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C H A P T E R 19 ACCOUNTING FOR INCOME TAXES Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield Fundamental Differences between Financial and Tax Reporting 4 Background Deferral approach to tax allocation (APB Opinion 11)
Income tax expense = amount of taxes that would be paid if income statement numbers appeared on the current year's tax return.
Deferred taxes was the plug figure (difference between taxes payable and tax expense).
The effect of subsequent changes in tax rates on deferred tax account were essentially ignored. Matching Approach 5 Background A method that was proposed theoretically (but has never been GAAP in US)
Assets and liabilities would be recorded NET of any deferred tax related to the item Net-of-Tax Approach 6 Background Liability approach to tax allocation (FASB 96, 109)
Income tax expense = taxes currently payable plus change in deferred taxes.
If tax rates change, the effect on deferred tax amounts affect income tax expense in the year the change is enacted.
If there are no changes in tax rates, income tax expense should be approximately the same as under APB Opinion 11. Asset/Liability Measurement Approach 7 Tax Code Exchanges Investors and Creditors Financial Statements Pretax Financial Income GAAP Income Tax Expense Taxable Income Income Tax Payable Tax Return vs. IRS Fundamentals of Accounting for Income Taxes LO 1 Identify differences between pretax financial income and taxable income. Illustration: KRC, Inc. reported revenues of $130,000 and expenses of $60,000 in each of its first three years of operations. For tax purposes, KRC reported the same expenses to the IRS in each of the years. KRC reported taxable revenues of $100,000 in 2010, $150,000 in 2011, and $140,000 in 2012. What is the effect on the accounts of reporting different amounts of revenue for GAAP versus tax? LO 1 Identify differences between pretax financial income and taxable income. Fundamentals of Accounting for Income Taxes Revenues Expenses Pretax financial income Income tax expense (40%) $130,000 60,000 $70,000 $28,000 $130,000 2011 60,000 $70,000 $28,000 $130,000 2012 60,000 $70,000 $28,000 $390,000 Total 180,000 $210,000 $84,000 GAAP Reporting Revenues Expenses Pretax financial income Income tax payable (40%) $100,000 2010 60,000 $40,000 $16,000 $150,000 2011 60,000 $90,000 $36,000 $140,000 2012 60,000 $80,000 $32,000 $390,000 Total 180,000 $210,000 $84,000 Tax Reporting 2010 LO 1 Identify differences between pretax financial income and taxable income. Book vs. Tax Difference Illustration 19-2 Illustration 19-3 Income tax expense (GAAP) Income tax payable (IRS) Difference $28,000 16,000 $12,000 $28,000 2011 36,000 $(8,000) $28,000 2012 32,000 $(4,000) $84,000 Total 84,000 $0 Comparison 2010 Are the differences accounted for in the financial statements? Year Reporting Requirement 2010 2011 2012 Deferred tax liability account increased to $12,000 Deferred tax liability account reduced by $8,000 Deferred tax liability account reduced by $4,000 Yes LO 1 Identify differences between pretax financial income and taxable income. Book vs. Tax Difference Illustration 19-4 Balance Sheet Assets: Liabilities: Equity: Income tax expense 28,000 Income Statement Revenues: Expenses: Net income (loss) 2010 2010 Deferred taxes 12,000 Where does the “deferred tax liability” get reported in the financial statements? Income tax payable 16,000 LO 1 Identify differences between pretax financial income and taxable income. Financial Reporting for 2010 – Chelsea Inc. 12 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 Future Deductible 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. 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 LO 2 Describe a temporary difference that results in future taxable amounts. Temporary Differences 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, 2010, GAAP-basis balance sheet. However, the receivables have a zero tax basis. Illustration 19-5 LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes KRC assumes that it will collect the accounts receivable and report the $30,000 collection as taxable revenues in future tax returns. KRC does this by recording a deferred tax liability. Illustration 19-6 Illustration: Reversal of Temporary Difference, Chelsea Inc. LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes A 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. Deferred Tax Liability – Chelsea Inc. Income tax expense (GAAP) Income tax payable (IRS) Difference $28,000 16,000 $12,000 $28,000 2011 36,000 $(8,000) $28,000 2012 32,000 $(4,000) $84,000 Total 84,000 $0 2010 Illustration 19-4 LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes Illustration: Because it is the first year of operations for KRC, there is no deferred tax liability at the beginning of the year. KRC computes the income tax expense for 2010 as follows: Deferred Tax Liability – Chelsea Inc. Illustration 19-9 LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes Illustration: Chelsea Inc. makes the following entry at the end of 2010 to record income taxes. Deferred Tax Liability Income Tax Expense 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 Illustration: Computation of Income Tax Expense for 2011. Deferred Tax Liability – Chelsea Inc. Illustration 19-10 LO 2 Describe a temporary difference that results in future taxable amounts. Future Taxable Amounts and Deferred Taxes Illustration: Chelsea Inc. makes the following entry at the end of 2011 to record income taxes. Deferred Tax Liability Income Tax Expense 28,000
Deferred Tax Liability 8,000
Income Tax Payable 36,000 20 E19-1 South Carolina Corporation has one temporary difference at the end of 2007 that will reverse and cause taxable amounts of $55,000 in 2008, $60,000 in 2009, and $65,000 in 2010. South Carolina’s pretax financial income for 2007 is $300,000, and the tax rate is 30% for all years. There are no deferred taxes at the beginning of 2007.
