Chapter 16
19th
Edition
Income Taxes
Intermediate
Accounting
James D. Stice
Earl K. Stice
PowerPoint presented by Douglas Cloud
Professor Emeritus of Accounting, Pepperdine University
© 2014 Cengage Learning
16-1
Deferred Income Tax Overview
•
Corporations in the United States compute
two different income numbers:
 Financial income for reporting to
stockholders and
 Taxable income for reporting to the
Internal Revenue Service (IRS).
(continued)
16-2
Deferred Income Tax Overview
•
•
The primary goal of financial accounting is
to provide useful information to
management, stockholders, creditors, and
others properly interested; the major
responsibility of the accountant is to protect
these parties from being misled.
The primary goal of the income tax system
is the equitable collection of revenue.
(continued)
16-3
Deferred Income Tax Overview
The difficulty of determining what is “income
tax expense” stems from two basic
considerations:
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.
(continued)
16-4
Deferred Income Tax Overview
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.
16-5
Example 1: Simple Deferred
Income Tax Liability
•
•
•
In 2013, Ibanez Company earned revenues
of $30,000. Ibanez has no expenses other
than income taxes.
In this case, the income tax law specifies
that income is taxed when received in cash
and that Ibanez received $10,000 in 2013
and expects to receive $20,000 in 2014.
The income tax rate is 40% and it is
expected to remain the same into the
foreseeable future.
(continued)
16-6
Example 1: Simple Deferred
Income Tax Liability
The journal entry to record all the tax-related
information for Ibanez for 2013 is as follows:
Income Tax Expense
Income Taxes Payable
Deferred Tax Liability
12,000
4,000
8,000
$30,000 × .40
$4,000 current year
+ $8,000 deferred
(continued)
$10,000 × .40
$20,000 × .40
16-7
Example 1: Simple Deferred
Income Tax Liability
Ibanez Company
Income Statement
For the Year Ended December 31, 2013
Revenues
Income tax expense:
Current
Deferred
Net income
$30,000
$4,000
8,000
12,000
$18,000
16-8
Example 2: Simple
Deferred Income Tax Asset
• In 2013, its first year of operation, Gupta
•
•
Company generated service revenues totaling
$60,000, all taxable in 2013.
No warranty claims were made in 2013, but
Gupta estimates that in 2014 warranty costs of
$10,000 will be incurred for claims related to
2013 service revenues.
Assume a 40% tax rate and that Gupta
Company had no expenses in 2013 other than
warranty costs and income taxes.
(continued)
16-9
Example 2: Simple
Deferred Income Tax Asset
The journal entry to record all the tax-related
information for Gupta for 2013 is as follows:
Income Tax Expense
Deferred Tax Asset
Income Taxes Payable
$24,000 current year –
$4,000 deferred
(continued)
20,000
4,000
24,000
$50,000 × .40
$10,000 × .40
$60,000 × .40
16-10
Example 2: Simple
Deferred Income Tax Asset
Gupta Company
Income Statement
For the Year Ended December 31, 2013
Revenues
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
16-11
Permanent and Temporary
Differences
Permanent differences are created by political
and social pressures to favor certain segments
of society or to promote certain industries or
economic activities.
 Nontaxable revenue—proceeds from
insurance policies; interest received on
municipal bonds
 Nondeductible expenses—fines for
violations of laws; payment of insurance
premiums
(continued)
16-12
Permanent and Temporary
Differences
More commonly, differences between pretax
financial income and taxable income arise from
business events that are recognized for both
financial reporting and tax purposes but in
different time periods. These differences are
referred to as temporary differences.
(continued)
16-13
Permanent and Temporary
Differences
•
The first category includes differences,
called taxable temporary differences, that
will result in taxable amounts in future years.
•
The second category includes differences,
called deductible temporary differences,
that will result in deductible amounts in
future years.
16-14
Illustration of Permanent and
Temporary Differences
• The permanent differences are not
•
•
included in either the financial income
subject to tax or the taxable income.
Permanent differences have no impact on
income taxes payable in subsequent
periods.
In general, the accounting for temporary
differences is referred to as interperiod
tax allocation.
16-15
Annual Computation of Deferred
Tax Liabilities and Assets
• FASB ASC Topic 740 reflects the
Board’s preference for the asset and
liability method of interperiod tax
allocation, which emphasizes the
measurement and reporting of balance
sheet amounts.
• One drawback of this method is that in
some ways, it is still too complicated.
(continued)
16-16
Annual Computation of Deferred
Tax Liabilities and Assets
The major advantages of the asset and liability
method of accounting for deferred taxes are as
follows:
1. Assets and liabilities are recorded in
agreement with FASB definitions of financial
statement elements.
