Volume 2 19-1 CHAPTER 19 ACCOUNTING FOR INCOME TAXES Intermediate Accounting IFRS Edition Kieso, Weygandt, and Warfield 19-2 Learning Objectives 1. Identify differences between pretax financial income and taxable income. 2. Describe a temporary difference that results in future taxable amounts. 3. Describe a temporary difference that results in future deductible amounts. 4. Explain the non-recognition of a deferred tax asset. 5. Describe the presentation of income tax expense in the income statement. 6. Describe various temporary and permanent differences. 7. Explain the effect of various tax rates and tax rate changes on deferred income taxes. 8. Apply accounting procedures for a loss carryback and a loss carryforward. 9. Describe the presentation of income taxes in financial statements. 10. Indicate the basic principles of the asset-liability method. 19-3 Accounting for Income Taxes Fundamentals of Accounting for Income Taxes Future taxable amounts and deferred taxes Future deductible amounts and deferred taxes Income statement presentation Specific differences Rate considerations 19-4 Accounting for Net Operating Losses Loss carryback Loss carryforward Loss carryback example Loss carryforward example Financial Statement Presentation Statement of financial position Income statement Tex reconciliation Review of AssetLiability Method Fundamentals of Accounting for Income Taxes Corporations must file income tax returns following the guidelines developed by the appropriate taxing authority, thus they: calculate taxes payable based upon tax regulations, calculate income tax expense based upon IFRS. Amount reported as tax expense will often differ from the amount of taxes payable to the taxing authority. 19-5 LO 1 Identify differences between pretax financial income and taxable income. Fundamentals of Accounting for Income Taxes Financial Statements Tax Return Illustration 19-1 vs. Tax Authority Taxable Income Tax Code Income Tax Payable Exchanges Investors and Creditors Pretax Financial Income IFRS Income Tax Expense 19-6 LO 1 Identify differences between pretax financial income and taxable income. Fundamentals of Accounting for Income Taxes Illustration: Chelsea, Inc. reported revenues of $130,000 and expenses of $60,000 in each of its first three years of operations. For tax purposes, Chelsea reported the same expenses to the tax authority in each of the years. Chelsea reported taxable revenues of $100,000 in 2011, $150,000 in 2012, and $140,000 in 2013. What is the effect on the accounts of reporting different amounts of revenue for IFRS versus tax? 19-7 LO 1 Identify differences between pretax financial income and taxable income. Book vs. Tax Difference Illustration 19-2 IFRS Reporting 2011 2012 2013 Total Revenues $130,000 $130,000 $130,000 $390,000 Expenses 60,000 60,000 60,000 180,000 Pretax financial income $70,000 $70,000 $70,000 $210,000 Income tax expense (40%) $28,000 $28,000 $28,000 $84,000 Illustration 19-3 Tax Reporting 2011 2012 2013 Total Revenues $100,000 $150,000 $140,000 $390,000 Expenses 60,000 60,000 60,000 180,000 Pretax financial income $40,000 $90,000 $80,000 $210,000 Income tax payable (40%) $16,000 $36,000 $32,000 $84,000 19-8 LO 1 Identify differences between pretax financial income and taxable income. Book vs. Tax Difference Illustration 19-4 Comparison Income tax expense (IFRS) Income tax payable (tax authority) Difference 2011 2012 2013 Total $28,000 $28,000 $28,000 $84,000 16,000 36,000 32,000 84,000 $12,000 $(8,000) $(4,000) Are the differences accounted for in the financial statements? 19-9 Year Reporting Requirement 2011 Deferred tax liability account increased to $12,000 2012 Deferred tax liability account reduced by $8,000 2013 Deferred tax liability account reduced by $4,000 $0 Yes LO 1 Identify differences between pretax financial income and taxable income. Financial Reporting Statement of Financial Position Assets: Income Statement 2011 2011 Revenues: Expenses: Liabilities: Deferred taxes Income tax payable Equity: 12,000 16,000 Income tax expense 28,000 Net income (loss) Where does the “deferred tax liability” get reported in the financial statements? 