
In 2011, Ibanez Company earned
revenues of $30,000. Ibanez has no
expenses other than income taxes. In
this case, Ibanez is taxed on cash
received. The company received
$10,000 in 2011 and $20,000 in
2012. The income tax rate is 40% and
it is expected to remain the same into
the foreseeable future.
(continues)
16-5
Example 1: Simple Deferred
Tax Liability
Income Tax Expense
Income Taxes Payable
Deferred Tax Liability
12,000
4,000
8,000
$30,000 × .40
$4,000 current year
+ $8,000 deferred
$10,000 × .40
$20,000 × .40
(continues)
16-6
Example 1: Simple Deferred
Tax Liability
Ibanez Company
Income Statement
For the Year Ended December 31, 2011
Revenues
Income tax expense:
Current
Deferred
Net income
$30,000
$4,000
8,000
12,000
$18,000
16-7
Example 2: Simple Deferred
Tax Liability
In 2011, Gupta Company generated
service revenues totaling $60,000, all
taxable in 2011. No warranty claims
were made in 2011, but Gupta
estimates that in 2012 warranty costs
of $10,000 will be incurred for claims
related to 2011 service revenues.
Assume a 40% tax rate.
(continues)
16-8
Example 2: Simple Deferred
Tax Liability
Income Tax Expense
Deferred Tax Asset
Income Taxes Payable
$24,000 current year –
$4,000 deferred
20,000
4,000
24,000
$50,000 × .40
$10,000 × .40
$60,000 × .40
(continues)
16-9
Example 2: Simple Deferred
Tax Liability
Gupta Company
Income Statement
For the Year Ended December 31, 2011
Revenues
Warranty expense
Income before taxes
Income tax expense:
Current
Deferred benefit
Net income
$60,000
10,000
$50,000
$24,000
(4,000)
20,000
$30,000
16-10
Permanent and Temporary
Differences
Permanent differences are caused by
specific provisions of the tax law that
exempt certain types of revenues from
taxation and prohibit the deduction of
certain types of expenses.
 Nontaxable revenue—proceeds from
insurance policies; interest received on
municipal bonds
 Nondeductible expenses—fines for violations
of laws; payment of insurance premiums
16-11
Permanent and Temporary
Differences
Temporary differences are caused by
differences between pretax financial
income and taxable income that arises
from business events that are
recognized for both financial reporting
and tax purposes but in different time
periods.
 Using ACRS for tax purposes and straightline depreciation for accounting purposes
16-12
Illustration of Permanent and
Temporary Differences
For the year ended December 31,
2011, Monroe Corporation reported
net income before taxes of $420,000.
This amount includes $20,000 of
nontaxable revenues and $5,000 of
nondeductible expenses. The
depreciation method used for tax
purposes allowed a deduction that
exceeded the book approach by
$30,000.
(continues)
16-13
Illustration of Permanent and
Temporary Differences
Pretax income from income statement
Add (deduct) permanent differences:
Nontaxable revenues
$(20,000)
Nondeductible expenses
5,000
Financial income subject to tax
Add (deduct) temporary differences:
Excess of tax depreciation over
book depreciation
Taxable income
Tax on taxable income (income
taxes payable): $375,000 × .35
$420,000
(15,000)
$405,000
(30,000)
$375,000
$131,250
16-14
Illustration of Permanent and
Temporary Differences
• The permanent differences are not
included in either the financial
income subject to tax or the taxable
income.
• In general, the accounting for
temporary differences is referred to as
interperiod tax allocation.
16-15
Annual Computation of Deferred
Tax Liabilities and Assets
• FASB Statement No 109 reflects the
Board’s preference for the asset
and liability method of
interperiod tax allocation, which
emphasizes the measurement and
reporting of balance sheet amounts.
• One drawback of this method is that
it is too complicated.
16-16
Annual Computation of Deferred
Tax Liabilities and Assets
Advantages of the asset and liability
method:
1. Assets and liabilities are recorded in
agreement with FASB definitions of
financial statement elements.
2. The method is flexible and recognizes
changes in circumstances and adjusts
the reported amounts accordingly.
