Provision for Income Tax Expense ASC 740
An exercise requiring analysis, synthesis and critical thinking
I. INTRODUCTION
The professional skill set required to create a complex provision for income tax expense (tax
provision) requires many companies to retain outside accounting firms to prepare their
respective tax provision.
Because SEC regulations and auditing standards prohibit
accounting firms from auditing their own professional work, a client-company must hire one
accounting firm to prepare its tax provision and a different firm to audit its financial
statements. The firm performing the audit often finds it necessary to use its tax accountants
to assist in auditing the tax provision.
II. TAX PROVISION EXERCISE
The following exercise for STUMBLE & FALL, INC., is structured to develop the critical thinking
skills essential to creating a tax provision. This exercise will require you to:




Understand concepts from both accounting and tax courses
Apply your knowledge to prepare journal entries and financial statements
Analyze differences between the accounting book values and tax bases
Synthesize concepts from accounting and tax to prepare the required disclosures
We encourage you to work as part of a team for this exercise because teamwork simulates
the professional accounting firm experience. For example, one team member would read the
following sections of Accounting Standard Codification 740 (ASC 740), while another member
analyzes the relevant sections of Statement of Financial Accounting Standards No. 109
(SFAS 109), and a third member reads the course textbook. The foregoing approach—each
team member’s analysis of different authoritative resources on the same topic—will provide
different perspectives for your team to approach the tax provision exercise. This team
approach will also familiarize team members with the professional literature. Although
SFAS 109 pre-existed the Financial Accounting Standard Board’s issuance of Accounting
Standard Updates (ASU), it is similar to an ASU and illustrates how accounting standards are
issued.
Accounting Standards Codification - 740 Income Taxes
ASC 740-10-05
ASC 740-10-10
ASC 740-10-15
ASC 740-10-25- 1-7
ASC 740-10-25- 18-29
ASC 740-10-25- 47-48
ASC 740-10-30- 1-8
ASC 740-30- 16-25
ASC 740-10-45- 1-10
ASC 740-10-50- 1/-2
Overview and Background
Objectives
Scope and Scope Exceptions
Recognition
Temporary Differences
Changes in Laws or Rates
Initial Measurement
Establishment of a Valuation Allowance for Deferred Tax Assets
Other Presentation Matters
Disclosure
1
Implementation
ASC 740-10-55-7/9
ASC 740-10-55-13/14
ASC 740-10-55-15/19
ASC 740-10-55-23/24
ASC 740-10-55-34/37
Recognition of Deferred Tax Assets and Liabilities
Pattern of Taxable or Deductible Amounts
The Need to Schedule Temporary Difference Reversals
Measurement of Deferred Tax Liabilities and Assets
Recognition of a Tax Benefit for Carrybacks and Carryforwards
SFAS No. 109 (as amended) - Accounting for Income Taxes
1-2
3-5
6-9
10-15
16
17-25
26
27
28-40
41-42
43-49
Appendix B
Summary
Introduction
Scope
Objectives and Basic Principles
Temporary Differences
Recognition and Measurement
Annual Computation of Deferred Tax Liabilities and Assets
A Change in the Valuation Allowance
An Enacted Change in Tax Laws or Rates
omit
Financial Statement Presentation
Financial Statement Disclosure
Application of the Standard provides guidance on application of the standard
and may be a useful reference
III. ASSIGNMENTS
The Stumble & Fall, Inc. tax provision exercise is divided into four separate parts—Part 1
through Part 4—with a total of 10 assignments enumerated explained in each part.
Part 1
Stumble & Fall, Inc. provided you with the following documents for 20x1:



income tax worksheet (the federal income tax rate is 40% for Part 1),
12/31/x1 trial balance,
a list of journal entries for the year,
A. The first assignment consists of the following four tasks. You are expected to
review the materials but NOT complete this assignment.
1. Complete the journal entry for the federal income tax accrual. You should assume it is
more likely than not Stumble & Fall’s future taxable income will be sufficient to realize
all deferred tax assets (DTA).
2. Complete the financial statements which are provided at the end of Part 1 of this
exercise.
2
3. Prepare the reconciliations required to be disclosed by ASC 740-10-50-12.
4. Complete the IRS Schedule M-3 worksheet provided at the end of the Part 1.
ASC 740 50-12 A public entity shall disclose a reconciliation using percentages
or dollar amounts of the reported amount of income tax expense attributable to
continuing operations for the year to the amount of income tax expense that
would result from applying domestic federal statutory tax rates to pretax income
from continuing operations. The statutory tax rates shall be the regular tax rates
if there are alternative tax systems. The estimated amount and the nature of
each significant reconciling item shall be disclosed.