19-10 LO 1 Identify differences between pretax financial income and taxable income. Temporary Differences A Temporary Difference is the difference between the tax basis of an asset or liability and its reported (carrying or book) amount in the financial statements that will result in taxable amounts or deductible amounts in future years. Future Taxable Amounts Deferred Tax Liability represents the increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year. Future Deductible Amounts Deferred Tax Asset represents the increase in taxes refundable (or saved) in future years as a result of deductible temporary differences existing at the end of the current year. Illustration 19-22: Examples of Temporary Differences 19-11 LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes Illustration: In Chelsea’s situation, the only difference between the book basis and tax basis of the assets and liabilities relates to accounts receivable that arose from revenue recognized for book purposes. Chelsea reports accounts receivable at $30,000 in the December 31, 2011, IFRS-basis statement of financial position. However, the receivables have a zero tax basis. Illustration 19-5 19-12 LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes Illustration: Reversal of Temporary Difference, Chelsea Inc. Illustration 19-6 Chelsea assumes that it will collect the accounts receivable and report the $30,000 collection as taxable revenues in future tax returns. Chelsea does this by recording a deferred tax liability. 19-13 LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes Deferred Tax Liability Represents the increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year. Illustration 19-4 Income tax expense (IFRS) Income tax payable (tax authority) Difference 19-14 2010 2011 2012 Total $28,000 $28,000 $28,000 $84,000 16,000 36,000 32,000 84,000 $12,000 $(8,000) $(4,000) $0 LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes Deferred Tax Liability Illustration: Because it is the first year of operations for Chelsea, there is no deferred tax liability at the beginning of the year. Chelsea computes the income tax expense for 2011 as follows: Illustration 19-9 19-15 LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes Deferred Tax Liability Illustration: Chelsea makes the following entry at the end of 2011 to record income taxes. Income Tax Expense 19-16 28,000 Income Tax Payable 16,000 Deferred Tax Liability 12,000 LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes Deferred Tax Liability Illustration: Computation of Income Tax Expense for 2012. Illustration 19-10 19-17 LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes Deferred Tax Liability Illustration: Chelsea makes the following entry at the end of 2012 to record income taxes. Income Tax Expense 28,000 Deferred Tax Liability 8,000 Income Tax Payable 36,000 Illustration 19-11 19-18 LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes E19-1: Starfleet Corporation has one temporary difference at the end of 2010 that will reverse and cause taxable amounts of $55,000 in 2011, $60,000 in 2012, and $75,000 in 2013. Starfleet’s pretax financial income for 2010 is $400,000, and the tax rate is 30% for all years. There are no deferred taxes at the beginning of 2010. Instructions a) Compute taxable income and income taxes payable for 2010. b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2010. 19-19 LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes Ex. 19-1: Current Yr. INCOME: 2010 Financial income (GAAP) 400,000 Temporary Diff. Taxable income (IRS) b. 19-20 2012 2013 (190,000) 55,000 60,000 75,000 210,000 55,000 60,000 75,000 a. Tax rate Income tax 2011 30% a. Income tax expense (plug) 63,000 30% 16,500 30% 18,000 30% 22,500 120,000 Income tax payable 63,000 Deferred tax liability 57,000 LO 2 Describe a temporary difference that results in future taxable amounts. Future Deductible Amounts and Deferred Taxes Illustration: During 2011, Cunningham Inc. estimated its warranty costs related to the sale of microwave ovens to be $500,000, paid evenly over the next two years. For book purposes, in 2011 Cunningham reported warranty expense and a related estimated liability for warranties of $500,000 in its financial statements. For tax purposes, the warranty tax deduction is not allowed until paid. Illustration 19-12 19-21 LO 3 Describe a temporary difference that results in future deductible amounts. Future Deductible Amounts and Deferred Taxes Illustration: Reversal of Temporary Difference, Cunningham Inc. Illustration 19-13 When Cunningham pays the warranty liability, it reports an expense for tax purposes. Cunningham reports this future tax benefit in the December 31, 2010, statement of financial position as a deferred tax asset. 