Intermediate
Financial Accounting
Accounting for Income
Taxes
by Professor Hsieh
Objectives of the Chapter



To learn the permanent difference
between the financial income and
taxable income.
To learn the temporary difference
between the financial income and
taxable income.
To learn the accounting treatment for
the temporary difference and
permanent difference.
Accounting for Income Taxes
2
Permanent Difference versus
Temporary Difference
Permanent Difference:
A difference between financial income
and taxable income in an accounting
period that will never be reversed in
later accounting periods.
This difference does not require an
interperiod tax allocation.
Accounting for Income Taxes
3
Permanent Difference versus
Temporary Difference (contd.)
Examples of Permanent Difference
1. Revenue recognized for F/R (financial
report) but not taxable.
a. Interest on municipal bonds.
b. Life insurance proceeds payable to a
corporation upon the death of an
insured employee
Accounting for Income Taxes
4
Permanent Difference versus
Temporary Difference (contd.)
Examples (contd.)
2. Expense recognized for F/R but not tax
deductible:
Life insurance premium paid for
employees.
3. Expense is tax deductible but not
recognized for F/R purpose:
Percentage depletion in excess of Cost
Depletion.
Accounting for Income Taxes
5
Permanent Difference versus
Temporary Difference (contd.)
Temporary Difference:
A difference between a taxable income and a
financial income in an accounting period that
will be reversed in later accounting periods.
This difference requires an intertperiod tax
allocation.
Causes of Temporary Difference:
Different treatment between GAAP and IRC
Accounting for Income Taxes
6
Difference between IRC and GAAP
Depreciation
GAAP: any systematic depr. method
IRC : ACRS or MACRS

Installment Sales (future taxable)
GAAP: on accrual basis
IRC : on cash basis

Accounting for Income Taxes
7
Difference between IRC and GAAP
(contd.)
Warranty Expense (future deductible)
GAAP: accrual basis (estimated and
recognized at the end of each period)
IRC : cash basis (tax deductible when paid)
Bad Debt Expense (future deductible)
GAAP: estimated and recognized at the end
of each period.
IRC : tax deductible when accounts
defaulted.

Accounting for Income Taxes
8
Temporary Difference: an example
Depreciation method:
For tax filing purpose: ACRS, 4-year life
For financial reporting purpose: straightline method, 5-year life
The asset was purchased on 1/1/x1 with a
cost of $10,000 and a zero residual value.
Accounting for Income Taxes
9
Temporary Difference: an example
(contd.)
Financial depr. expense vs. tax depr.:
Year
20x1
S-L method Tax
Depr. exp. Depr.exp.
$2,000
$2,500a
20x2
$2,000
$3,750b
20x3
$2,000
$1,875c
20x4
$2,000
$1,250d
20x5
$2,000
$ 625
Accounting for Income Taxes
10
Temporary Difference: an example
(contd.)
a. $10,000*50% *0.5 = 2,500
b. $7,500*50% = 3,750
c. $3,750*50% = 1,875
d. $1,875*50% = 937.5 < (1,875/1.5 =1,250)
Accounting for Income Taxes
11
Temporary Difference: an example
(contd.)
Assuming a 30% tax rate, the following table
presents the annual temporary difference and the
deferred tax liability:
Annual
temp. diff.
Cum.
Ending Beg.
Change
Temp.diff deferre Deferred in defer.
d T/L
T/L
Liam.
500
500
150
0
150
1,750
2,250
675
150
525
(125)
2,125
637.5 675
(37.5)
(750)
1,375
412.5 637.5
(225)
0
Accounting for Income Taxes
0
(412.5)
(1,375)
412.5
12
Temporary Difference: an example
(contd.)
