Chapter 16
ACCOUNTING FOR
INCOME TAXES
© 2009 The McGraw-Hill Companies, Inc.
Slide 2
Deferred Tax Assets and Deferred Tax
Liabilities
GAAP is the set of
rules for preparing
financial
statements.
Results in . . .
Financial statement
income tax expense.
The Internal
Revenue Code is
the set of rules for
preparing tax
returns.
Usually. . .
Results in . . .
IRS income taxes
payable.
The objective of accounting for income taxes is to
recognize a deferred tax liability or deferred tax asset
for the tax consequences of amounts that will become
taxable or deductible in future years as a result of
transactions or events that already have occurred.
McGraw-Hill /Irwin
Slide 3
Temporary Differences
Often, the difference between pre-tax
accounting income and taxable income
results from items entering the income
computations at different times.
These are called
temporary
differences.
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Slide 4
Temporary Differences
Temporary differences will reverse out in
one or more future periods.
Accounting Income>Taxable Income
Accounting Income<Taxable Income
Future Taxable Amounts
Future Deductible Amounts
Deferred Tax Liability
Deferred Tax Asset
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Revenues (or gains)
 Installment sales of
property (installment
method for taxes)
Items
reported on
the tax return
AFTER the
 Unrealized gain from
income
recording investments at
statement
fair value (taxable when
asset is sold)
Items
reported on
the tax return
BEFORE the
income
statement
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Expenses (or losses)Slide 5
 Estimated expenses and
losses (tax deductible
when paid)
 Unrealized loss from
recording investments at
fair value or inventory at
LCM (tax deductible when
asset is sold)
 Rent or subscriptions
collected in advance
 Accelerated depreciation
on tax return (straight-line
on income statement)
 Other revenue collected
in advance
 Prepaid expenses (tax
deductible when paid)
Deferred tax assets
result in deductible
amounts in the future.
Deferred tax liabilities
result in taxable
amounts in the future.
Slide 6
Deferred Tax Liabilities
In 2009, Baxter reports $300,000 of pretax income. Included in this
amount is $100,000 resulting from revenue earned from an
installment sale for which no cash was collected. The revenue will be
taxed as the cash is collected in 2010 and 2011. Baxter expects to
collect $70,000 in 2010 and the remaining $30,000 in 2011. In 2010 and
2011, Baxter reports $200,000 of pretax income. The company is
subject to a 32% tax rate.
There are no other temporary differences.
Accounting income
Installment sale
income on the
income statement
Installment sale
income on the
tax return
Taxable income
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Temporary Difference
Originates
Reverses
2009
2010
2011
$
300,000 $
200,000 $
200,000 $
(100,000)
$
200,000 $
Total
700,000
(100,000)
70,000
270,000 $
30,000
230,000 $
100,000
700,000
Slide 7
Deferred Tax Liabilities
Accounting income
Installment sale
income on the
income statement
Installment sale
income on the
tax return
Taxable income
Temporary Difference
Originates
Reverses
2009
2010
2011
$
300,000 $
200,000 $
200,000 $
(100,000)
$
200,000 $
Total
700,000
(100,000)
70,000
270,000 $
30,000
230,000 $
100,000
700,000
2009 Income tax payable = $200,000 × 32% = $64,000
2009 Deferred tax liability change = ($100,000 × 32%) - $0
= $32,000
General Journal
Description
Income tax expense
Income tax payable
Deferred tax liability
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Debit
96,000
Credit
64,000
32,000
Slide 8
Deferred Tax Liabilities
Deferred Tax Liability
32,000 2009
2010
Future taxable amounts
$
70,000
2011
$
30,000
Total
$
Enacted tax rate
Deferred tax liability
The Deferred Tax
Liability
represents the
future taxes Baxter
will pay in 2010
and 2011.
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100,000
32%
$
General Journal
Description
Debit
Income tax expense
96,000
Income tax payable
Deferred tax liability
32,000
Credit
64,000
32,000
Slide 9
Deferred Tax Liabilities
Recall this
information for
Baxter.
Accounting income
Installment sale
income on the
income statement
Installment sale
income on the
tax return
Taxable income
Temporary Difference
Originates
Reverses
2009
2010
2011
$
300,000 $
200,000 $
200,000 $
Total
700,000
(100,000)
$
200,000 $
(100,000)
70,000
270,000 $
30,000
230,000 $
100,000
700,000
2010 Income tax payable = $270,000 × 32% = $86,400
2010 Deferred tax liability change = ($30,000 × 32%) - $32,000
= $22,400
General Journal
Description
Debit
Income tax expense
64,000
Deferred tax liability
22,400
Income tax payable
McGraw-Hill /Irwin
Credit
86,400
Slide 10
Deferred Tax Liabilities
The Deferred Tax Liability represents the future taxes
Baxter will pay in 2011.
Future
Taxable
Amount
Schedule
2011
Future taxable amounts
$
30,000
Total
$
Enacted tax rate
Deferred tax liability
32%
$
Deferred Tax Liability
2010
22,400
32,000 2009
9,600 Balance
McGraw-Hill /Irwin
30,000
9,600
Slide 11
Deferred Tax Liabilities
Recall this
information for
Baxter.