19-22 LO 3 Describe a temporary difference that results in future deductible amounts. Future Deductible Amounts and Deferred Taxes Deferred Tax Asset Represents the increase in taxes refundable (or saved) in future years as a result of deductible temporary differences existing at the end of the current year. 19-23 LO 3 Describe a temporary difference that results in future deductible amounts. Future Deductible Amounts and Deferred Taxes Deferred Tax Asset Illustration: Hunt Co. accrues a loss and a related liability of $50,000 in 2011 for financial reporting purposes because of pending litigation. Hunt cannot deduct this amount for tax purposes until the period it pays the liability, expected in 2012. Illustration 19-14 19-24 LO 3 Describe a temporary difference that results in future deductible amounts. Future Deductible Amounts and Deferred Taxes Deferred Tax Asset Illustration: Assuming that 2011 is Hunt’s first year of operations, and income tax payable is $100,000, Hunt computes its income tax expense as follows. Illustration 19-16 19-25 LO 3 Describe a temporary difference that results in future deductible amounts. Future Deductible Amounts and Deferred Taxes Deferred Tax Asset Illustration: Hunt makes the following entry at the end of 2011 to record income taxes. Income Tax Expense 80,000 Deferred Tax Asset 20,000 Income Tax Payable 19-26 100,000 LO 3 Describe a temporary difference that results in future deductible amounts. Future Deductible Amounts and Deferred Taxes Deferred Tax Asset Illustration: Computation of Income Tax Expense for 2012. Illustration 19-17 19-27 LO 3 Describe a temporary difference that results in future deductible amounts. Future Deductible Amounts and Deferred Taxes Deferred Tax Asset Illustration: Hunt makes the following entry at the end of 2012 to record income taxes. Income Tax Expense 160,000 Deferred Tax Asset 20,000 Income Tax Payable 140,000 Illustration 19-18 19-28 LO 3 Describe a temporary difference that results in future deductible amounts. Future Deductible Amounts and Deferred Taxes Illustration: Columbia Corporation has one temporary difference at the end of 2010 that will reverse and cause deductible amounts of $50,000 in 2011, $65,000 in 2012, and $40,000 in 2013. Columbia’s pretax financial income for 2010 is $200,000 and the tax rate is 34% for all years. There are no deferred taxes at the beginning of 2010. Columbia expects to be profitable in the future. Instructions a) Compute taxable income and income taxes payable for 2010. b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2010. 19-29 LO 3 Describe a temporary difference that results in future deductible amounts. Future Deductible Amounts and Deferred Taxes Illustration Current Yr. INCOME: 2010 Financial income (GAAP) 200,000 Temporary Diff. Taxable income (IRS) a. Tax rate Income tax b. 2012 2013 155,000 (50,000) (65,000) (40,000) 355,000 (50,000) (65,000) (40,000) 34% 34% 34% (17,000) (22,100) (13,600) 34% a. 120,700 Income tax expense 68,000 Deferred tax asset 52,700 Income tax payable 19-30 2011 120,700 LO 3 Describe a temporary difference that results in future deductible amounts. Future Deductible Amounts and Deferred Taxes Deferred Tax Asset (Non-Recognition) A company should reduce a deferred tax asset if it is probable that it will not realize some portion or all of the deferred tax asset. “Probable” means a level of likelihood of at least slightly more than 50 percent. 