2. This method is flexible and recognizes
changes in circumstances and adjusts the
reported amounts accordingly. This flexibility
may improve the predictive value of the
financial statements.
(continued)
16-17
Annual Computation of Deferred
Tax Liabilities and Assets
Identify type and amounts of existing
temporary differences.
Measure the deferred tax
liability for taxable
temporary differences (use
enacted rates).
Measure the deferred tax
asset for deductible
temporary differences (use
enacted rates).
Establish valuation allowance account if more
likely than not some portion or all of the
deferred tax asset will not be realized.
16-18
Example 3: Deferred Tax Liability
•
•
For 2013, Roland computes pretax financial
income of $75,000. The only difference
between financial and taxable income is
depreciation.
Roland uses the straight-line method of
depreciation for financial reporting purposes
and ACRS on its tax return.
(continued)
16-19
Example 3: Deferred Tax Liability
The enacted tax rate for 2013 and future years
is 40%. Roland’s taxable income for 2013 is
$60,000, computed as follows:
Financial income subject to tax
Deduct temporary difference:
Excess of tax depreciation ($40,000)
over book depreciation ($25,000)
Taxable income
Tax ($60,000 x 0.40)
$75,000
(15,000)
$60,000
$24,000
(continued)
16-20
Example 3: Deferred Tax Liability
Roland’s Journal Entry for 2013
Income Tax Expense
Income Taxes Payable
Deferred Tax Liability—
Noncurrent
30,000
24,000
6,000
$30,000 – $6,000
$24,000 current + $6,000 deferred
$15,000 × .40
(continued)
16-21
Example 3: Deferred Tax Liability
Income taxes would be shown on Roland’s
2013 income statement as follow:
Income before income taxes
Current
Deferred
Net income
$75,000
$24,000
6,000
30,000
$45,000
The December 31, 2013, balance sheet
would report a current liability of $24,000.
16-22
Example 3: Deferred Tax Liability
Roland earns financial income of $75,000 in each
of the years 2014 through 2016. Roland reports
taxable income of $70,000, computed as follows:
Financial income subject to tax
Deduct temporary difference:
Excess of tax depreciation ($30,000)
over book depreciation ($25,000)
Taxable income
Tax ($70,000 × 0.40)
(continued)
$75,000
(5,000)
$70,000
$28,000
16-23
Example 3: Deferred Tax Liability
Roland’s Journal Entry for 2014
Income Tax Expense
Income Taxes Payable
Deferred Tax Liability—
Noncurrent
30,000
28,000
2,000
$30,000 – $2,000
$28,000 current + $2,000 deferred
$5,000 x 0.40
(continued)
16-24
Example 3: Deferred Tax Liability
Depreciation expense in 2015 is the same for
both financial and tax, so the entry is simple.
Income Tax Expense
Income Taxes Payable
30,000
30,000
$75,000 × 0.40
(continued)
16-25
Example 3: Deferred Tax Liability
For 2016, Roland earns income of $75,000 and
the taxable income is $95,000, computed as
follows:
Financial income subject to tax
Add temporary difference:
Excess of book depreciation
($25,000) over tax depreciation
($5,000)
Taxable income
Tax ($95,000 × 0.40)
$75,000
20,000
$95,000
$38,000
(continued)
16-26
Example 3: Deferred Tax Liability
Roland’s Journal Entry for 2016
Income Tax Expense
Deferred Tax Liability—
Noncurrent
Income Taxes Payable
30,000
8,000
38,000
$38,000 current – $8,000 deferred benefits
$95,000 × 0.40
(continued)
16-27
Effect of Currently Enacted Changes
in Future Tax Rates
• If changes in future tax rates have been
enacted, the deferred tax liability (or asset) is
measured during the enacted tax rate for the
future years when the temporary difference is
expected to reverse.
• Under IAS 12, deferred tax items are to be
measured at the income tax rates “that have
been enacted or substantively enacted by the
end of the reporting period.”