Table 1
Year 1 - Part 1 assignment A
Income Tax Worksheet
Income
Trial Balance
8,000.00
Cash
Receivable from IRS
Cost of goods sold
Inventory abandoned
Accounts written off
Bonus deductions
MACRS deduction
Other deductions
Deductions
Taxable income or -LOSS
Loss carryforward
Income tax @ 40%
Tax credits / carryback / fwd
Payment due
-6,000.00
0.00
0.00
0.00
-1,333.33
0.00
-7,333.33
666.67
0.00
266.67
0.00
266.67
Accounts receivable
Allow for uncollectible
Inventory
Reserve for obsolescence
DTA current
Machine
Accumulated dep
DTA loss carryforward
DTA non current
Accounts payable
CUR Bonus pay - 12/31/x4
Income tax payable
Tax basis after current year depreciation
basis in Accounts receivable
basis in Inventory
basis in Machine at year end
basis in CUR Bonus pay - 12/31/x4
500.00
1,000.00
2,666.67
0.00
DTL current
DTL non current
NC Bonus pay - 12/31/x4
Jounal Entries
450.00
0.00
500.00
<100.00>
1,000.00
<75.00>
70.00
4,000.00
<1,000.00>
0.00
0.00
0.00
0.00
<266.67>
0.00
<133.33>
0.00
<4,000.00>
0.00
Non Deduct Cash expenditures
0.00
Common stock
4,000.00
Common stock
<4,000.00>
Inventory
7,000.00
Cash
<7,000.00>
Accounts receivable
8,000.00
Sales
<8,000.00>
Cost of goods sold
6,000.00
Inventory
<6,000.00>
Depreciation expense
1,000.00
Accumulated dep
<1,000.00>
Bad debt expense
100.00
Allow for uncollectible
<100.00>
Inventory reserve expense
75.00
Reserve for obsolescence
<75.00>
Non deductible penalties
50.00
Cash
<50.00>
Cash
7,500.00
Accounts receivable
<7,500.00>
Current income tax expense 266.67
Income tax payable
<266.67>
Machine
Retained earnings
<8,000.00>
6,000.00
Inventory reserve expense
75.00
Bad debt expense
100.00
Deferred bonus expense
0.00
Depreciation expense
1,000.00
Other expense
0.00
Non deductible penalties
50.00
Current income tax expense
266.67
Deferred income tax expense
63.33
Sales
Cost of goods sold
3
Stumble & Fall Inc. has provided the following documents for 20x2; 20x3 and 20x4:



income tax worksheet (the federal income tax rate is 40% for Part 1),
12/31/x1 trial balance,
a list of journal entries for the year,
The second assignment consists of the following four tasks. You are expected to
review the materials but NOT complete this assignment.
1. Complete the journal entry for the federal income tax accrual. Assume it is more
likely than not Stumble & Fall’s future taxable income will be sufficient to realize all
DTAs.
2. Complete the financial statements provided at the end of Part 1.
3. Prepare the reconciliations required to be disclosed by ASC 740-10-50-12.
4. Complete the IRS Schedule M-3 worksheet provided at the end of the Part 1.
Table 2
Year 2 - Part 1 assignment B
Income Tax Worksheet
Income
Trial Balance
8,000.00
Cash
Receivable from IRS
Cost of goods sold
Inventory abandoned
Accounts written off
Bonus deductions
MACRS deduction
Other deductions
Deductions
Taxable income or -LOSS
Loss carryforward
Income tax @ 40%
Tax credits / carryback / fwd
Payment due
-6,000.00
-90.00
-75.00
0.00
-1,777.78
0.00
-7,942.78
57.22
0.00
22.89
0.00
22.89
Accounts receivable
Allow for uncollectible
Inventory
Reserve for obsolescence
DTA current
Machine
Accumulated dep
DTA loss carryforward
DTA non current
Accounts payable
CUR Bonus pay - 12/31/x4
Income tax payable
Tax basis after current year depreciation
basis in Accounts receivable
basis in Inventory
basis in Machine at year end
basis in CUR Bonus pay - 12/31/x4
DTL current
325.00
910.00
888.89
0.00
DTL non current
NC Bonus pay - 12/31/x4
Jounal Entries
2,208.33
0.00
325.00
<105.00>
910.00
<85.00>
76.00
4,000.00
<2,000.00>
0.00
60.00
0.00
0.00
<22.89>
0.00
<444.44>
<150.00>
<4,000.00>
<445.00>
Non Deduct Cash expenditures
0.00
Common stock
Retained earnings
<8,000.00>
6,000.00
Inventory reserve expense
100.00
Bad debt expense
80.00
Deferred bonus expense
150.00
Depreciation expense
1,000.00
Other expense
0.00
Non deductible penalties
75.00
Current income tax expense
22.89
Deferred income tax expense
245.11
Sales
Cost of goods sold
266.67
<266.67>
Inventory
6,000.00
Cash
<6,000.00>
Accounts receivable
8,000.00
Sales
<8,000.00>
Cost of goods sold
6,000.00
Inventory
<6,000.00>
Depreciation expense
1,000.00
Accumulated dep
<1,000.00>
Bad debt expense
80.00
Allow for uncollectible
<80.00>
Allow for uncollectible
75.00
Accounts receivable
<75.00>
Inventory reserve expense
100.00
Reserve for obsolescence
<100.00>
Reserve for obsolescence
90.00
Inventory
<90.00>
Deferred bonus expense
150.00
NC Bonus pay - 12/31/x4
<150.00>
Non deductible penalties
75.00
Cash
<75.00>
Cash
8,100.00
Accounts receivable
<8,100.00>
Current income tax expense
22.89
Income tax payable
<22.89>
Income tax payable
Cash
4
B. The third assignment consists of the following four tasks. You are expected to
review the materials but NOT complete this assignment.