19-31 LO 4 Explain the non-recognition of a deferred tax asset. Future Deductible Amounts and Deferred Taxes E19-14: Callaway Corp. has a deferred tax asset balance of $150,000 at the end of 2010 due to a single cumulative temporary difference of $375,000. At the end of 2011 this same temporary difference has increased to a cumulative amount of $500,000. Taxable income for 2011 is $850,000. The tax rate is 40% for all years. No valuation account is in existence at the end of 2010. Instructions Assuming that it is probable that $30,000 of the deferred tax asset will not be realized, prepare the journal entries required for 2011. 19-32 LO 4 Explain the non-recognition of a deferred tax asset. Future Deductible Amounts and Deferred Taxes E19-14: INCOME: 2009 Financial income (GAAP) Current Yr. 2010 2011 725,000 Temporary difference 375,000 125,000 (500,000) Taxable income (IRS) 375,000 850,000 (500,000) - Tax rate Income tax 40% 150,000 40% 340,000 40% (200,000) 40% - Income tax expense 290,000 Deferred tax asset 50,000 Income tax payable Income tax expense 30,000 Deferred tax asset 19-33 340,000 30,000 LO 4 Explain the non-recognition of a deferred tax asset. Income Statement Presentation Formula to Compute Income Tax Expense Illustration 19-20 Income tax payable or refundable + - Change in deferred income tax = Income tax expense or benefit In the income statement or in the notes to the financial statements, a company should disclose the significant components of income tax expense attributable to continuing operations. 19-34 LO 5 Describe the presentation of income tax expense in the income statement. Income Statement Presentation Given the previous information related to Chelsea Inc., Chelsea reports its income statement as follows. Illustration 19-21 19-35 LO 5 Describe the presentation of income tax expense in the income statement. Specific Differences Temporary Differences Taxable temporary differences - Deferred tax liability Deductible temporary differences - Deferred tax Asset Text Illustration 19-22: Examples of Temporary Differences 19-36 LO 6 Describe various temporary and permanent differences. Specific Differences Permanent Differences Enter into pretax financial income but never into taxable income or Enter into taxable income but never into pretax financial income. Affect only the period in which they occur. Do not give rise to future taxable or deductible amounts. Text Illustration 19-24: Examples of Permanent Differences 19-37 LO 6 Describe various temporary and permanent differences. Specific Differences Do the following generate: Future Deductible Amount = Deferred Tax Asset Future Taxable Amount = Deferred Tax Liability Permanent Difference E19-6 1. An accelerated depreciation system is used for tax purposes, and the straight-line depreciation method is used for financial reporting purposes. Future Taxable Amount 2. A landlord collects some rents in advance. Rents received are taxable in the period when they are received. Future Deductible Amount 3. Expenses are incurred in obtaining tax-exempt income. Permanent Difference 4. Costs of guarantees and warranties are estimated and accrued for financial reporting purposes. Future Deductible Amount 19-38 LO 6 Describe various temporary and permanent differences. Specific Differences Do the following generate: Future Deductible Amount = Deferred Tax Asset Future Taxable Amount = Deferred Tax Liability Permanent Difference 5. Sales of investments are accounted for by the accrual method for financial reporting purposes and the installment method for tax purposes. E19-6 Future Taxable Amount 6. Interest is received on an investment in tax-exempt governmental obligations. Permanent Difference 7. Estimated losses on pending lawsuits and claims are accrued for books. These losses are tax deductible in the period(s) when the related liabilities are settled. Future Deductible Amount 19-39 LO 6 Describe various temporary and permanent differences. Permanent Differences E19-4: Havaci Company reports pretax financial income of €80,000 for 2010. The following items cause taxable income to be different than pretax financial income. 1. Depreciation on the tax return is greater than depreciation on the income statement by €16,000. 2. Rent collected on the tax return is greater than rent earned on the income statement by €27,000. 3. Fines for pollution appear as an expense of €11,000 on the income statement. Havaci’s tax rate is 30% for all years, and the company expects to report taxable income in all future years. There are no deferred taxes at the beginning of 2010. 