3. It has better predictive value.
16-17
Annual Computation of Deferred
Tax Liabilities and Assets
Identify type and amounts of existing
temporary differences.
Measure the deferred tax
liability for taxable
temporary differences (use
enacted rates).
Measure the deferred tax
asset for deductible
temporary differences (use
enacted rates).
Establish valuation allowance account if more
likely than not some portion or all of the
deferred tax asset will not be realized.
16-18
Example 3: Deferred Tax Liability
For 2011, Roland computes pretax financial
income of $75,000. The only difference between
financial and taxable income is depreciation.
Roland uses the straight-line method of
depreciation for financial reporting purposes and
ACRS on its tax return. The depreciation amounts
for 2011 through 2014 are:
(continues)
16-19
Example 3: Deferred Tax Liability
The enacted tax rate for 2011 and future
years is 40%. Roland’s taxable income is
$60,000, computed as follows:
Financial income subject to tax
Deduct temporary difference:
Excess of tax depreciation ($40,000)
over book depreciation ($25,000)
Taxable income
$75,000
(15,000)
$60,000
(continues)
16-20
Example 3: Deferred Tax Liability
Journal Entry for 2011
Income Tax Expense
Income Taxes Payable
Deferred Tax Liability—
Noncurrent
30,000
24,000
6,000
$30,000 – $6,000
$24,000 current + $6,000 deferred
$15,000 × .40
(continues)
16-21
Example 3: Deferred Tax Liability
Roland earns financial income of $75,000 in
each of the years 2012 through 2014.
Roland reports taxable income of $70,000,
computed as follows:
Financial income subject to tax
$75,000
Deduct temporary difference:
Excess of tax depreciation ($30,000)
over book depreciation ($25,000)
(5,000)
Taxable income
$70,000
Tax ($70,000 × 0.40)
$28,000
(continues)
16-22
Example 3: Deferred Tax Liability
Journal Entry for 2012
Income Tax Expense
Income Taxes Payable
Deferred Tax Liability—
Noncurrent
30,000
28,000
2,000
$30,000 – $2,000
$28,000 current + $2,000 deferred
$5,000 x 0.40
(continues)
16-23
Example 3: Deferred Tax Liability
Depreciation expense in 2013 is the
same for both financial and tax, so
the entry is simple.
Income Tax Expense
Income Taxes Payable
30,000
30,000
$75,000 × 0.40
(continues)
16-24
Example 3: Deferred Tax Liability
For 2014, Roland earns income of $75,000
and the taxable income is $95,000,
computed as follows:
Financial income subject to tax
Add temporary difference:
Excess of book depreciation
($25,000) over tax depreciation
($5,000)
Taxable income
Tax ($95,000 × 0.40)
$75,000
20,000
$95,000
$38,000
16-25
Example 3: Deferred Tax Liability
Journal Entry for 2014
Income Tax Expense
30,000
Deferred Tax Liability—Noncurrent 8,000
Income Taxes Payable
$38,000 current – $8,000 deferred benefits
38,000
$95,000 × 0.40
(continues)
16-26
Example 3: Deferred Tax Liability
16-27
Example 4: Deferred Tax Asset
For 2011, Sandusky Inc. computes pretax
financial income of $22,000. The only
difference between financial and taxable
income is Sandusky accruing warranty
expense in the year of the sale for financial
reporting. For tax purpose, it deducts only
actual expenditures. Actual warranty
expense for 2011 was $18,000; no actual
warranty expenditures were made in 2011.