T-account of the deferred tax liability
Deferred Tax Liability
20x3….. 37.5
150……..20x1
20x4…. 225
525……..20x2
20x5…. 412.5
0…..20x5
Accounting for Income Taxes
13
Interperiod Income Tax Allocation
Example A: the following information is
available for the year ended 12/31/x1:
Accounting income = $10,400
Taxable income
= $ 9,000 (AI > TI)
Tax Rate
= 30%
The difference of $1,400 is resulting from
using ACRS for I/T filing while using S-L for
F/R purposes. This difference will be
reversed as follows:
Accounting for Income Taxes
14
Interperiod Income Tax Allocation
Reversed Amount (F/R depr.>Tax Depr.)
20x1
20x2
20x3
Total
$500
700
200
1,400
Tax payable for 20x1
=>
9,000 *30% =$2,700
Accounting for Income Taxes
15
Interperiod Income Tax Allocation
(contd.)
Alternative Accounting Treatments
I. No Allocation of Deferred I/T Liam.
Income Tax Exp.
Income Tax Payable
2,700
2,700
II. With Allocation (comply with the matching
principle) – Deferred Approach(APB No. 11)
Income Tax Expense 3,120
Income Tax Payable
2,700
Deferred Income Tax Liam.
Accounting for Income Taxes
420*
16
Interperiod Income Tax Allocation
(contd.)
Alternative Accounting Treatments (contd.)
III.With Allocation- Liability Approach
(SFAS 109)
Income Tax Expense 3,120
Income Tax Payable
2,700
Deferred Income Tax Liam. 420**
Accounting for Income Taxes
17
Interperiod Income Tax Allocation
(contd.)
* Deferred tax lia. is calculated as income
tax exp. minus income tax payable.
**Deferred tax lia.is calculated based on the
reversed amount in the future times the
future tax rate. If the future tax rate
remains at 30%, the deferred tax lib. Is
$420. Otherwise, the deferred tax lib. will
not be $420 (see the example next).
Accounting for Income Taxes
18
Interperiod Income Tax Allocation
(contd.)—Example B
Example B:
The taxable income of 20x1
= $9,000
The accounting income of 20x1 =$10,400
Partial Income statement:
Pretax financial income
Less: additional accelerated
depr. Deducted for I/T
Taxable Income
Accounting for Income Taxes
$10,400
(1,400)
$9,000
19
Interperiod Income Tax Allocation
(contd.)—Example B (contd.)
At the beg. of 20x1, the deferred I/T
has a balance of $0 (due to 20x1 is
the first year of occurrence of
difference in depr.) and the current
tax rate is 30%.
There is no expectation of tax rate
changes in the future.
Accounting for Income Taxes
20
Interperiod Income Tax Allocation
(contd.)—Example B (contd.)
The financial depr. exp. will exceed the
taxable depr. by the following amount in the
next three years:
Year
Acc.Depr.a
20x2
20x3
20x4
$1,000
1,000
1,000
Tax depr.b
$500
300
800
Diff.
$500
700
200
a&b: assumed numbers.
Accounting for Income Taxes
21
Interperiod Income Tax Allocation
(contd.)—Example B (contd.)
The following table shows the annual
temporary difference, accumulative
temporary diff. and deferred liability (tax
rate = 30%):
Year
Temp. Diff
Accu.
Temp. Diff
End.
Defer.
I/T lia.
$420
Beg.
Change
Defer. I/T in def.
lia.
I/T lia.
$0
420
20x1
$1,400
$1,400
20x2
20x3
(500)
(700)
900
200
270
60
420
270
(150)
(210)
20x4
(200)
0
0
60
(60)
Accounting for Income Taxes
22
Interperiod Income Tax Allocation
(contd.)—Example B (contd.)
T-account of Deferred income tax lia.
Deferred I/T Liam.
20x2…..150
20x3…..210
20x4….. 60
420…….20x1
0 (bal)20x4
Accounting for Income Taxes
23
Interperiod Income Tax Allocation
(contd.)—Example B (contd.)
J.E. (for 20x1) (based on APB No.11; the
deferred approach)
Income Tax Expense
3,120a
Income Tax Payable
2,700 b
Deferred Income Tax Liam.