19-40 LO 6 Describe various temporary and permanent differences. Permanent Differences E19-4: Current Yr. Deferred Deferred INCOME: 2010 Asset Liability Financial income (GAAP) € 80,000 Excess tax depreciation (16,000) Excess rent collected 27,000 Fines (permanent) 11,000 Taxable income (IRS) 102,000 Tax rate Income tax Income tax expense (€ 27,000) (27,000) 16,000 30% 30% 30% € 30,600 (€ 8,100) € 4,800 - 27,300 Deferred tax asset 8,100 Deferred tax liability Income tax payable 19-41 € 16,000 4,800 30,600 LO 6 Describe various temporary and permanent differences. Tax Rate Considerations Future tax Rates A company must consider presently enacted changes in the tax rate that become effective for a particular future year(s) when determining the tax rate to apply to existing temporary differences. Revision of Future Tax Rates When a change in the tax rate is enacted, companies should record its effect on the existing deferred income tax accounts immediately. 19-42 LO 7 Explain the effect of various tax rates and tax rate changes on deferred income taxes. Accounting for Net Operating Losses Net operating loss (NOL) = tax-deductible expenses exceed taxable revenues. Tax laws permit taxpayers to use the losses of one year to offset the profits of other years (carryback and carryforward). 19-43 LO 8 Apply accounting procedures for a loss carryback and a loss carryforward. Accounting for Net Operating Losses Loss Carryback Back 2 years and forward 20 years. Losses must be applied to earliest year first. Illustration 19-29 19-44 LO 8 Apply accounting procedures for a loss carryback and a loss carryforward. Accounting for Net Operating Losses Loss Carryforward May elect to forgo loss carryback and Carryforward losses 20 years. Illustration 19-30 19-45 LO 8 Apply accounting procedures for a loss carryback and a loss carryforward. Accounting for Net Operating Losses BE19-12: Conlin Corporation had the following tax information. Taxable Income Year 2008 $ Tax Rate Taxes Paid 300,000 35% $ 105,000 2009 325,000 30% 97,500 2010 400,000 30% 120,000 In 2011 Conlin suffered a net operating loss of $480,000, which it elected to carry back. The 2011 enacted tax rate is 29%. Prepare Conlin’s entry to record the effect of the loss carryback. 19-46 LO 8 Apply accounting procedures for a loss carryback and a loss carryforward. Accounting for Net Operating Losses BE19-12 Financial income 2008 $ 300,000 2009 $ 2010 325,000 $ 2011 400,000 Difference Taxable income (loss) 300,000 325,000 Rate Income tax $ 35% 105,000 $ $ 300,000 400,000 30% 97,500 $ 30% 120,000 (480,000) 29% NOL Schedule Taxable income $ Carryback 325,000 $ (325,000) Taxable income 300,000 - Rate Income tax (revised) 35% 105,000 $ 30% $ Refund 19-47 $ $ 97,500 400,000 (480,000) (155,000) 480,000 245,000 $ 30% 73,500 46,500 29% - $144,000 LO 8 Apply accounting procedures for a loss carryback and a loss carryforward. Accounting for Net Operating Losses E19-12: Journal Entry for 2011 Income tax refund receivable Benefit due to loss carryback 19-48 144,000 144,000 LO 8 Apply accounting procedures for a loss carryback and a loss carryforward. Accounting for Net Operating Losses BE19-13: Rode Inc. incurred a net operating loss of €500,000 in 2010. Combined income for 2008 and 2009 was €350,000. The tax rate for all years is 40%. Rode elects the carryback option. Prepare the journal entries to record the benefits of the loss carryback and the loss carryforward. 19-49 LO 8 Apply accounting procedures for a loss carryback and a loss carryforward. Accounting for Net Operating Losses BE19-13 2008-2009 Financial income $ 2010 2011 350,000 Difference Taxable income (loss) 350,000 (500,000) Rate Income tax $ 40% 140,000 $ 350,000 (500,000) (350,000) 350,000 40% NOL Schedule Taxable income Carryback 19-50 Taxable income - Rate Income tax (revised) 40% - $ (150,000) 40% (60,000) LO 8 Apply accounting procedures for a loss carryback and a loss carryforward. Accounting for Net Operating Losses E19-13: Journal Entries for 2010 Income tax refund receivable 140,000 Benefit due to loss carryback Deferred tax asset Benefit due to loss carryforward 19-51 140,000 60,000 60,000 LO 8 Apply accounting procedures for a loss carryback and a loss carryforward. Accounting for Net Operating Losses BE19-14: Use the information for Rode Inc. given in BE19-13. Assume that it is more likely than not that the entire net operating loss carryforward will not be realized in future years. Prepare all the journal entries necessary at the end of 2010. 