16
Accounting for Income Taxes
PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
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.
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Temporary Differences
The difference in the rules for computing
between pre-tax accounting income
(according to GAAP) and taxable income
(according to the IRS) often causes
amounts to be reported in different years.
This results in
temporary
differences.
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Temporary Differences
Temporary differences will reverse
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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Deferred Tax Liabilities
A temporary difference originates in one period and reverses,
or turns around, in one or more subsequent periods.
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Deferred Tax Liabilities
Calculate income tax that is currently payable: $100 × 40% = $40
Calculate change in deferred tax liability: ($40 × 40%) = $16
Combine the two to get the income tax expense: $40 + $16 = $56
Income tax expense
Income tax payable
Deferred tax liability
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56
40
16
The FASB’s Balance Sheet Approach
16 - 7
Types of Temporary Differences
Deferred tax assets
result in deductible
amounts in the future.
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Deferred tax liabilities
result in taxable amounts
in the future.
Deferred Tax Liabilities
A temporary difference originates in one period and reverses,
or turns around, in one or more subsequent periods.
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Deferred Tax Liabilities
Calculate income tax that is currently payable: $92 × 40% = $36.8
Calculate change in deferred tax liability: ($25 - $33) × 40% = $3.2
Combine the two to get the income tax expense: $36.8 + $3.2 = $40
Journal entry at the end of 2011
Income tax expense
Income tax payable
Deferred tax liability
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40.0
36.8
3.2
Deferred Tax Liabilities
Calculate income tax that is currently payable: $81 × 40% = $32.4
Calculate change in deferred tax liability: (($25 - $44) × 40%)) = $7.6
Combine the two to get the income tax expense: $32.4 + $7.6 = $40
Journal entry at the end of 2012
Income tax expense
Income tax payable
Deferred tax liability
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40.0
32.4
7.6
Deferred Tax Liabilities
Calculate income tax that is currently payable: $110 × 40% = $44
Calculate change in deferred tax liability: (($25 - $15) × 40%)) = $4
Combine the two to get the income tax expense: $44 – 4 = $40
Journal entry at the end of 2013
Income tax expense
Deferred tax liability
Income tax payable
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40
4
44
Deferred Tax Liabilities
Journal entry at the end of 2014
Income tax expense
Deferred tax liability
Income tax payable
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40.0
6.8
46.8
Deferred Tax Assets
RDP Networking reported pretax accounting income in 2011, 2012, and 2013 of
$70 million, $100 million, and $100 million, respectively. The 2011 income
statement includes a $30 million warranty expense that is deducted for tax
purposes when paid in 2012 ($15 million) and 2013 ($15 million). The income
tax rate is 40% each year.
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Deferred Tax Assets
Calculate income tax that is currently payable: $100 × 40% = $40
Calculate change in deferred tax asset: $30 × 40% = $12
Combine the two to get the income tax expense: $40 – 12 = $28
Journal entry at the end of 2011
Income tax expense
Deferred tax asset
Income tax payable
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28
12
40
Deferred Tax Assets
Journal entry at the end of 2012 and 2013
Income tax expense
Deferred tax asset
Income tax payable
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40
6
34
Valuation Allowance
• A valuation allowance
account is needed if 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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Permanent 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.
Permanent differences are disregarded when
determining both the tax payable currently and the
deferred tax asset or liability.
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U.S. GAAP vs. IFRS
Despite the similar approaches for accounting for income
taxes under IFRS and U.S. GAAP, differences in reported
amounts for deferred taxes are among the most frequent
between the two reporting approaches.
• For example, U.S. GAAP
requires a loss contingency be
accrued if it is both probable
and can be reasonably
estimated. Accruing a loss
contingency leads to a
deferred tax asset.
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• For loss contingencies, IFRS
uses a “more likely than not”
threshold, which is lower than
the U.S. “probable”
requirement. As a result,
under the lower threshold of
IFRS, a loss contingency and
a deferred tax asset
sometimes is recorded for
IFRS but not for U.S. GAAP.
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.
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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
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.
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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Operating Loss Carryforward
Deferred tax asset
Income tax benefit-operating loss
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50
50
Operating Loss Carryback
The carryback of the NOL must be applied to
the earlier year first and then to the next year.
Any remaining NOL may be carried forward.
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Operating Loss Carryback
Receivable—income tax refund
Deferred tax asset
Income tax benefit-operating loss
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29
20
49
Balance Sheet Classification
Deferred tax assets/liabilities are classified as
current or noncurrent based on the
classification of the related asset or liability.
A deferred tax asset that
is not related to a
specific asset or
liability should be
classified according to
when the underlying
temporary difference
is expected to reverse.
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Deferred Tax AssetsDisclosure
and
Notes
Deferred Tax Liabilities
• Total of all deferred tax liabilities.
• Total of all deferred tax assets.
• Total valuation allowance
recognized.
• Net change in valuation account. Income Tax Expense
• Current portion of the
• Approximate tax effect of each
tax expense (or benefit).
type of temporary difference
• Deferred portion of the
(and carryforward).
tax expense (or benefit)
with separate
disclosures of amounts
Operating Loss Carryforwards
attributable to several
• Amounts.
specific items.
• Expiration dates.
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Coping with Uncertainty in Income
Taxes
Two-step Decision Process
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.
If the tax benefit is not “more likely
than not,” then none of the tax
benefit is allowed to be recorded.
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Intraperiod Tax Allocation
Income Statement:
• Income from continuing operations.
• Discontinued operations.
• Extraordinary items.
Other Comprehensive Income:
• Investments.
• Postretirement benefit plans.
• Derivatives.
• Foreign currency translation.
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U.S. GAAP vs. IFRS
The approach for accounting for intraperiod tax allocation is
the same under IFRS and U.S. GAAP, but the categories used
on the income statement are different.
• GAAP separately reports both
discontinued operations and
extraordinary items on the
income statement and each
are shown net of tax.
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• IFRS does not separately
report extraordinary items on
the income statement. As a
result, the only income
statement item reported
separately net of tax using
IFRS is discontinued
operations.
End of Chapter 16