16-28
Subsequent Changes in
Enacted Tax Rates
Using the Roland, Inc. example, assume that
the enacted rate for 2016 changed from 40%
to 35% during 2014. The balance in the
deferred tax liability at the beginning of 2014
is $6,000. The following adjusting entry would
be made for 2016:
Deferred Tax Liability—
Noncurrent
Income Tax Benefit—Rate
Change
750
750
$15,000 x 0.05
16-29
Example 4: Deferred Tax Asset
Taxable income for 2013 is computed as
follows:
Financial income subject to tax
Add temporary difference:
Excess of warranty expense over
warranty deductions
Taxable income
Taxable income ($40,000 × 0.40)
$22,000
18,000
$40,000
$16,000
(continued)
16-30
Example 4: Deferred Tax Asset
Sandusky’s Journal Entry for 2013
Income Tax Expense
Deferred Tax Asset—Current
Deferred Tax Asset—
Noncurrent
Income Taxes Payable
8,800
2,400
4,800
16,000
1/3 × $7,200
$16,000 current – $7,200 deferred benefits
2/3 × $7,200
(continued)
16-31
Example 4: Deferred Tax Asset
Sandusky’s 2013 income statement would
present income tax expense as follows:
Income before income taxes
Income tax expense:
Current
Deferred (benefit)
Net income
$22,000
$16,000
(7,200)
8,800
$13,200
(continued)
16-32
Example 4: Deferred Tax Asset
In the years 2014 through 2016, taxable
income would be equal to $16,000, computed
as follows:
Income subject to tax
Reversal of temporary difference:
Excess of warranty deductions
(1/3 × $18,000) over warranty
expense ($0)
Taxable income
Tax ($16,000 × .40)
$22,000
(6,000)
$16,000
$ 6,400
16-33
Example 5: Deferred Tax
Liabilities and Assets
•
For 2013, Hsieh reported pretax financial
income of $38,000.
•
As of December 31, 2013, the actual
depreciation expense was $25,000 and the
actual warranty expense was $18,000.
•
For income tax reporting, these expenses
were $40,000 and $0, respectively.
16-34
Example 5: Deferred Tax
Liabilities and Assets
For 2013, taxable income would be
computed as follows:
Financial income subject to tax
Add (deduct) temporary differences:
Excess of warranty expense
over warranty deductions
Excess of tax depreciation over
book depreciation
Taxable income
Tax ($41,000 × .40)
(continued)
$38,000
18,000
(15,000)
$41,000
$16,400
16-35
Example 5: Deferred Tax
Liabilities and Assets
Heich’s December 31, 2013 Entries
Income Tax Expense
Income Taxes Payable
16,400
Deferred Tax Asset—Current
2,400
Deferred Tax Asset—
Noncurrent
4,800
Income Tax Benefit
Deferred Tax Liability—
Noncurrent
These two are netted against one another and
a single $1,200 amount is shown as a
noncurrent tax liability ($6,000 – $4,800).
16,400
1,200
6,000
16-36
Valuation Allowance for
Deferred Tax Assets
•
•
•
A deferred tax asset represents future
income tax benefits.
The tax benefit will be realized only if there
is sufficient taxable income from which the
deductible amount can be deducted.
Topic 740 requires that the deferred tax
asset be reduced by a valuation
allowance, a contra asset account that
reduces the asset to its expected realizable
value.
(continued)
16-37
Valuation Allowance for
Deferred Tax Assets
Some possible sources of taxable income to be
considered in evaluating the realizable value of a
deferred tax asset are as follows:
1. Future reversals of existing taxable temporary
differences
2. Future taxable income exclusive of reversing
temporary differences
3. Taxable income in prior (carryback) years
16-38
Valuation Allowance for
Deferred Tax Assets
•
In 2013, Hsieh Company has a $15,000
excess of aggregate tax depreciation over
aggregate book depreciation.
•
The reversal of this temporary difference will
provide taxable income in the future against
which the $18,000 warranty deduction can be
offset. Accordingly, the total deferred tax asset
is $7,200 ($18,000 x 0.40), but the realized
amount is only $6,000 ($15,000 x 0.40). The
$1,200 difference would be recorded as a
valuation allowance.
(continued)
16-39
Valuation Allowance for
Deferred Tax Assets
First, the deferred tax asset and liability are
recognized, as follows:
Deferred Tax Asset—Current
Deferred Tax Asset—
Noncurrent
Income Tax Benefit
Deferred Tax Liability—
Noncurrent
2,400
4,800
1,200
6,000
A subtraction
Note that this is the same as the deferred
tax
income
journal entry shown earlier on Slidefrom
16-50.
tax expense
(continued)
16-40
Valuation Allowance for
Deferred Tax Assets
The second journal entry represents the fact
that it is more likely than not that $1,200 of
the deferred tax asset will not be realized.