19-52 LO 8 Apply accounting procedures for a loss carryback and a loss carryforward. Accounting for Net Operating Losses E19-14: Journal Entries for 2010 Income tax refund receivable Benefit due to loss carryback 19-53 140,000 140,000 Deferred tax asset Benefit due to loss carryforward 60,000 Benefit due to loss carryforward Allowance for deferred tax asset 60,000 60,000 60,000 LO 8 Apply accounting procedures for a loss carryback and a loss carryforward. Valuation Allowance Revisited Whether the company will realize a deferred tax asset depends on whether sufficient taxable income exists or will exist within the carryforward period. Text Illustration 19-37: Possible Sources of Taxable Income To the extent that it is not probable that taxable profit will be available against which the unused tax losses or unused tax credits can be utilized, the deferred tax asset is not recognized. 19-54 LO 8 Apply accounting procedures for a loss carryback and a loss carryforward. Financial Statement Presentation Statement of Financial Position The net deferred tax asset or net deferred tax liability is reported in the non-current section of the statement of financial position. Illustration 19-38 19-55 LO 9 Financial Statement Presentation Income Statement Companies allocate income tax expense (or benefit) to 19-56 continuing operations, discontinued operations, other comprehensive income, and prior period adjustments. LO 9 Describe the presentation of income taxes in financial statements. Income Statement Components of income tax expense (benefit) may include: 1. Current tax expense (benefit). 2. Any adjustments recognized in the period for current tax of prior periods. 3. Amount of deferred tax expense (benefit) relating to the origination and reversal of temporary differences. 4. Amount of deferred tax expense (benefit) relating to changes in tax rates or the imposition of new taxes. 5. Amount of the benefit arising from a previously unrecognized tax loss, tax credit, or temporary difference of a prior period that is used to reduce current and deferred tax expense. 19-57 LO 9 Financial Statement Presentation Tax Reconciliation Companies either provide: 19-58 A numerical reconciliation between tax expense (benefit) and the product of accounting profit multiplied by the applicable tax rate(s), disclosing also the basis on which the applicable tax rate(s) is (are) computed; or A numerical reconciliation between the average effective tax rate and the applicable tax rate, disclosing also the basis on which the applicable tax rate is computed. LO 9 Describe the presentation of income taxes in financial statements. Review of the Asset-Liability Method Companies apply the following basic principles: Illustration 19-42 19-59 LO 10 Indicate the basic principles of the asset-liability method. Review of the Asset-Liability Method Illustration 19-43 Procedures for Computing and Reporting Deferred Income Taxes 19-60 LO 10 Indicate the basic principles of the asset-liability method. 19-61 U.S. GAAP classifies deferred taxes based on the classification of the asset or liability to which it relates. The classification of deferred taxes under IFRS is always non-current. U.S. GAAP uses an impairment approach for deferred tax assets. In this approach, the deferred tax asset is recognized in full. It is then reduced by a valuation account if it is more likely than not that all or a portion of the deferred tax asset will not be realized. Under IFRS, an affirmative judgment approach is used, by which a deferred tax asset is recognized up to the amount that is probable to be realized. 