Accounting income
Installment sale
income on the
income statement
Installment sale
income on the
tax return
Taxable income
Temporary Difference
Originates
Reverses
2009
2010
2011
$
300,000 $
200,000 $
200,000 $
(100,000)
$
200,000 $
Total
700,000
(100,000)
70,000
270,000 $
30,000
230,000 $
100,000
700,000
2011 Income tax payable = $230,000 × 32% = $73,600
2011 Deferred tax liability change = ($0 × 32%) - $9,600
= $9,600
General Journal
Description
Income tax expense
Deferred tax liability
Income tax payable
McGraw-Hill /Irwin
Debit
64,000
9,600
Credit
73,600
Slide 12
Deferred Tax Liabilities
The Deferred Tax Liability represents the future taxes
Baxter will pay.
Future
Taxable
Amount
Schedule
2012
Future taxable amounts
$
-
Total
$
Enacted tax rate
Deferred tax liability
32%
$
Deferred Tax Liability
2010
22,400
32,000 2009
9,600 Balance
2011
9,600
0 Balance
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-
Slide 13
Deferred Tax Assets
Health Magazine received $150,000 of subscriptions in
advance during 2009.
Subscription revenue will be earned equally in 2010,
2011 and 2012 for financial accounting purposes.
The entire $150,000 will be taxed in 2009.
There is additional income of $500,000 in each year.
The company is subject to a 30% tax rate in each year.
Accounting income
Subscription revenue on
the income statement
Subscription revenue
on the tax return
Taxable income
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Temporary Difference
Originates
Reverses
2009
2010
2011
$
500,000 $
550,000 $ 550,000 $
(50,000)
$
150,000
650,000 $
(50,000)
500,000 $ 500,000 $
2012
Total
550,000 $ 2,150,000
(50,000)
(150,000)
150,000
500,000 $ 2,150,000
Slide 14
Deferred Tax Assets
Accounting income
Subscription revenue on
the income statement
Subscription revenue
on the tax return
Taxable income
Temporary Difference
Originates
Reverses
2009
2010
2011
$
500,000 $
550,000 $ 550,000 $
(50,000)
$
150,000
650,000 $
2012
Total
550,000 $ 2,150,000
(50,000)
500,000 $ 500,000 $
(50,000)
(150,000)
150,000
500,000 $ 2,150,000
This is the computation for the Deferred Tax Asset.
Calculation of Deferred Tax
Asset
Future deductible amount
Enacted tax rate
Deferred tax asset
2010
$ (50,000)
$
2011
(50,000)
$
2012
(50,000)
$
$
Total
(150,000)
30%
(45,000)
Now, let’s record the income tax entry for 2009.
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Slide 15
Deferred Tax Assets
Accounting income
Subscription revenue on
the income statement
Subscription revenue
on the tax return
Taxable income
Temporary Difference
Originates
Reverses
2009
2010
2011
$
500,000 $
550,000 $ 550,000 $
(50,000)
$
150,000
650,000 $
(50,000)
500,000 $ 500,000 $
2012
Total
550,000 $ 2,150,000
(50,000)
(150,000)
150,000
500,000 $ 2,150,000
2009 Income tax payable = $650,000 × 30% = $195,000
2009 Deferred tax asset change = [($150,000 × 30%] - $0
= $45,000
General Journal
Description
Debit
Income tax expense
150,000
Deferred tax asset
45,000
Income tax payable
McGraw-Hill /Irwin
Credit
195,000
Slide 16
Deferred Tax Assets
After posting the entry, the Deferred Tax Asset account
will have the desired ending balance of $45,000.
2009
Balance
Calculation of Deferred Tax
Asset
Future deductible amount
Enacted tax rate
Deferred tax asset
Deferred Tax Asset
45,000
45,000
2010
$ (50,000)
$
2011
(50,000)
$
2012
(50,000)
General Journal
Description
Debit
Income tax expense
150,000
Deferred tax asset
45,000
Income tax payable
McGraw-Hill /Irwin
$
$
Total
(150,000)
30%
(45,000)
Credit
195,000
Slide 17
Deferred Tax Assets
Accounting income
Subscription revenue on
the income statement
Subscription revenue
on the tax return
Taxable income
Temporary Difference
Originates
Reverses
2009
2010
2011
$
500,000 $
550,000 $ 550,000 $
(50,000)
$
150,000
650,000 $
(50,000)
500,000 $ 500,000 $
2012
Total
550,000 $ 2,150,000
(50,000)
(150,000)
150,000
500,000 $ 2,150,000
2010 Income tax payable = $500,000 × 30% = $150,000
2010 Deferred tax asset change = [($100,000) × 30%] - $45,000
= ($15,000)
General Journal
Description
Debit
Credit
Income tax expense
165,000
Deferred tax asset
15,000
Income tax payable
150,000
McGraw-Hill /Irwin
Slide 18
Deferred Tax Assets
In 2010, the balance in the Deferred Tax Asset should
decrease to $30,000.
