ACCOUNTING FOR INCOME TAXES
CHAPTER 16
INCOME TAXES
Learning Objectives
The concept of deferred taxes
 Permanent differences:
 Temporary differences.
Apply the concept & compute:
Changes in Enacted Tax rates
Use of Valuation Allowance
The Provisions of Tax loss carry-backs/forwards
Financial statement presentation and disclosure
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FUNDAMENTAL REPORTING
Financial & Tax Reporting
FINANCIAL REPORTING
- Useful Information
INCOME TAX SYSTEM:
Equitable collection of revenue
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Fundamentals of Accounting for Income Taxes
FINANCIAL REPORTING
TAX REPORTING
vs.
SEC
Investors and Creditors
Pretax Financial Income
GAAP
Income Tax Expense


Taxable Income
Tax Code
Income Tax Payable
INCOME COMPUTATION:
Two sets of rules
 Pretax Financial (Accounting) Income:
– according to GAAP (FASB 109)
is income before income taxes for financial reporting
purposes
 Taxable Income:
- according to IRS rules
is the amount of income on which the income tax is
based
Therefore the above two income differ
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DIFFERENT TAXABLE
Depreciation
GAAP: (based on estimated amount)
IRS: The Modified Accelerated Cost
Recovery System (MACRS)
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Temporary Differences
TIMMING DIFFERENCES
A temporary difference
corporation’s pretax financial income &
taxable income that “originates” in one or
more years and
“reverses” in later years.
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HOW IS ADVANCED SUBSCRIPTION
RECORDING ACCORDING TO:
 GAAP?
 IRS?
For recording expense we need GAAP reporting
For Income tax payment we need IRS rule
STOP & THINK!
Is it possible for a company to have both deferred tax assets
and deferred tax liability at the same time?
If so, How? Give Example!
Let’s Illustrate
Examples:
Types of Temporary Differences
Deferred tax assets
result in deductible
amounts in the future.
Deferred tax liabilities
result in taxable amounts
in the future.
Permanent Differences
Some items of revenue and expense that a
corporation reports for financial accounting
purposes are never reported for income tax
purposes. These permanent differences never
reverse in a later accounting period.
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Book-Tax Differences – Permanent
 Examples of permanent book-tax differences
 Tax-exempt state and local bond interest
income
 Nondeductible expenses incurred to generate
state and local bond interest income
 Life insurance proceeds (death benefits)
 50% of meals and entertainment
 Political contributions
 Fines and penalties
 Bribes, kickbacks and illegal payments
 Dividends-received deduction: Certain
deductions
Professor Vedd
CONT… PART II
CHANGES IN TAX RATES
ACCOUNTING FOR INCOME TAXES
CHAPTER 16 PART II
INCOME TAXES
DEFERED TAX: WITH CHANGES IN
ENACTED TAX RATES
Professor Vedd
Tax Rate Considerations
 Deferred tax assets and liabilities should be determined
using the future tax rates, if known.
 The deferred tax asset or liability must be adjusted if a
change in a tax law or rate occurs.
Revision of Future Tax Rates
 When a change in tax rate is enacted, its effect should be
recorded immediately
 The effect is reported as an adjustment to tax expense in the
period of change
 Changes in tax rates are treated just like any other change in
estimate, prospectively
 See example following slide
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Net Operating Losses (NOL)
Tax laws often allow a company to use tax NOLs
to offset taxable income in earlier or subsequent
periods.
When used to offset earlier taxable
income:
 Called: operating loss carryback.
 Result: tax refund.
When used to offset future taxable
income:
 Called: operating loss
carryforward.
 Result: reduced tax payable.
Accounting for Net Operating Losses
Loss Carryback
Back 2 years and forward 20 years
Losses must be applied to earliest year first
Loss Carryforward
May elect to forgo loss carryback and
Carryforward losses 20 years
A company would most likely choose the carry-forward option for a
net operating loss if the company expected higher tax rates in the
future compared to the past
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Balance Sheet Classification
Deferred tax
assets/liabilities are
classified as current
or noncurrent based
on the classification
of the related asset
or liability.
Disclose the following:
 Total of all deferred tax liabilities.
 Total of all deferred tax assets.
 Total valuation allowance
recognized.
 Net change in valuation account.
 Approximate tax effect of each
type of temporary difference (and
carryforward).
INTERPERIOD/INTRAPERIOD INCOME TAX ALLOCATION
INTERPERIOD:
is to recognize an asset or liability for the tax consequences of
temporary differences that exist at the balance sheet date.
INTRAPERIOD:
The total income tax expense for a reporting period is allocated among
the financial statement items that gave rise to the income tax expense.
The following items should be reported net of their respective income tax
effects:
• Income (or loss) from continuing operations
• Discontinued operations
• Extraordinary items
• Changes in accounting principle
• Prior period adjustments (to the beginning retained earnings balance)
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