19-62 For U.S. GAAP, the enacted tax rate must be used. IFRS uses the enacted tax rate or substantially enacted tax rate. (“Substantially enacted” means virtually certain.) The tax effects related to certain items are reported in equity under IFRS. That is not the case under U.S. GAAP, which charges or credits the tax effects to income. U.S. GAAP requires companies to assess the likelihood of uncertain tax positions being sustainable upon audit. Potential liabilities must be accrued and disclosed if the position is “more likely than not” to be disallowed. Under IFRS, all potential liabilities must be recognized. With respect to measurement, IFRS uses an expected-value approach to measure the tax liability, which differs from U.S. GAAP. Fiscal Year-2010 Allman Company, which began operations at the beginning of 2010, produces various products on a contract basis. Each contract generates a gross profit of $80,000. Some of Allman’s contracts provide for the customer to pay on an installment basis. Under these contracts, Allman collects one-fifth of the contract revenue in each of the following four years. For financial reporting purposes, the company recognizes gross profit in the year of completion (accrual basis); for tax purposes, Allman recognizes gross profit in the year cash is collected (installment basis). 19-63 LO 11 Understand and apply the concepts and procedures of interperiod tax allocation. Fiscal Year-2010 Presented below is information related to Allman’s operations for 2010. 19-64 1. In 2010, the company completed seven contracts that allow for the customer to pay on an installment basis. Allman recognized the related gross profit of $560,000 for financial reporting purposes. It reported only $112,000 of gross profit on installment sales on the 2010 tax return. The company expects future collections on the related installment receivables to result in taxable amounts of $112,000 in each of the next four years. 2. At the beginning of 2010, Allman Company purchased depreciable assets with a cost of $540,000. For financial reporting purposes, Allman depreciates these assets using the straight-line method over a six-year service life. The following is the depreciation schedule for both financial and tax purposes. LO 11 Fiscal Year-2010 3. 19-65 The company warrants its product for two years from the date of completion of a contract. During 2010, the product warranty liability accrued for financial reporting purposes was $200,000, and the amount paid for the satisfaction of warranty liability was $44,000. Allman expects to settle the remaining $156,000 by expenditures of $56,000 in 2011 and $100,000 in 2012. LO 11 Fiscal Year-2010 19-66 4. In 2010 nontaxable municipal bond interest revenue was $28,000. 5. During 2010 nondeductible fines and penalties of $26,000 were paid. 6. Pretax financial income for 2010 amounts to $412,000. 7. Tax rates enacted before the end of 2010 were: ► 2010 50% ► 2011 and later years 40% 8. The accounting period is the calendar year. 9. The company is expected to have taxable income in all future years. LO 11 Taxable Income and Income Tax Payable-2010 The first step is to determine Allman Company’s income tax payable for 2010 by calculating its taxable income. Illustration 19A-1 Illustration 19A-2 19-67 LO 11 Deferred Income Taxes – End of 2010 Illustration 19A-3 Illustration 19A-4 19-68 LO 11 Deferred Tax Expense (Benefit) and the Journal Entry to Record Income Taxes - 2010 Computation of Deferred Tax Expense (Benefit), 2010 Illustration 19A-5 Computation of Net Deferred Tax Expense, 2010 19-69 Illustration 19A-6 LO 11 Deferred Tax Expense (Benefit) and the Journal Entry to Record Income Taxes - 2010 Computation of Total Income Tax Expense, 2010 Illustration 19A-7 Journal Entry for Income Tax Expense, 2010 Income Tax Expense Deferred Tax Asset Income Tax Payable Deferred Tax Liability 19-70 174,000 62,400 50,000 186,400 LO 11 Financial Statement Presentation - 2010 Companies should classify deferred tax assets and liabilities as current and noncurrent on the balance sheet based on the classifications of related assets and liabilities. Illustration 19A-8 19-71 LO 11 Financial Statement Presentation - 2010 Statement of Financial Position 2010 Illustration 19A-9 Income Statement 2010 Illustration 19A-10 19-72 LO 11 Copyright Copyright © 2011 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. 19-73