1. Complete the journal entry for the federal income tax accrual. Assume it is more likely
than not Stumble & Fall’s future taxable income will be sufficient to realize all DTAs.
2. Complete the financial statements provided at the end of Part 1.
3. Prepare the reconciliations required to be disclosed by ASC 740-10-50-12.
4. Complete the IRS Schedule M-3 worksheet provided at the end of the Part 1.
Table 3
Year 3 - Part 1 assignment C
Income Tax Worksheet
Income
Trial Balance
6,000.00
Cash
Receivable from IRS
Cost of goods sold
Inventory abandoned
Accounts written off
Bonus deductions
MACRS deduction
Other deductions
Deductions
Taxable income or -LOSS
Loss carryforward
Income tax @ 40%
Tax credits / carryback / fwd
Payment due
-6,000.00
-90.00
-125.00
0.00
-592.59
0.00
-6,807.59
-807.59
0.00
0.00
-289.56
-289.56
Accounts receivable
Allow for uncollectible
Inventory
Reserve for obsolescence
DTA current
Machine
Accumulated dep
DTA loss carryforward
DTA non current
Accounts payable
CUR Bonus pay - 12/31/x4
Income tax payable
Tax basis after current year depreciation 0.00
basis in Accounts receivable
basis in Inventory
basis in Machine at year end
basis in CUR Bonus pay - 12/31/x4
400.00
820.00
296.30
0.00
DTL current
DTL non current
NC Bonus pay - 12/31/x4
Jounal Entries
1,960.44
289.56
400.00
<130.00>
820.00
<95.00>
230.00
4,000.00
<3,000.00>
33.48
0.00
0.00
<350.00>
0.00
0.00
<281.48>
0.00
<4,000.00>
<772.00>
Non Deduct Cash expenditures
0.00
Common stock
Retained earnings
<6,000.00>
6,000.00
Inventory reserve expense
100.00
Bad debt expense
150.00
Deferred bonus expense
200.00
Depreciation expense
1,000.00
Other expense
0.00
Non deductible penalties
25.00
Current income tax expense
0.00
Deferred income tax expense
<580.00>
Sales
Cost of goods sold
22.89
<22.89>
Inventory
6,000.00
Cash
<6,000.00>
Accounts receivable
6,000.00
Sales
<6,000.00>
Cost of goods sold
6,000.00
Inventory
<6,000.00>
Depreciation expense
1,000.00
Accumulated dep
<1,000.00>
Bad debt expense
150.00
Allow for uncollectible
<150.00>
Allow for uncollectible
125.00
Accounts receivable
<125.00>
Inventory reserve expense
100.00
Reserve for obsolescence
<100.00>
Reserve for obsolescence
90.00
Inventory
<90.00>
Deferred bonus expense
200.00
NC Bonus pay - 12/31/x4
150.00
CUR Bonus pay - 12/31/x4 <350.00>
Cash
0.00
Non deductible penalties
25.00
Cash
<25.00>
Cash
5,800.00
Accounts receivable
<5,800.00>
Current income tax expense
0.00
Income tax payable
0.00
Receivable from IRS
289.56
Income tax payable
Cash
5
C. The fourth assignment consists of the following four tasks. You are expected to
review the materials but NOT complete this assignment.
A. Complete the journal entry for the federal income tax accrual. Assume it is more likely
than not Stumble & Fall’s future taxable income will be sufficient to realize all DTAs.