?
c
a: $10,400 (accounting income)*30%
b. $9,000 (taxable income)*30%
c. ?= 3,120-2,700
Accounting for Income Taxes
24
Interperiod Income Tax Allocation
(contd.)—Example B (contd.)
J.E. (for 20x1) (based on SFAS 109; the
liability approach)
Income Tax Expense
?a
Income Tax Payable
2,700 b
Deferred Income Tax Liam.
420c
a. ? = b+c = 2,700+420 = 3,120
b.$9,000 (taxable income)*30%
c.$420 = $500*30% +700*30% +200*30%
revered
lia. Of 20x2
revered
lia. Of 20x3
revered
lia. Of 20x4
Accounting for Income Taxes
25
Interperiod Income Tax Allocation
(contd.)—Example B (contd.)
Note c is also presented in the following table:
20x2
20x3
20x3
Total
Futurea
taxable
amount
$500
$700
$200
$1,400
I/T Rate
30%b
30%
30%
Defer.
Liam.
reversed
$150
$210
$60
$420
a. Due to future taxable income > future acc. Income. It is a
result of future tax depr. < future acc. Depr.
b. Future expected tax rate should be used. Example B
assumed all future tax ratesAccounting
remainfor at
30%.
Income Taxes
26
Interperiod Income Tax Allocation
(contd.)—Example B (contd.)
Assuming taxable income of 20x2,20x3 and 20x4
are $7,000, $6,000 and $8,000, respectively,
journal entries of income tax for those year are as
follows (all future tax rate remains at 30%) (follow
SAFS 109):
20x2
Deferred I/T Liam.
150 a
I/T Expense
?b
I/T Payable
2,100c
a. See the previous table for year 20x2
b. income tax expense = $2,100 –150
c. taxable income 7,000*30%
Accounting for Income Taxes
27
Interperiod Income Tax Allocation
(contd.)—Example B (contd.)
20x3 Deferred I/T Liam.
I/T Expense
I/T Payable
20x4 Deferred I/T Liam.
I/T Expense
I/T Payable
210 a
?b
1,800c
60 d
?e
2,400f
a. See the previous table for year 20x3
b. income tax expense = $1,800 –210
c. taxable income 6,000*30%
d. See the previous table for year 20x4
e. income tax expense = $2,400 –60
f. taxable income 8,000*30%
Accounting for Income Taxes
28
Interperiod tax Allocation with
Different Expected Tax Rate
Using the same information as in Example B
except the tax rates are expected to change
in the future as follows:
20x1 = 30% (the current year)
20x2 = 40%
20x3 = 40%
20x4 = 40%
The ending bal. of the deferred I/T lia. for year
20x1 would be $$560 instead of $420 as in
Example B when future rate states at 30%.
Accounting for Income Taxes
29
Interperiod tax Allocation with
Different Expected Tax Rate (cont.)
The computation of the ending balance of
deferred I/T lia. For 20x1 is as follows:
I/T rate
20x2 20x 3 20x4
$500 $700 $200
40% 40% 40%
Total
$1,400
40%
Reversed tax lia.
$200 $280
$560
Taxable amount
$80
Accounting for Income Taxes
30
Interperiod tax Allocation with
Different Expected Tax Rate (cont.)
Journal Entry for 20x1 is as follows based on
a 40% expected tax rate for 20x2 to 20x4:
Income Tax Expense
?a
Income Tax Payable
2,700 b
Deferred Income Tax Liam. 560c
a. ? = b+c = 2,700+560 = 3,260
b.$9,000 (taxable income)*30%
c.$560 = $500*40% +700*40% +200*40% or as shown in the
previous table
Accounting for Income Taxes
31
Interperiod tax Allocation with
Different Expected Tax Rate (cont.)
