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1.
2.
3.
Understand the concept of deferred taxes and the distinction between permanent and temporary differences.
Compute the amount of deferred tax liabilities and assets.
Explain the provisions of tax loss carrybacks and carryforwards, and be able to account for these provisions.
4.
Schedule future tax rates, and determine the effect on tax assets and liabilities.
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5.
Determine appropriate financial statement presentation and disclosure associated with deferred tax assets and liabilities.
6.
Comply with income tax disclosure requirements associated with the statement of cash flows.
7.
Describe how, with respect to deferred income taxes, international accounting standards have converged toward the U.S. treatment.
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Deferred Income Taxes: An
Overview
The primary goal of financial accounting is to provide useful information to management, stockholders, creditors, and other properly interested.
The primary goal of the income tax system is the equitable collection of revenue.
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Deferred Income Taxes: An
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.
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Deferred Income Taxes: An
Overview
Two basic considerations in U.S. corporations computed net income.
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.
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Simple Deferred Tax Liabilities
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•
– Revenues (or gains) taxable after they are recognized for financial reporting, such as receivables from installment sales.
– Expenses (or losses) deductible for tax purposes before they are recognized for financial reporting purposes, such as accelerated tax depreciation.

Simple Deferred Tax Liabilities
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In 2005, 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 2005 and $20,000 in 2006. The income tax rate is 40% and it is expected to remain the same into the foreseeable future.
Continued

Simple Deferred Tax Liabilities
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Income Tax Expense
Income Taxes Payable
Deferred Tax Liability
12,000
4,000
8,000
$20,000 x
.40

Simple Deferred Tax Liabilities
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Ibanez Company
Income Statement
For the Year Ended December 31, 2005
$30,000 Revenues
Income tax expense:
Current
Deferred
Net income
$4,000
8,000
$18,000

Simple Deferred Tax Asset
•
Examples
– Expenses (or losses) that are deductible for tax purposes after they are recognized for financial reporting purposes, such as warranty expenses.
– Revenues (or gains) that are taxable before they are recognized for financial reporting purposes, such as subscriptions received in advance.
Realization of a Deferred Tax Asset depends on the existence of taxable income in future years
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Simple Deferred Tax Asset
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In 2005, Gupta Corporation generated service revenues totaling $60,000, all taxable in 2005. No warranty claims were made in 2005, but Gupta estimates that in 2006 warranty costs of
$10,000 will incurred for claims related to 2005 service revenues. Assume a
40% tax rate.
Continued

Simple Deferred Tax Asset
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Income Tax Expense
Deferred Tax Asset
Income Taxes Payable
20,000
4,000
24,000
$60,000 x
.40
Continued

Simple Deferred Tax Asset
Gupta Company
Income Statement
For the Year Ended December 31, 2005
Revenues
Less: Warranty expense
Income before taxes
Income tax expense:
Current
Deferred benefit
Net income
$24,000
(4,000)
$60,000
10,000
$50,000
20,000
$30,000
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Nondeductible expenses or nontaxable revenues that are recognized for financial reporting purposes but are never part of taxable income.
Differences between pretax financial income and taxable income arising from business events that are recognized for both financial and tax purposes, but in different time periods.
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For the year ended December 31, 2005,
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.
Continued

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Pretax income from income statement
Add (deduct) permanent differences:
Nontaxable revenues $(20,000)
$420,000
Nondeductible expenses
Financial income subject to tax
Add (deduct) temporary differences:
5,000 (15,000)
$405,000
Excess of tax depreciation over book depreciation
Taxable income
(30,000)
$375,000
Tax on taxable income (income taxes payable): $375,000 x .35 $131,250

Annual Computation of Deferred
Tax Liabilities and Assets
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Advantages of the Asset and
Liability Method
1.
Because the assets and liabilities recorded under this method are in agreement with the FASB definitions of financial statement elements, the method is conceptually consistent with other standards.
Continued

Annual Computation of Deferred
Tax Liabilities and Assets
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2.
The asset and liability method is a flexible method that recognizes changes in circumstances and adjusts the reported amounts accordingly.
This flexibility may improve the predictive value of the financial statements.

Annual Computation of Deferred
Tax Liabilities and Assets
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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 ( >50%) some portion or all of the deferred tax asset will not be realized.

Example 3: Deferred Tax Liability
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For 2005, Roland computes pretax financial income of $75,000. The only difference between financial and taxable income is depreciation. The enacted tax rate is 40%.
The 2005 tax is $24,000 (40% of $60,000).
Financial income subject to tax
Deduct temporary difference:
Excess of tax depreciation ($40,000)
$75,000 over book depreciation ($25,000) (15,000)
Taxable income $60,000
Continued

Pre-tax financial income (or financial income subject to tax i.e. excluding permanent differences)
X Tax %
Note – the above is true only if future tax rates do not change
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Example 3: Deferred Tax Liability
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Journal entry for 2005
Income Tax Expense
Income Taxes Payable
Deferred Tax Liability—
Noncurrent
30,000
24,000
6,000
Continued