B. Complete the financial statements provided at the end of Part 1.
C. Prepare the reconciliations required to be disclosed by ASC 740-10-50-12.
D. Complete the IRS Schedule M-3 worksheet provided at the end of the Part 1.
Table 4
Year 4 - Part 1 assignment D
Income Tax Worksheet
Income
Trial Balance
7,250.00
Cash
Receivable from IRS
Cost of goods sold
Inventory abandoned
Accounts written off
Bonus deductions
MACRS deduction
Other deductions
Deductions
Taxable income or -LOSS
Loss carryforward
Income tax @ 40%
Tax credits / carryback / fwd
Payment due
-6,000.00
-95.00
-130.00
-350.00
-296.30
0.00
-6,871.30
378.70
83.70
118.00
0.00
118.00
Accounts receivable
Allow for uncollectible
Inventory
Reserve for obsolescence
DTA current
Machine
Accumulated dep
DTA loss carryforward
DTA non current
Accounts payable
CUR Bonus pay - 12/31/x4
Income tax payable
Tax basis after current year depreciation 0.00
basis in Accounts receivable
basis in Inventory
basis in Machine at year end
basis in CUR Bonus pay - 12/31/x4
0.00
0.00
0.00
0.00
DTL current
DTL non current
NC Bonus pay - 12/31/x4
Jounal Entries
4,145.00
0.00
0.00
0.00
0.00
0.00
0.00
4,000.00
<4,000.00>
0.00
0.00
0.00
0.00
<118.00>
0.00
0.00
0.00
<4,000.00>
123.00
Non Deduct Cash expenditures
0.00
Common stock
Retained earnings
0.00
0.00
Cash
289.56
Receivable from IRS
<289.56>
Inventory
5,275.00
Cash
<5,275.00>
Accounts receivable
7,250.00
Sales
<7,250.00>
Cost of goods sold
6,000.00
Inventory
<6,000.00>
Depreciation expense
1,000.00
Accumulated dep
<1,000.00>
Allow for uncollectible
130.00
Accounts receivable
<130.00>
Reserve for obsolescence
95.00
Inventory
<95.00>
CUR Bonus pay - 12/31/x4
350.00
Cash
<350.00>
Cash
7,520.00
Accounts receivable
<7,520.00>
Current income tax expense 118.00
Income tax payable
<118.00>
Income tax payable
Cash
<7,250.00>
6,000.00
Inventory reserve expense
0.00
Bad debt expense
0.00
Deferred bonus expense
0.00
Depreciation expense
1,000.00
Other expense
0.00
Non deductible penalties
0.00
Current income tax expense
118.00
Deferred income tax expense
<18.00>
Sales
Cost of goods sold
6
E. Be prepared to explain why the four-year total for income before income tax
expense on the income statement differs from total taxable income.
Similarly, compare the four-year total for income tax expense with the total of income tax
paid and payable to the IRS during the period. Explain any differences between these
totals.
Be prepared to discuss why the implementation of ASC 740 results in income tax
expense for each year that is different than the amount owed to the IRS.
7
Financial Statements and
IRS Schedule M-3 worksheet
to be completed for
Part 1 Assignments A - D
Stumble & Fall, Inc.
Income Statement (for Part 1)
for the years ending Dec. 31, 20x4
12/31/x4
12/31/x3
12/31/x2
12/31/x1
Sales
Cost of goods sold
Inventory reserve expense
Gross profit
7,250.00 6,000.00 8,000.00 8,000.00
6,000.00 6,000.00 6,000.00 6,000.00
0.00 100.00 100.00
75.00
1,250.00 -100.00 1,900.00 1,925.00
Bad debt expense
Deferred bonus expense
Depreciation expense
Other expense
Non deductible penalties
Operating expense
0.00 150.00
80.00
100.00
0.00 200.00 150.00
0.00
1,000.00 1,000.00 1,000.00 1,000.00
0.00
0.00
0.00
0.00
0.00
25.00
75.00
50.00
1,000.00 1,375.00 1,305.00 1,150.00
Income before income tax
250.00 -1,475.00 595.00
775.00
Current income tax expense 118.00
0.00
22.89
266.67
Deferred income tax expense -18.00 -580.00 245.11
63.33
Net income
150.00 -895.00 327.00
445.00
8
Stumble & Fall, Inc.