(continues)
16-28
Example 4: Deferred Tax Asset
Taxable income for 2011 is computed
as follows:
Financial income subject to tax
Add temporary difference:
Excess of warranty expense over
warranty deductions
Taxable income
Taxable income ($40,000 × 0.40)
$22,000
18,000
$40,000
$16,000
(continues)
16-29
Example 4: Deferred Tax Asset
Journal Entry for 2011
Income Tax Expense
Deferred Tax Asset—Current
Deferred Tax Asset—
Noncurrent
Income Taxes Payable
8,800
2,400
4,800
16,000
1/3 × $7,200
$16,000 current – $7,200 deferred benefits
2/3 × $7,200
(continues)
16-30
Example 4: Deferred Tax Asset
Sandusky’s 2011 income statement
would present income tax expense as
follows:
Income before income taxes
Deferred Tax Asset—Current
Deferred Tax Asset—
Noncurrent
Net income
$22,000
$16,000
(7,200)
8,800
$13,200
(continues)
16-31
Example 4: Deferred Tax Asset
In subsequent periods, taxable income
would be $16,000, computed as
follows:
Income subject to tax
Reversal of temporary difference:
Excess of warranty deductions
(1/3 × $18,000) over warranty
expense ($0)
Taxable income
Tax ($16,000 × .40)
(continues)
$22,000
(6,000)
$16,000
$ 6,400
16-32
Example 4: Deferred Tax Asset
The following table illustrates the
journal entries that would be made
each year:
16-33
Example 5: Deferred Tax
Liabilities and Assets
For 2011, Hsieh reported pretax
financial income of $38,000. As of
December 31, 2011, the actual
depreciation expense was $25,000 and
the actual warranty expense was
$18,000. For income tax reporting,
these expenses were $40,000 and $0,
respectively. The table on Slide 16-35
summarizes 2012 through 2014.
(continues)
16-34
Example 5: Deferred Tax
Liabilities and Assets
(continues)
16-35
Example 5: Deferred Tax
Liabilities and Assets
Taxable income in 2011 is calculated as
follows:
Financial income subject to tax
Add (deduct) temporary differences:
Excess of warranty expense
over warranty deductions
Excess of tax depreciation over
book depreciation
Taxable income
Tax ($41,000 × .40)
(continues)
$38,000
18,000
(15,000)
$41,000
$16,400
16-36
Example 5: Deferred Tax
Liabilities and Assets
Journal Entry for 2011
Income Tax Expense
Income Taxes Payable
Deferred Tax Asset—Current
Deferred Tax Asset—Noncurrent
Income Tax Benefit
Deferred Tax Liability—
Noncurrent
A subtraction from
Income tax expense
16,400
16,400
2,400
4,800
1,200
6,000
16-37
Valuation Allowance for
Deferred Tax Assets
• A deferred tax asset represents future
income tax benefits.
• The tax benefit will be realized only if
there is sufficient taxable income from
which the deductible amount can be
deducted.
• Statement No. 109 requires that the
deferred tax asset be reduced by a
valuation allowance, a contra asset
account that reduces the asset to its
expected realizable value.
16-38
Valuation Allowance for
Deferred Tax Assets
Some possible sources of taxable income to
be considered in evaluating the realizable
value of a deferred tax asset are as follows:
1. Future reversals of existing taxable
temporary differences
2. Future taxable income exclusive of
reversing temporary differences
3. Taxable income in prior (carryback) years
16-39
Valuation Allowance
Under IAS 12
Under the provisions of IAS 12, there is
no valuation allowance. Instead,
deferred tax assets are recognized only
“to the extent that it is probable that
taxable profit will be available against
which the deductible temporary
difference can be utilized.”
16-40
Accounting for Uncertain
Tax Positions
Case 1: Highly Certain Tax Position
If the probability that the tax benefit
of $100 would be greater than 50%,
this would be deemed a “highly
certain” position. In other words, it is
more likely than not that the position
taken and the amount in question
would be upheld if reviewed.
16-41
Accounting for Uncertain
Tax Positions
Case 2: Uncertain Tax Position—
More Likely Than Not
Assume the following assessment of
probabilities:
(continues)
16-42
Accounting for Uncertain
Tax Positions
If Company A determines that the technical merits
of its position exceed the more-than-not threshold
(cumulative probability becomes greater than
50%), the amount of tax benefit to be recognize for
financial statement purposes is $60.
(continues)
16-43
Accounting for Uncertain
Tax Positions
The required journal entry is as
follows:
Income Tax Expense
Unrecognized Tax Benefit
40
40
Current liability if payment is
anticipated within one year of
the current operating cycle
16-44
Accounting for Uncertain
Tax Positions
Case 3: Uncertain Tax Position—
NOT More Likely Than Not
If the company determines that it is not
more likely than not that the tax position
will be sustained, then the entire amount
of the position must be recognized as a
liability.