Example 3: Deferred Tax Liability
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For 2006, Roland earned income of $75,000 and the taxable income is $70,000, or a tax of
$28,000.
Financial income subject to tax
Deduct temporary difference:
Excess of tax depreciation ($30,000)
$75,000 over book depreciation ($25,000) (5,000)
Taxable income
Tax @ 40%
$70,000
$28,000
Continued

Example 3: Deferred Tax Liability
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Journal entry for 2006
Income Tax Expense
Income Taxes Payable
Deferred Tax Liability—
Noncurrent
30,000
28,000
2,000
Continued
$5,000 x .40

Example 3: Deferred Tax Liability
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Depreciation expense in
2007 is the same for both financial and tax, so the entry is simple.
Income Tax Exp.
30,000
Income Taxes Pay.
30,000

Example 3: Deferred Tax Liability
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For 2008, Roland earned income of $75,000 and the taxable income is $95,000, or a tax of
$38,000.
$75,000 Financial income subject to tax
Add temporary difference:
Excess of book depreciation
($25,000) over tax depreciation
($5,000)
Taxable income
Tax @ 40%
Continued
20,000
$95,000
$38,000

Example 3: Deferred Tax Liability
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Journal entry for 2008
Income Tax Expense
Deferred Tax Liability—
Noncurrent
Income Taxes Payable
30,000
8,000
38,000
$30,000 +
$8,000

• If changes in future tax rates hare enacted, the deferred tax liability (or asset) is measured using the enacted tax rate for future years when the temporary difference is expected to reverse.
• Subsequent changes in tax rates after a deferred tax/liability has already been computed, requires an adjustment to the income tax expense for the year of the change e.g. for a tax reduction, the adjustment entry would be
• Dr. Deferred Tax Liability
– Cr. Income Tax Expenses
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Example 4: Deferred Tax Asset
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Some possible sources of taxable income to be considered in evaluating the realistic value of a deferred tax asset are:
 Future reversals of existing taxable temporary differences.
 Future taxable income exclusive of reversing temporary differences.
 Taxable income in prior (carryback) years.

Example 4: Deferred Tax Asset
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For 2005, Sandusky Inc. computes pretax financial income of $22,000. The only difference between financial and taxable income is the recognition of warranty expense. Accrued warranty expense for 2005 was $18,000; no actual warranty expenditures were made in 2005.
The warranty obligation is considered one-third current and two-thirds noncurrent.
Continued

Example 4: Deferred Tax Asset
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Taxable income in 2005 is calculated as follows:
$22,000 Financial income subject to tax
Add temporary difference:
Excess of warranty expense
($18,000) over warranty deductions ($0)
Taxable income
18,000
$40,000
Tax ($40,000 x .40) $16,000
Continued

Example 4: Deferred Tax Asset
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Journal entry for 2005
Income Tax Expense
Noncurrent
Income Taxes Payable
8,800
Deferred Tax Asset—Current 2,400
Deferred Tax Asset—
4,800
16,000
Continued

Example 4: Deferred Tax Asset
34
In the years 2006 through 2008, taxable income would be $16,000, computed as follows:
$22,000 Financial income subject to tax
Reversal of temporary difference:
Excess of warranty deductions
(1/3 x $18,000) over warranty expense ($0)
Taxable income
Tax ($16,000 x .40)
(6,000)
$16,000
$ 6,400

Example 4: Deferred Tax Asset
35
Journal entry for 2006
Income Tax Expense
Deferred Tax Asset—
Current
Income Taxes Payable
8,800
2,400
6,400
Deferred Tax Asset—
Current
Deferred Tax Asset—
Noncurrent Continued
2,400
2,400

Example 4: Deferred Tax Asset
36
Journal entry for 2007
Income Tax Expense
Deferred Tax Asset—
Current
Income Taxes Payable
8,800
2,400
6,400
Deferred Tax Asset—
Current
Deferred Tax Asset—
Noncurrent
2,400
2,400

Example 4: Deferred Tax Asset
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Journal entry for 2008
Income Tax Expense
Deferred Tax Asset—
Current
Income Taxes Payable
8,800
2,400
6,400

Example 5: Deferred Tax
Liabilities and Assets
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For 2005, Hsieh reported pretax financial income of $38,000. As of December 31, 2005, 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.
Continued

Example 5: Deferred Tax
Liabilities and Assets
Taxable income in 2005 is calculated as follows:
$38,000 Financial income subject to tax
Add (deduct) temporary difference:
Excess of warranty expense over warranty deductions
Excess of tax depreciation over book depreciation
Taxable income
Tax ($41,000 x .40)
18,000
(15,000)
$41,000
$16,400
Continued
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Example 5: Deferred Tax
Liabilities and Assets
Journal entry for 2005
Income Tax Expense 15,200
Deferred Tax Asset—Current 2,400
Deferred Tax Asset—
4,800 Noncurrent
Deferred Tax Liability—
Noncurrent
Income Taxes Payable
6,000
16,400
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Statement No. 109 stipulates that both positive and negative evidence be considered when determining whether deferred tax assets will be fully realized.