Balance Sheet (for Part 1)
as of Dec. 31, 20x4
12/31/x4
Cash
Receivable from IRS
Accounts receivable
Allow for uncollectible
Inventory
Reserve for obsolescence
DTA current
DTA loss carryforward
Current assets
4,145
0
0
0
0
0
0
0
4,145
12/31/x3
12/31/x2
12/31/x1
1,960
2,208
450
290
0
0
400
325
500
< 130>
< 105>
< 100>
820
910
1,000
< 95>
< 85>
< 75>
230
76
70
33
0
0
3,508
3,329
1,845
Accounts payable
CUR Bonus pay - 12/31/x4
Income tax payable
Current liabilities
DTL non current
NC Bonus pay - 12/31/x4
Non current liabilities
Machine
4,000
4,000
4,000
4,000
Accumulated dep
< 4,000> < 3,000> < 2,000> < 1,000>
Property plant & equipment
0
1,000
2,000
3,000
Common stock
Retained earnings
Stockholders' equity
Total assets
Liabilities and equity
4,145
4,508
5,329
4,845
12/31/x4
12/31/x3
12/31/x2
12/31/x1
0
0
118
118
0
350
0
350
0
0
23
23
0
0
267
267
0
0
0
281
0
281
384
150
534
133
0
133
4,000
27
4,027
4,000
< 123>
3,877
4,000
772
4,772
4,000
445
4,445
4,145
4,508
5,329
4,845
9
worksheet for schedule M-3
20x4
Gross revenues
Cost of goods sold
Total income (loss) items
U.S. current income tax expense
U.S. deferred income tax expense
Fines and penalties
Deferred compensation
Depreciation
Bad debt exense
Total expense/deduction items
Net income to taxable income
Income(Loss) per
Temporary
Permanent
Income Statement
Difference
Difference
7,250.00
-6,000.00
1,250.00
-118.00
18.00
0.00
0.00
-1,000.00
0.00
-1,100.00
150.00
-95.00
-95.00
0.00
118.00
Income(Loss) per
Tax Return
7,250.00
-6,095.00
1,155.00
-18.00
-350.00
703.70
-130.00
205.70
110.70
0.00
118.00
118.00
0.00
-350.00
-296.30
-130.00
-776.30
378.70
Income(Loss) per
Temporary
Permanent
Income(Loss) per
Income Statement
Difference
Difference
Tax Return
20x3
Gross revenues
Cost of goods sold
Total income (loss) items
U.S. current income tax expense
U.S. deferred income tax expense
Fines and penalties
Deferred compensation
Depreciation
Bad debt exense
Total expense/deduction items
Net income to taxable income
6,000.00
-6,100.00
-100.00
0.00
580.00
-25.00
-200.00
-1,000.00
-150.00
-795.00
-895.00
10.00
10.00
0.00
0.00
6,000.00
-6,090.00
-90.00
-580.00
200.00
407.41
25.00
52.41
62.41
25.00
25.00
25.00
0.00
0.00
-592.59
-125.00
-717.59
-807.59
Income(Loss) per
Temporary
Permanent
Income(Loss) per
Income Statement
Difference
Difference
Tax Return
20x2
Gross revenues
Cost of goods sold
Total income (loss) items
U.S. current income tax expense
U.S. deferred income tax expense
Fines and penalties
Deferred compensation
Depreciation
Bad debt exense
Total expense/deduction items
Net income to taxable income
8,000.00
-6,100.00
1,900.00
-22.89
-245.11
-75.00
-150.00
-1,000.00
-80.00
-1,573.00
327.00
10.00
10.00
0.00
22.89
8,000.00
-6,090.00
1,910.00
245.11
150.00
-777.78
5.00
-377.67
-367.67
75.00
97.89
97.89
0.00
0.00
-1,777.78
-75.00
-1,852.78
57.22
Income(Loss) per
Temporary
Permanent
Income(Loss) per
Income Statement
Difference
Difference
Tax Return
20x1
Gross revenues
8,000.00
8,000.00
10
Provision for Income Tax Expense ASC 740
Teaching Notes and Solutions
The teaching notes are in two sections: the first discusses implementation, while the
second provides the numerical solutions. The amount of time necessary to complete this
exercise will depend on the level of your students and the desired outcomes. This is a difficult
time-consuming project that involves increasingly complex issues designed to require two or
three weeks to complete. You may wish to simply assign the first part, two, three or all four
parts. In its entirety the project requires students to synthesize concepts from both accounting
and tax courses. While the calculation of DTA, DTL and deferred income tax expense is
difficult, preparation of the required disclosures requires a higher level of understanding and
analysis than the preparation of journal entries or financial statements.
Having students work in groups permits the use of multiple sources: ASC 740, SFAS 109,
and a textbook. This will familiarize students with professional accounting literature and
provide different perspectives with which to approach the exercise.
The first two assignments in Part 1 cover the basic concepts of DTAs, DTLs and
income tax expense. As of 12/31/20x2, the bonus payable is a noncurrent liability because it
is not payable until 12/31/20x4. This creates a noncurrent DTA which must be offset against
the noncurrent DTL relating to the machine. The third and fourth assignments introduce a tax
loss carryback and a carry forward.
Part 1 also requires students to prepare the reconciliation required by ASC 740-10-5012. In addition to material traditionally covered in intermediate accounting, Part 1 requires
students to complete the IRS schedule M-3 reconciliation. A worksheet is provided to guide
students through the reconciliation.
In Part 1, income tax expense can be calculated simply by applying the tax rate to
income before income tax expense after adding back the non-deductible penalties. For the
four-year period, taxable income is $150 larger than income before income tax expense, due
to the non-deductible penalties. These penalties are the only item in the ASC 740-50-10-12
reconciliation. Total income tax expense over the four-year period equals the total of the
amount paid and payable to the IRS as of 12/31/20x4. This allows students to see that the
provision for income tax expense merely attempts to allocate the income tax paid over the
period. This can foster a discussion about ASC 740’s rather atypical implementation of the
matching principle. Rather than apply the current tax rate to income before tax expense,
ASC 740 backs into income tax expense by estimating future income tax payments and
benefits attributable to the events recognized in the current financial statements or tax
returns. ASC 740 states the objectives as follows:
740-10-10-1 There are two primary objectives related to accounting for income
taxes:
a. To recognize the amount of taxes payable or refundable for the current year
b. To recognize deferred tax liabilities and assets for the future tax
consequences of events that have been recognized in an entity's financial
statements or tax returns.