Income Tax Expense
1,200
Allowance to Reduce Deferred
Tax Asset to Realizable Value—
Current
Allowance to Reduce Deferred
Tax Asset to Realizable Value—
Noncurrent
400
800
16-41
Valuation Allowance
Under IAS 12
Under the provisions of IAS 12, there is no
valuation allowance. Instead, deferred tax
assets are recognized only “to the extent
that it is probable that taxable profit will be
available against which the deductible
temporary difference can be utilised
[utilized].”
16-42
Accounting for Uncertain
Tax Positions
Topic 740 requires the use of a 2-step process
to determine the recognition of any tax benefit
associated with an uncertain tax position.
1. Step 1—Determine if it is more likely than not
that a tax position would be sustained if it
were examined, and it must be assumed that
the tax position will be examined.
2. Step 2—The measurement of the tax benefit
is based on a probability assessment of the
likelihood of specific outcomes and the
amounts of those outcomes.
(continued)
16-43
Accounting for Uncertain
Tax Positions
Case 1: Highly Certain Tax Position
If the probability that the tax benefit of $100
would be achieved were greater than 50%,
this would be deemed a “highly certain”
position. In other words, it is more likely
than not that the position taken and the
amount in question would be upheld if
reviewed.
16-44
Accounting for Uncertain
Tax Positions
Case 2: Uncertain Tax Position—
More Likely Than Not
Assume the following assessment of probabilities:
(continued)
16-45
Accounting for Uncertain
Tax Positions
Case 3: Uncertain Tax Position—
NOT More Likely Than Not
If the company completes Step 1 of the
analysis and determines that it is NOT more
likely than not that the tax position will be
sustained, then the entire amount of the
position must be recognized as a liability.
Income Tax Expense
Unrecognized Tax Benefit
100
100
16-46
Net Operating Loss
(NOL) Carryforward
•
If an operating loss exceeds income for the
two preceding years, the remaining unused
loss may be applied against income earned
over the next 20 years as a net operating
loss (NOL) carryforward.
•
A valuation allowance is used to reduce the
asset if it is more likely than not that some
or all of the future benefits will not be
realized.
16-47
Financial Statement
Presentation and Disclosure
The income statement must show, either in the
body of the statement or in a note, the following
components of income taxes related to
continuing operations.
1. Current tax expense or benefit
2. Deferred tax expense or benefit
3. Investment tax credits
4. Government grants recognized as tax
reductions
(continued)
16-48
Financial Statement
Presentation and Disclosure
5. Benefits of operating loss carryforwards
6. 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
7. Adjustments in beginning-of-the-year
valuation allowance because of a change in
circumstances
16-49
Deferred Taxes and the
Statement of Cash Flows
•
•
•
FASB ASC Topic 230 requires a separate
disclosure of the amount of cash paid for
income taxes during a period.
This separate disclosure is required for just
two items:
 Cash paid for income taxes
 Cash paid for interest
Income taxes affect the Operating Activities
section of the statement of cash flows.
(continued)
16-50
Deferred Taxes and the
Statement of Cash Flows
Collazo Company had the following information
for 2013:
Revenue (all cash)
Income tax expense:
Current
Deferred
Net income
(continued)
$30,000
$10,300
1,700
12,000
$18,000
16-51
Deferred Taxes and the
Statement of Cash Flows
The operating activities section of Collazo’s
statement of cash flows is as follows if the direct
method is used.
Cash collected from customers
Income taxes paid
Cash provided by operating activities
(continued)
$30,000
(13,300)
$16,700
16-52
Deferred Taxes and the
Statement of Cash Flows
Collazo Company
Statement of Cash Flows (Partial)
(Indirect Approach)
Cash provided by operating activities:
Net income
Decrease in income tax refund receivable
Decrease in income taxes payable
Increase in deferred tax liability
Cash provided by operating activities
If the indirect method is used, the amount of
cash paid for income taxes, $13,300, must
be separately disclosed either in the SCF or
in the notes to the financial statements.
$18,000
(2,000)
(1,000)
1,700
$16,700
16-53
International Accounting
for Deferred Taxes
•
•
No-deferral approach: Using this approach,
the differences are ignored. Income tax
expense equal to the amount of tax payable
for the year is reported.
Comprehensive recognition approach:
Deferred taxes are included in the computation
of income tax expense and reported on the
balance sheet. The IASB has embraced this
approach.
(continued)
16-54
International Accounting
for Deferred Taxes
•
•
•
Partial recognition approach: Historically,
the United Kingdom employed this innovate
technique.
A deferred tax liability is recorded only to the
extent that the deferred taxes are actually
expected to be paid in the future.
In recent years, this method has lost favor
internationally because it is so subjective
(relying heavily on management expectations
about future events).
16-55
Chapter 16
₵
The End
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16-56
16-57