Calculation of Deferred Tax
Asset
Future deductible amount
Enacted tax rate
Deferred tax asset
2009
Balance
$
2011
(50,000)
$
2012
(50,000)
$
$
Total
(100,000)
30%
(30,000)
Deferred Tax Asset
45,000
15,000 2010
30,000
Can you prepare the entries for 2011 and 2012?
McGraw-Hill /Irwin
Slide 19
Deferred Tax Assets
This would be the entry for 2011 and 2012.
General Journal
Description
Debit
Income tax expense
165,000
Deferred tax asset
Income tax payable
Credit
15,000
150,000
At the end of 2012, the balance in the Deferred
Tax Asset would be zero.
Deferred Tax Asset
2009
45,000
15,000 2010
15,000 2011
15,000 2012
Balance
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Slide 20
Valuation Allowance
A valuation allowance account
is required when it is more
likely than not that some
portion of the deferred tax asset
will not be realized.
 The deferred tax asset is then
reported at its estimated net
realizable value.

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Slide 21
Nontemporary Differences
Created when an income item is
included in taxable income or
accounting income but will never be
included in the computation of the
other.
Example: Interest on tax-free
municipal bonds is included in
accounting income but is never
included in taxable income.
Also called permanent differences.
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Slide 22
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.
McGraw-Hill /Irwin
Internal
Revenue
Code
Slide 23
Multiple Temporary Differences
It would be unusual for any but a very small
company to have only a single temporary
difference in any given year.
Categorize all temporary
differences according to
whether they create …
Future taxable
amounts
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Future deductible
amounts
Slide 24
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.
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When used to offset
future taxable income:
 Called: operating loss
carryforward.
 Result: reduced tax
payable.
Slide 25
Net Operating Losses (NOL)
Carryback
Period
-2
-1
Carryforward
Period
+1 +2 +3 +4 +5
Current
Year
. . . +20
The NOL may first be applied against taxable
income from two previous years.
Unused NOL may be carried forward for 20
years.
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Slide 26
Net Operating Losses (NOL)
In 2009 Garson, Inc. incurred an $85,000 net
operating loss. The company is subject to a
30% tax rate. In 2007, Garson reported
taxable income of $20,000, and in 2008,
taxable income was $10,000. The company
elects to carryback the NOL.
Tax
year
Taxable
Income
Tax
rate
Taxes Paid
2007 $
20,000
30% $
6,000
2008
10,000
30%
3,000
McGraw-Hill /Irwin
Let’s look at the tax
benefits of the
operating loss
carryback and
carryforward.
Slide 27
Net Operating Losses (NOL)
Prior Years
2007
2008
Operating loss
Loss carryback
Loss carryforward
Subtotal
Enacted tax rate
Tax refund
Deferred tax asset
$
$
$
(20,000) $
(20,000) $
30%
(6,000) $
(10,000)
(10,000) $
30%
(3,000) $
Description
Receivable--income tax refund
Deferred tax asset
Income tax benefit-operating loss
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Current Year
2009
$
(85,000)
Future
Deductible
Amounts
30,000
55,000 $
$
30%
$
Debit
9,000
16,500
(55,000)
(55,000)
30%
(16,500)
Credit
25,500
Slide 28
Net Operating Losses (NOL)
Garson, Inc.
Partial Income Statement
For the Year Ended December 31, 2009
Operating loss before income taxes
$
(85,000)
Benefit of NOL carryback
9,000
Benefit of NOL carryforward
16,500
Net loss
$
(59,500)
The deferred tax asset account created by the
benefit of the carryforward will be used to lower
income taxes payable in future years.
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Slide 29
Balance Sheet Classification
Disclose the following:
Deferred tax
assets/liabilities
are classified as
current or
noncurrent based
on the
classification of
the related asset
or liability.
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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).

Slide 30
Additional Disclosures


Current portion of tax expense (benefit)
Deferred portion of tax expense (benefit), with
separate disclosure for
 Portion that does not include the effect of
the following separately disclosed amounts.
 Operating loss carryforwards.
 Adjustments due to changes in tax laws or
rates.
 Adjustments to the beginning-of-the-year
valuation allowance due to revised
estimates.
 Investment tax credits.
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Slide 31
Coping with Uncertainty in Income Taxes
FASB Interpretation No. 48
Step 1. A tax benefit may be reflected in the
financial statements only if it is “more likely than
not” that the company will be able to sustain the tax
return position, based on its technical merits.
Step 2. A tax benefit should be measured as the
largest amount of benefit that is cumulatively
greater than 50-percent likely to be realized.
Not “more likely than not” = none
of the tax benefit is allowed to be
recorded
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Slide 32
Intraperiod Tax Allocation
SFAS No. 109 requires
intraperiod tax allocation for:
• Income from continuing
operations.
• Discontinued operations.
• Extraordinary items.
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Slide 33
Conceptual Concerns
Some accountants disagree with the FASB’s
approach to accounting for income taxes.
Should deferred taxes be recognized?
Should deferred taxes be recognized for only
some items?
Should deferred taxes be discounted?
Should classification be based on the timing of
temporary difference reversals?
McGraw-Hill /Irwin
End of Chapter 16
McGraw-Hill /Irwin
© 2008 The McGraw-Hill Companies, Inc.