Income Tax Expense
Unrecognized Tax Benefit
100
100
16-45
Carryback and Carryforward of
Operating Losses
Net operating loss
carryback is applied to the
preceding two years in
reverse order
Carryback Election
Year
–2
Loss
Year
Net operating loss carryforward
Carryforward
Election
is applied
to income over the
next 20 years
Year
+20
16-46
Net Operating Loss
(NOL) Carryback
Prairie Company had the following pattern of
income and losses for 2010 through 2012:
Journal Entry in 2012:
Income Tax Refund Receivable
Income Tax Benefit from NOL
Carryback
[$3,500 + (30% × $9,000)]
6,200
6,200
16-47
Net Operating Loss
(NOL) Carryforward
Continuing with the Prairie Company illustration
from Slide 16-47, assume that in 2013 the firm
incurred an operating loss of $35,000.
Income
Income
(Loss)
Year
Tax Rate
Tax
2012
$(19,000)
30%
$0
2013
(35,000)
30%
0
The only loss remaining against which operating
income can be applied is $5,000 from 2011. This
leaves $30,000 to be carried forward from 2013 as
a future tax benefit of $9,000 ($30,000 × .30).
(continues)
16-48
Accounting for NOL
Carryforward
The journal entry for 2013 to record
the tax benefits:
Income Tax Refund Receivable
Deferred Tax Asset—NOL
Carryforward
Income Tax Benefit from NOL
Carryback
Income Tax Benefit from NOL
Carryforward
(continues)
1,500
9,000
1,500
9,000
Current asset if
expected to be
realized in 2014
16-49
Accounting for NOL
Carryforward
The firm reports a taxable income of $50,000
in 2014. The tax carryforward allows
management to deduct the carryforward
from the $15,000 tax ($50,000 × .30) that
would be due without the carryforward.
Journal Entry in 2014:
Income Tax Expense
Income Taxes Payable
Deferred Tax Asset—NOL
Carryforward
(continues)
15,000
6,000
9,000
16-50
Accounting for NOL
Carryforward
• If, however, it is more likely than not that
some portion or all of the deferred tax
asset will not be realized, a valuation
allowance account is needed.
• To illustrate, assume that Prairie
Company’s management believes that
losses will continue in the future and the
tax benefit will not be realized. As a
result, management believes it is more
likely than not that none of the asset will
be realized.
(continues)
16-51
Accounting for NOL
Carryforward
The journal entry to record the carryback and
carryforward would be as follows:
Income Tax Refund Receivable
Deferred Tax Asset—NOL
Carryforward
Income Tax Benefit from NOL
Carryback
Allowance to Reduce Deferred
Tax Asset to Realizable Value—
NOL Carryforward
1,500
9,000
1,500
9,000
16-52
Scheduling for Enacted
Future Tax Rates
• Proper recognition of deferred tax assets
and liabilities is required when future tax
rates are expected to differ from current tax
rates.
• The firm must determine the temporary
differences that will reverse.
• Statement No. 109 eliminates much of the
need for scheduling through the “morelikely-than-not” criterion for future income.
16-53
Financial Statement
Presentation and Disclosure
The income statement must show, either
in the body of the statement or in a note,
the following components of income taxes
related to continuing operations.
1. Current tax expense or benefit
2. Deferred tax expense or benefit
3. Investment tax credits
4. Government grants recognized as tax
reductions
(continues)
16-54
Financial Statement
Presentation and Disclosure
5. Benefits of operating loss
carryforwards
6. Adjustments of a deferred tax liability
or asset for enacted changes in tax
laws or rates or a change in the tax
status of an enterprise
7. Adjustments in beginning-of-the-year
valuation allowance because of a
change in circumstances
16-55
International Accounting for
Deferred Taxes
• No-deferral approach―Using this
approach, the differences are ignored.
Income tax expense equal to the amount
of tax payable for the year is reported.
• Comprehensive recognition
approach―Deferred taxes are included
in the computation of income tax
expense and reported on the balance
sheet.
(continues)
16-56
International Accounting for
Deferred Taxes
• Partial recognition approach―A
deferred tax liability is recorded only to
the extent that the deferred taxes are
actually expected to be paid in the
future.
16-57