11
As it relates to the second objective, some events do not have tax consequences.
Certain revenues are exempt from taxation and certain expenses are not
deductible. In some tax jurisdictions, for example, interest earned on certain
municipal obligations is not taxable and fines are not deductible.
740-10-10-2 Ideally, the second objective might be stated more specifically to
recognize the expected future tax consequences of events that have been
recognized in the financial statements or tax returns. However, that objective is
realistically constrained because:
a. The tax payment or refund that results from a particular tax return is a joint
result of all the items included in that return.
b. Taxes that will be paid or refunded in future years are the joint result of
events of the current or prior years and events of future years.
c. Information available about the future is limited. As a result, attribution of
taxes to individual items and events is arbitrary and, except in the simplest
situations, requires estimates and approximations.
Preparing the Journal Entries
ASC 740-10-25-20 states “An assumptions inherent in an entity’s statement of
financial position prepared in accordance with generally accepted accounting principles
(GAAP) is that the reported amounts of assets and liabilities will be recovered and settled,
respectively. Based on that assumption, a difference between the tax basis of an asset or
liability and its reported amount in the statement of financial position will result in taxable or
deductible amounts in some future year(s) when the reported amounts of assets are
recovered and the reported amounts of liabilities are settled.”
Some students may calculate income tax expense correctly without calculating the
DTAs and DTL. However, in order to prepare the journal entry, they must allocate the
deferred portion of income tax expense between a DTA and a DTL. This requires them to
compare the recorded carrying value of accounts receivable, inventory, machinery and bonus
payable with the corresponding tax bases. It also requires students to determine whether the
subsequent reversal of these differences will create future deductible amounts or future
taxable amounts. The difference between the reported carrying value and tax bases for
accounts receivable, inventory and bonus payable result in future deductible amounts which
are recorded as DTAs. The difference between the carrying value and tax basis of the
machine results in a future taxable amount which is recorded as a DTL. Refer to ASC 74010-05-7/8 and 740-10-25-10 for additional guidance.
Financial Statement Presentation
The journal entries for the tax provision allow students to update the trial balance and
prepare financial statements. However the balances on the trial balances are not simply
transferred to the balance sheet. ASC 740-10-45-7 requires “a deferred tax liability or asset
for a temporary difference that is related to an asset or liability shall be classified as current or
noncurrent based on the classification of the related asset or liability.” Therefore the DTAs
relating to accounts receivable and inventory are classified as current. The DTA relating to
12
the bonus payable is noncurrent as of 12/31/20x3 and current as of 12/31/20x4. The DTL
relating to the machine is classified as noncurrent.
ASC 740 also requires entities to offset current DTAs and DTLs and also offset
noncurrent DTAs and DTLs. “All current deferred tax liabilities and assets shall be offset and
presented as a single amount and all noncurrent deferred tax liabilities and assets shall be
offset and presented as a single amount” if they are within a single tax jurisdiction (refer to
ASC 740-10-45-6). Be sure to point out that entities are not permitted to offset deferred
tax liabilities and assets from different tax jurisdictions.
We suggest you allocate a similar amount of time to Part 1 as you would allocate for
the income tax expense chapter in an intermediate text.
Part 1 Solutions
Journal entries for Part 1
Current income tax expense and deferred income tax expense comprise the income
statement accounts in this entry. Current income tax expense is calculated from the changes
in the related payable and receivable accounts, while deferred income tax expense is
calculated from the change in the DTA and DTL balance sheet accounts.
598 Current income tax expense
241 Income tax payable
110 Receivable from IRS
140 DTA current
170 DTA loss carryforward
171 DTA non current
252 DTL non current
599 Deferred income tax expense
20x1
20x2
20x3
20x4
266.67
<266.67>
0.00
70.00
0.00
0.00
<133.33>
63.33
22.89
<22.89>
0.00
6.00
0.00
60.00
<311.11>
245.11
0.00
0.00
289.56
154.00
33.48
<60.00>
162.96
<580.00>
118.00
<118.00>
0.00
<230.00>
<33.48>
0.00
281.48
<18.00>
Reconciliation required by ASC 741-10-50-12
“A public entity shall disclose a reconciliation using percentages or dollar amounts of the
reported amount of income tax expense attributable to continuing operations for the year to
the amount of income tax expense that would result from applying domestic federal statutory
tax rates to pretax income from continuing operations.”