What if at the end of 20x2, the tax rate has
been increased to 45% (instead of 40% as
expected at the end of 20x1), the deferred
liability at the end of 20x1 should have been
$625a rather than $560 as using the 40%
expected rate.
The following adjusting entry should be
prepared on 12/31/20x2:
a. $500*45%+700*45%+200*45% = $625
Accounting for Income Taxes
32
Interperiod tax Allocation with
Different Expected Tax Rate (cont.)
12/31/20x2
Loss on Adjustment
of Deferred Taxes
65 a
Deferred I/T Liam.
65
a. $625-560 = $65
Accounting for Income Taxes
33
Interperiod tax Allocation – Example
C
The following is a reconciliation of a pretax
financial income with a taxable income for
20x3:
Financial Income
Add: estimated warranty exp. deducted
$3,000
for financial reporting in excess of actual
warranty exp. deducted for I/T (a future deductible) 100
Less:Additional accelerated depr.
deducted for I/T (a future taxable)
(150)
Taxable Income
$2,950
Accounting for Income Taxes
34
Interperiod tax Allocation – Example
C (contd.)
No expectation of tax changes in the future
and the current tax rate is 30%. The
beginning balance of deferred income tax lia.
account is $495 due to the first year of depr.
exp. difference occurred in 20x1.
Accounting for Income Taxes
35
Interperiod tax Allocation – Example
C (contd.)
Additional information regarding depr. exp. Lib. as
follows:
year
Difference of tax depr.
And financial depr.
20x1
$800 (tax dep>fin. Dep)
20x2
860 (tax dep>fin. Dep)
20x3a
150 (tax dep>fin. Dep)
20x4
(300) (fin.dep > tax dep)
20x5
(300) (fin.dep > tax dep)
20x6
(1,200) (fin.dep >taxdep)
Total
0
a. 20x3 is the current year.
Accounting for Income Taxes
36
Interperiod tax Allocation – Example
C (contd.)
The followings are projections regarding the
temporary differences for years 20x4 to 20x6(future
years):

year
Diff. In warranty
amounta
Diff. In depr.
amountb
20x4
20x5
20x6
Total
$50
30
20
$100
$ 300
300
1,200
$1,800
a. Tax warranty cost in excess of financial warranty
b. Financial depr. exp. In excess of tax depr. exp.
Accounting for Income Taxes
cost
37
Interperiod tax Allocation – Example
C (contd.)
J.E. for the current year 20x3 (SFAS 109):
I/T Exp.
?a
Deferred I/T assets
30b
I/T Payable
885c
Deferred I/T Liam.
45d
a. $885+45-30 = $900
b. $50*30%+30*30%+20%30% = 100*30% =$30
c. $2,950*30% = $885
d. (800+850+150)*30% - $495 = $540-495 = $45
Accounting for Income Taxes
38
Interperiod tax Allocation – Example
C (contd.)
T-accounts of deferred tax lia. And deferred
tax assets:
Deferred I/T Asset
Deferred I/T Liam.
0
Adj. Of 20x3 30
30a
495..beg.bal.
45..adj.Of 20x3
540b
beg. bal.
a. $50*30%+30*30%+20%30%
= 100*30% =$30
b.(800+850+150)*30% =1,800*30% =$540
Accounting for Income Taxes
39
Interperiod tax Allocation – Example
C (contd.)
Presentation of selected accounts on I/S:
Pretax Income
I/T exp.
Net Income
$3,000
(900)
$2,100
Presentation of selected accounts on B/S:
Current Assets:
Current Lia.:
Deferred Tax Assets 30 I/T Payable
885
Deferred Tax Lia. 540
Accounting for Income Taxes
40
Interperiod tax Allocation – Example
C (contd.)
Had APB No. 11 been followed (the
deferred approach), the following entry will
be prepareda:
I/T Exp. (3,000*30%)
900
I/T Payable (2,950*30%)
885
Deferred I/T Liam. (900-885) 15
a. This treatment is NOT acceptable.
Accounting for Income Taxes
41