Instructions
Compute taxable income and income taxes payable for 2007.
Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2007. South Carolina Corporation 21 South Carolina Corporation a. a. 22 LO 2 Describe a temporary difference that results in future taxable amounts. South Carolina Corp. (Solution) a. a. 23 Columbia Corporation has one temporary difference at the end of 2007 that will reverse and cause deductible amounts of $50,000 in 2008, $65,000 in 2009, and $40,000 in 2010. Columbia’s pretax financial income for 2007 is $200,000 and the tax rate is 34% for all years. There are no deferred taxes at the beginning of 2007. Columbia expects to be profitable in the future.
Instructions
Compute taxable income and income taxes payable for 2007.
Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2007. Columbia Corporation 24 Columbia Corporation a. a. Income tax payable or refundable LO 5 Describe the presentation of income tax expense in the income statement. Income Statement Presentation 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 (current and deferred). Formula to Compute Income Tax Expense Illustration 19-20 LO 5 Describe the presentation of income tax expense in the income statement. Income Statement Presentation Given the previous information related to KRC Inc., KRC reports its income statement as follows. Illustration 19-21 Temporary Differences (1) Revenues and gains, recognized in financial income, are later taxed for income tax purposes.
Installment sales
Expenses and losses are deducted for income tax purposes before they are recognized in financial income.
MACRS depreciation
Goodwill deduction on tax return Called “taxable temporary differences” Revenues and gains are taxed for income tax purposes before they are recognized in financial income.
Subscription revenue
Prepaid rent
Expenses and losses, recognized in financial income, are later deducted for income tax purposes.
Warranty expense
Called “deductible temporary differences” Temporary Differences (2) Transaction When recorded
in books When recorded
on tax return Deferred
tax effect Rev or Gain Earlier Later Liability Rev or Gain Later Earlier Asset Exp or Loss Earlier Later Asset Exp or Loss Later Earlier Liability Summary of Temporary Differences 30 Sources of Permanent Differences No deferred tax effects
for permanent differences Permanent Differences 31 Permanent Differences: Examples Items, recognized for financial accounting purposes, but not for income tax purposes:
Interest revenue on Municipal Bonds
Life insurance premiums and proceeds when corporation is beneficiary
Fines and penalties
Items, recognized for tax purposes, but not for financial accounting purposes:
Dividend exclusion
Statutory depletion Deferred Tax Asset & Deferred Tax Liability: Sources Deferred taxes may be a:
Deferred tax liability, or
Deferred tax asset
Deferred tax liability arises due to net taxable amounts in the future.
Deferred tax asset arises due to net deductible amounts in the future. If the deferred tax asset appears doubtful, a Valuation Allowance account is needed.
Journal entry:
Income Tax Expense $$
Allowance to Reduce Deferred Tax Asset to Expected Realizable Value $$
The entry records a potential future tax benefit that is not expected to be realized in the future. Valuation Allowance for Deferred Tax Assets Basic Rule: Apply the yearly tax rate to calculate deferred tax effects.
If future tax rates change: use the enacted tax rate expected to apply in the future year.
If new rates are not yet enacted into law for future years, the current rate should be used.
The appropriate enacted rate for a year is the average tax rate [based on graduated tax brackets]. What Tax Rate to Apply Let’s do an example Second Best Company
Working paper style – working paper blank will be provided on Exam 2 35 36 The deferred tax classification relates to its underlying asset or liability.
Classify the deferred tax amounts as current or non-current.
Presentation is
NET amount related to current items
If DR>CR, current deferred tax asset
If DRCR, noncurrent deferred tax asset
If DR
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