13
ASC 740-10-50-12 Reconciliation for Part 1
20x1
20x2
20x3
20x4
reconciliation by dollar amount
@0.4
Pretax Book Income
<775.00>
Non deductible penalties
<50.00>
Current income tax expense
310.00
20.00
330.00
@0.4
<595.00>
<75.00>
238.00
30.00
268.00
@0.4
1,475.00
<25.00>
<590.00>
10.00
<580.00>
@0.4
<250.00>
0.00
100.00
0.00
100.00
Or, reconciliation by percentages
Pretax Book Income
Non deductible penalties
Current income tax expense
40.0%
2.6%
42.6%
40.0%
5.0%
45.0%
40.0%
-0.7%
39.3%
40.0%
0.0%
40.0%
14
Year 1
Book
401 Sales
Year 3
Book
Year 4
Taxes
Book
Taxes
<8,000.00> <8,000.00> <8,000.00> <8,000.00> <6,000.00> <6,000.00> <7,250.00> <7,250.00>
501 Cost of goods sold
6,000.00
502 Inventory reserve expense
75.00
511 Bad debt expense
100.00
521 Deferred bonus expense
0.00
531 Depreciation expense
1,000.00
541 Other expense
0.00
551 Non deductible penalties
50.00
Pretax Book Income
<775.00>
Loss CarryForward (gross)
598 Current income tax expense 266.67
599 Deferred income tax expense 63.33
Loss CarryBack / Fwd (net)
Loss CarryForward (gross)
Net Income
<445.00>
301 Common stock
311 Retained earnings
Financial Statements for Part 1
Year 2
Taxes
Book
Taxes
6,000.00
0.00
0.00
0.00
1,333.33
0.00
0.00
<666.67>
6,000.00
100.00
80.00
150.00
1,000.00
0.00
75.00
<595.00>
266.67
22.89
245.11
6,000.00
90.00
75.00
0.00
1,777.78
0.00
0.00
<57.22>
22.89
6,000.00
100.00
150.00
200.00
1,000.00
0.00
25.00
1,475.00
0.00
<580.00>
6,000.00
90.00
125.00
0.00
592.59
0.00
0.00
807.59
6,000.00
0.00
0.00
0.00
1,000.00
0.00
0.00
<250.00>
0.00
118.00
<18.00>
6,000.00
95.00
130.00
350.00
296.30
0.00
0.00
<378.70>
83.70
118.00
<289.56>
83.70
<327.00>
895.00
<150.00>
<4,000.00> <4,000.00> <4,000.00> <4,000.00> <4,000.00> <4,000.00> <4,000.00> <4,000.00>
<445.00> <400.00>
<772.00> <434.33>
123.00
83.70
<27.00> <177.00>
101 Cash
110 Receivable from IRS
111 Accounts receivable
112 Allow for uncollectible
121 Inventory
129 Reserve for obsolescence
140 DTA current
151 Machine
171 DTA non current
Total Assets
450.00
0.00
500.00
<100.00>
1,000.00
<75.00>
70.00
4,000.00
0.00
4,845.00
450.00
0.00
500.00
0.00
1,000.00
0.00
0.00
4,000.00
0.00
4,616.67
2,208.33
0.00
325.00
<105.00>
910.00
<85.00>
76.00
4,000.00
60.00
5,389.33
201 Accounts payable
221 CUR Bonus pay - 12/31/x4
241 Income tax payable
251 DTL current
252 DTL non current
260 NC Bonus pay - 12/31/x4
Total Liabilities
0.00
0.00
<266.67>
0.00
<133.33>
0.00
<400.00>
0.00
0.00
<266.67>
0.00
0.00
0.00
<266.67>
0.00
0.00
<22.89>
0.00
<444.44>
<150.00>
<617.33>
2,208.33
0.00
325.00
0.00
910.00
0.00
0.00
4,000.00
0.00
4,332.22
0.00
0.00
<22.89>
0.00
0.00
0.00
<22.89>
1,960.44
289.56
400.00
<130.00>
820.00
<95.00>
230.00
4,000.00
0.00
4,508.48
1,960.44
289.56
400.00
0.00
820.00
0.00
0.00
4,000.00
0.00
3,766.30
0.00
<350.00>
0.00
0.00
<281.48>
0.00
<631.48>
0.00
0.00
0.00
0.00
0.00
0.00
0.00
4,145.00
0.00
0.00
0.00
0.00
0.00
0.00
4,000.00
0.00
4,145.00
4,145.00
0.00
0.00
0.00
0.00
0.00
0.00
4,000.00
0.00
4,145.00
0.00
0.00
<118.00>
0.00
0.00
0.00
<118.00>
0.00
0.00
<118.00>
0.00
0.00
0.00
<118.00>
301 Common stock
<4,000.00> <4,000.00> <4,000.00> <4,000.00> <4,000.00> <4,000.00> <4,000.00> <4,000.00>
311 Retained earnings
<445.00> <400.00>
<772.00> <434.33>
123.00
83.70
<27.00> <177.00>
312 Non Deduct Cash expenditures
50.00
125.00
150.00
150.00
Total Equity
<4,445.00> <4,350.00> <4,772.00> <4,309.33> <3,877.00> <3,766.30> <4,027.00> <4,027.00>
Liabilities & Equity
<4,845.00> <4,616.67> <5,389.33> <4,332.22> <4,508.48> <3,766.30> <4,145.00> <4,145.00>
15
Sample Disclosures modified from an SEC filing
Income taxes: FASB Accounting Standard Codification (ASC) 740 which is titled Income Taxes describes the
manner in which income taxes are to be provided for in Stumble and Fall’s (the Company or S&F) financial
statements. We are required to recognize (i) the amount of taxes payable or refundable for the current period
and (ii) deferred tax assets and liabilities for the future tax consequences of events that have been reported in
S&F's financial statements or tax returns. With respect to uncertain positions that may be taken on a tax return,
we recognize related tax benefits only if it is more likely than not that the position will be sustained under
examination based on the technical merits of the position. The determination of income tax balances for
financial statement purposes requires significant judgment, and actual outcomes may vary from the amounts
recorded.