Net Operating Loss (NOL)
Carryback
42
Carryback Election
Year
-2
Loss
Year
Carryforward Election
Year
+20

Net Operating Loss (NOL)
Carryback
Year
2004
2005
2006
Income
(Loss)
$10,000
14,000
(19,000)
Tax Rate
35%
30
30
Income
Tax
$3,500
4,200
0
Journal Entry in 2006:
Income Tax Refund Receivable
Income Tax Benefit From NOL
Carryback (Income Tax Expense)
6,200
[$3,500 + (30% x $9,000)]
6,200
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Accounting for NOL Carryforward
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Continuing with the Prairie Company illustration, assume that in 2007 the firm incurred an operating loss of $35,000.
Year
Income
(Loss) Tax Rate
Income
Tax
2006 $(19,000) 30%
2007 (35,000) 30%
$0
0
Continued

Accounting for NOL Carryforward
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The only loss remaining against which operating income can be applied is $5,000 from 2005 ($14,000
– $9,000). This leaves $30,000 to be carried forward from 2007 as a future tax benefit of $9,000 ($30,000 x .30).
Continued

Accounting for NOL Carryforward
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The journal entry at the end of 2007 to record the tax benefits would be as follows:
Income Tax Refund Receivable
Deferred Tax Asset—NOL
Carryforward
Income Tax Benefit from NOL
Carryback
Income Tax Benefit from NOL
Carryforward
1,500
9,000
1,500
9,000

Accounting for NOL Carryforward
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The firm reports a taxable income of $50,000 in 2008. The tax carryforward allows management to deduct the carryforward from the $15,000 tax ($50,000 x .30) that would be due without the carryforward.
Journal Entry:
15,000 Income Tax Expense
Income Taxes Payable
Deferred Tax Asset—NOL
Carryforward
6,000
9,000

Accounting for NOL Carryforward
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What if, due to a declining market, management believes that losses will continue in the future and the tax benefit will not be realized?

Accounting for NOL Carryforward
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Journal Entry:
Income Tax Refund Receivable
Deferred Tax Asset—NOL
Carryforward
Income Tax Benefit from NOL
Carryback
Allowance to Reduce Deferred
Tax Assets to Realizable Value—
NOL Carryforward
1,500
9,000
1,500
9,000
As a result of this entry, the deferred tax asset is zero— the expected realizable value.

Financial Statement
Presentation and Disclosure
The following items must appear in the income statement or an accompanying note:
• Current tax expense or benefit
• Deferred tax expense or benefit
• Investment tax credits
• Government grants recognized as tax reductions
Continued
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Financial Statement
Presentation and Disclosure
The following items must appear in the income statement or an accompanying note:
• Benefits of NOL carryforwards
• 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
• Adjustments in beginning-of-the-year valuation allowance because of a change in circumstances
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Deferred Taxes and the Statement of Cash Flows
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Callazo Company had the following information for 2005:
Revenue (all cash)
Income tax expense:
Current $10,300
$30,000
Deferred
Net income
1,700 (12,000)
$18,000
Cash paid for income taxes during 2005 totaled
$13,300.
Continued

Deferred Taxes and the Statement of Cash Flows
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Income tax refund receivable
Income taxes payable
Deferred tax liability
Analysis
Adjustment
12/31/05 12/31/05
$2,000 $ 0
0
9,700
1,000
8,000
SCF Income Statement
Revenue (all cash),
$30,000 No adjustment $30,000 cash collected from
Continued customers

Deferred Taxes and the Statement of Cash Flows
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Analysis
Income Statement Adjustment
Income tax expense—current
–$2,000—
$(10,300) Increase in tax receivable
–$1,000—
Decrease in taxes payable
SCF
$(13,300) Cash paid for taxes
Continued

Deferred Taxes and the Statement of Cash Flows
55
Analysis
Income Statement Adjustment
Income tax expense—deferred +$2,000—
$(1,700) Increase in deferred tax liability
SCF
No effect
Continued

Deferred Taxes and the Statement of Cash Flows
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Analysis
Income Statement Adjustment
Net income, $18,000 –$1,300
Continued
SCF
$16,700 Cash flow from operations
Collazo Company
Statement of Cash Flows
(Direct Approach)
Cash collected from customers
Income taxes paid
Cash provided by operating activities
$30,000
(13,300)
$16,700

Deferred Taxes and the Statement of Cash Flows
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Collazo Company
Statement of Cash Flows
(Indirect Approach)
Net income
Decrease in income tax refund receivable
Decrease in income taxes payable
Increase in deferred tax liability
Cash provided by operating activities
$18,000
(2,000)
(1,000)
1,700
$16,700

International Accounting for
Deferred Taxes
• No-Deferral Approach:
Ignore the differences and report income tax expense equal to the amount of tax payable for the year.
• Comprehensive Recognition Approach:
Deferred taxes are included in the computation of income tax expense and reported on the balance sheet.
• 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.
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