StIce | StIce |Skousen
Income Taxes
Chapter 16
Intermediate Accounting
16E
Prepared by: Sarita Sheth | Santa Monica College
COPYRIGHT © 2007
Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are
trademarks used herein under license.
Learning Objectives
1. Understand the concept of deferred
taxes and the distinction between
permanent and temporary
differences.
2. Compute the amount of deferred tax
liabilities and assets.
3. Explain the provisions of tax loss
carrybacks and carryforwards, and
be able to account for these
provisions.
Learning Objectives
4. Schedule future tax rates, and determine
the effect on tax assets and liabilities.
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.
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.
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.
Deferred Income Tax 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.
Simple Deferred Income Tax
Liability
• Examples:
– 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 Liability
In 2007, Hernandez Company earned
revenues of $30,000. Hernandez has no
expenses other than income taxes. In
this case, Hernandez is taxed on cash
received. The company received $10,000
in 2007 and $20,000 in 2008. The
income tax rate is 40% and it is expected
to remain the same into the foreseeable
future.
Simple Deferred Tax Liability
Income Tax Expense
Income Taxes Payable
Deferred Tax Liability
12,000
4,000
8,000
$30,000 x .40
$10,000 x .40
$20,000 x .40
Hernandez Company
Income Statement
For the Year Ended December 31, 2007
Revenues
Income tax expense:
Current
Deferred
Net income
$30,000
$4,000
8,000
$18,000
Simple Deferred Income 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.
Simple Deferred Tax Asset
In 2007, Shah Corporation generated
service revenues totaling $60,000, all
taxable in 2007. No warranty claims
were made in 2007, but Gupta estimates
that in 2008 warranty costs of $10,000
will incurred for claims related to 2007
service revenues. Assume a 40% tax
rate.
Simple Deferred Tax Asset
Income Tax Expense
Deferred Tax Asset
Income Taxes Payable
20,000
4,000
24,000
$30,000 x .40
Shah Company
$10,000 x .40
Income Statement
$20,000 x .40
For the Year Ended December 31, 2007
Revenues
Less: 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
Temporary Differences
• Permanent Differences- Nondeductible
expenses or nontaxable revenues that are
recognized for financial reporting purposes
but are never part of taxable income.
• Temporary Differences- 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.
Example of Permanent and
Temporary Differences
For the year ended December 31, 2007,
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.
Example of Permanent and
Temporary Differences
Pretax income from income statement $420,000
Add (deduct) permanent differences:
Nontaxable revenues
$(20,000)
Nondeductible expenses
5,000 (15,000)
Financial income subject to tax
$405,000
Add (deduct) temporary differences:
Excess of tax depreciation over
book depreciation
(30,000)
Taxable income
$375,000
Tax on taxable income (income
taxes payable): $375,000 x .35
$131,250
Annual Computation of Deferred
Tax Liabilities & Assets
•
Advantages of the asset and liability
method:
1. Assets and liabilities are recorded in
agreement with FASB definitions of
financial statement elements.
2. Method is flexible and recognizes
changes in circumstances and adjusts
the reported amounts accordingly.
3. Has better predictive value.
Valuation Allowance for
Deferred Tax Asset
• Statement No. 109 stipulates that
both positive and negative
evidence be considered when
determining whether deferred tax
assets will be fully realized.
Carryback and Carryforward of
Operating Losses
Carryback Election
Year
-2
Loss
Year
Carryforward Election
Year
+20
Net Operating Loss (NOL)
Carryback
Year
2007
2008
2009
Income
(Loss)
Tax Rate
$10,000
14,000
(19,000)
35%
30
30
Income
Tax
$3,500
4,200
0
Journal Entry in 2009:
Income Tax Refund Receivable
6,200
Income Tax Benefit From NOL
Carryback
6,200
[$3,500 + (30% x $9,000)]
Accounting for NOL
Carryforward
Continuing with the Prairie Company
illustration, assume that in 2010 the firm
incurred an operating loss of $35,000.
Year
2009
20010
Income
(Loss)
$(19,000)
(35,000)
Tax Rate
30%
30%
Income
Tax
$0
0
The only loss remaining against which operating income
can be applied is $5,000 from 2008 ($14,000 – $9,000).
This leaves $30,000 to be carried forward from 2009 as
a future tax benefit of $9,000 ($30,000 x .30).
Accounting for NOL
Carryforward
The journal entry for 2010 to
record the tax benefits :
Income Tax Refund Receivable
1,500
Deferred Tax Asset—NOL
Carryforward
9,000
Income Tax Benefit from NOL
Carryback
1,500
Income Tax Benefit from NOL
Carryforward
9,000
Accounting for NOL
Carryforward
The firm reports a taxable income of $50,000
in 2011. 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:
Income Tax Expense
Income Taxes Payable
Deferred Tax Asset—NOL
Carryforward
15,000
6,000
9,000
Accounting for NOL
Carryforward
• If
believes
that
will tax
continue
Asmanagement
a result of this
entry,
thelosses
deferred
asset
in the
and expected
the tax benefit
will not
be
is future
zero—the
realizable
value.
realized:
Journal Entry:
Income Tax Refund Receivable
1,500
Deferred Tax Asset—NOL
Carryforward
9,000
Income Tax Benefit from NOL
Carryback
1,500
Allowance to Reduce Deferred
Tax Assets to Realizable Value—
NOL Carryforward
9,000
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.
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
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
Deferred Taxes and the
Statement of Cash Flows
Callazo Company had the following information
for 2007:
Revenue (all cash)
$30,000
Income tax expense:
Current
$10,300
Deferred
Net income
1,700
(12,000)
$18,000
Cash paid for income taxes during 2007 totaled
$13,300.
Deferred Taxes and the
Statement of Cash Flows
12/31/07 12/31/07
Income tax refund receivable
Income taxes payable
Deferred tax liability
$2,000
0
9,700
$
0
1,000
8,000
Analysis
Income Statement
Adjustment
Revenue (all cash),
$30,000
No adjustment
SCF
$30,000 cash
collected from
customers
Deferred Taxes and the
Statement of Cash Flows
Analysis
Income Statement
Income tax
expense—current
$(10,300)
Adjustment
–$2,000—
Increase in
tax receivable
–$1,000—
Decrease in
taxes payable
SCF
$(13,300) Cash
paid for taxes
Deferred Taxes and the
Statement of Cash Flows
Analysis
Income Statement
Income tax
expense—deferred
$(1,700)
Adjustment
+$2,000—
Increase in
deferred tax
liability
SCF
No effect
Deferred Taxes and the
Statement of Cash Flows
Analysis
Income Statement
Net income, $18,000
Adjustment
–$1,300
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
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 ApproachDeferred 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.