Income Taxes and Deferred Taxes
ASC 740 (Income Taxes) requires recognition of "deferred" tax assets and liabilities for the expected future tax
consequences of events that have been included in the financial statements or tax returns, but not in both.
Deferred tax assets are also established for tax benefits associated with tax loss and tax credit carryforwards.
Such deferred balances reflect tax rates that are scheduled to be in effect, based on currently enacted
legislation, in the years the book/tax differences reverse and tax loss and tax credit carryforwards are expected
to be realized. An allowance is established for any deferred tax asset for which realization is not likely.
ASC 740 also prescribes the manner in which a company measures, recognizes, presents, and discloses in its
financial statements uncertain tax positions that the company has taken or expects to take on a tax return. The
Company recognizes tax benefits from uncertain tax positions only if it is more likely than not that the position
will be sustained following examination by taxing authorities, based on technical merits of the position. The
Company believes that it has no material uncertain tax positions.
Any interest or penalties incurred are reported as interest expense. The Company’s income tax filings are
subject to audit by various tax jurisdictions, and the current open year is fiscal 20x4.
NOTE xx INCOME TAXES
Provisions for income taxes for the years ended December 31, 20x4, 20x3, 20x2 and 20x1 are summarized
below:
Years Ended
Income Tax Provision
Current federal tax expense (benefit)
Deferred federal tax expense (benefit)
Provision for income taxes
Dec. 31, 20x4 Dec. 31, 20x3 Dec. 31, 20x2 Dec. 31, 20x1
118.00
( 289.56)
( 18.00)
( 290.44)
$ 100.00 $ ( 580.00)
22.89
245.11
$ 268.00
266.67
63.33
$ 330.00
Differences between the federal statutory rate and S&F’s effective rates of tax for 20x4, 20x3, 20x2 are
explained by the following reconciliation.
Years Ended
Taxes as Percent of Pretax Income
Dec. 31, 20x4 Dec. 31, 20x3 Dec. 31, 20x2 Dec. 31, 20x1
Federal statutory rate
40.0%
40.0%
40.0%
40.0%
Non deductible penalties
Income tax provision as percent of pretax income
2.6%
42.6%
5.0%
45.0%
-0.7%
39.3%
0.0%
40.0%
16
The following table displays deferred tax assets/liability by category as of December 31, 20x4, 20x3, 20x2 and
20x1. Recorded amounts include the establishment of deferred taxes for acquired companies.
December 31,
20x4
20x3
20x3
20x1
Current deferred tax assets:
Accounts receivable, allowance
Inventory obsolesence
Bonus payable -12/31/x4
Net operating loss carryforward
Total before allowance
Valuation allowance
Current deferred tax assets, net
0.00
0.00
0.00
0.00
0.00
0.00
0.00
52.00
38.00
140.00
33.48
263.48
0.00
263.48
42.00
34.00
0.00
0.00
76.00
0.00
76.00
40.00
30.00
0.00
0.00
70.00
0.00
70.00
Noncurrent deferred tax ( liabilities )
Depreciation of fixed assets
Bonus payable -12/31/x4
Noncurrent deferred liabilities, net
0.00
0.00
0.00
( 281.48)
0.00
( 281.48)
( 444.44)
60.00
( 384.44)
( 133.33)
0.00
( 133.33)
$ 0.00
$ ( 18.00)
$ ( 308.44)
$ ( 63.33)
Net deferred income taxes
S&F has federal and state net operating loss carryforwards (“NOLs”) for income tax purposes of approximately
$33.48 as of December 31, 20x3, expiring in 2x17. S&F expects to realize the benefits from these NOLs.
17