McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. ACCOUNTING FOR INCOME TAXES Chapter 16.

McGraw-Hill /Irwin © 2009 The McGraw-Hill Companies, Inc.

ACCOUNTING FOR ACCOUNTING FOR INCOME TAXESINCOME TAXES

Chapter 16

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The Internal Revenue Code is

the set of rules for preparing tax

returns.

The Internal Revenue Code is

the set of rules for preparing tax

returns.

Financial statement income tax expense.

Financial statement income tax expense.

IRS income taxes payable.

IRS income taxes payable.

GAAP is the set of rules for preparing

financial statements.

GAAP is the set of rules for preparing

financial statements.

Usually. . . Results in . . . Results in . . .

The objective of accounting for income taxes is to recognize a deferred tax liability or deferred tax assetfor 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.

The objective of accounting for income taxes is to recognize a deferred tax liability or deferred tax assetfor 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.

Deferred Tax Assets and Deferred Tax Deferred Tax Assets and Deferred Tax LiabilitiesLiabilities

Slide 3

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Temporary DifferencesTemporary Differences

These are called temporary

differences.

Often, the difference between pre-tax accounting income and taxable income results from items entering the income

computations at different times.

Often, the difference between pre-tax accounting income and taxable income results from items entering the income

computations at different times.

Slide 4

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Temporary differences will reverse out in one or more future periods.

Temporary differences will reverse out in one or more future periods.

Temporary DifferencesTemporary Differences

Accounting Income>Taxable Income

Future Taxable Amounts

Deferred Tax Liability

Accounting Income<Taxable Income

Future Deductible Amounts

Deferred Tax Asset

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Deferred tax liabilities result in taxable

amounts in the future.

Deferred tax liabilities result in taxable


Deferred tax assets result in deductible


Deferred tax assets result in deductible


Revenues (or gains) Expenses (or losses)

Items reported on

the tax return

Installment sales of property (installment method for taxes)

Estimated expenses and losses (tax deductible when paid)

AFTER the income

statement

Unrealized gain from recording investments at fair value (taxable when asset is sold)

Unrealized loss from recording investments at fair value or inventory at LCM (tax deductible when asset is sold)

Items reported on

the tax return

Rent or subscriptions collected in advance

Accelerated depreciation on tax return (straight-line on income statement)

BEFORE the income

statement

Other revenue collected in advance

Prepaid expenses (tax deductible when paid)

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Deferred Tax LiabilitiesDeferred Tax Liabilities

In 2009, Baxter reports $300,000 of pretax income. Included in this amount is $100,000 resulting from revenue earned from an

installment sale for which no cash was collected. The revenue will be taxed as the cash is collected in 2010 and 2011. Baxter expects to collect $70,000 in 2010 and the remaining $30,000 in 2011. In 2010

and 2011, Baxter reports $200,000 of pretax income. The company is subject to a 32% tax rate.

There are no other temporary differences.

In 2009, Baxter reports $300,000 of pretax income. Included in this amount is $100,000 resulting from revenue earned from an

installment sale for which no cash was collected. The revenue will be taxed as the cash is collected in 2010 and 2011. Baxter expects to collect $70,000 in 2010 and the remaining $30,000 in 2011. In 2010

and 2011, Baxter reports $200,000 of pretax income. The company is subject to a 32% tax rate.

There are no other temporary differences.

Originates2009 2010 2011 Total

Accounting income 300,000$ 200,000$ 200,000$ 700,000$ Installment sale income on the income statement (100,000) (100,000) Installment sale income on the tax return 70,000 30,000 100,000 Taxable income 200,000$ 270,000$ 230,000$ 700,000$

ReversesTemporary Difference

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Description Debit CreditIncome tax expense 96,000

Income tax payable 64,000 Deferred tax liability 32,000

General Journal




2009 Income tax payable = $200,000 × 32% = $64,0002009 Income tax payable = $200,000 × 32% = $64,000

2009 Deferred tax liability change = ($100,000 × 32%) - $02009 Deferred tax liability change = ($100,000 × 32%) - $0 = $32,000 = $32,000


2009 Deferred tax liability change = ($100,000 × 32%) - $02009 Deferred tax liability change = ($100,000 × 32%) - $0 = $32,000 = $32,000

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2010 2011 Total

Future taxable amounts 70,000$ 30,000$ 100,000$

Enacted tax rate 32%

Deferred tax liability 32,000$

32,000 2009Deferred Tax Liability

The Deferred Tax Liability

represents the future taxes Baxter

will pay in 2010 and 2011.

Description Debit CreditIncome tax expense 96,000

Income tax payable 64,000 Deferred tax liability 32,000

General Journal

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Description Debit CreditIncome tax expense 64,000 Deferred tax liability 22,400 Income tax payable 86,400

General JournalDescription Debit Credit

Income tax expense 64,000 Deferred tax liability 22,400 Income tax payable 86,400

General Journal

Recall this information for

Baxter.


2010 Deferred tax liability change = ($30,000 × 32%) - $32,0002010 Deferred tax liability change = ($30,000 × 32%) - $32,000 = $22,400 = $22,400


2010 Deferred tax liability change = ($30,000 × 32%) - $32,0002010 Deferred tax liability change = ($30,000 × 32%) - $32,000 = $22,400 = $22,400

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2011 Total

Future taxable amounts 30,000$ 30,000$


Deferred tax liability 9,600$

Future Taxable Amount

Schedule

2010 22,400 32,000 20099,600 Balance


The Deferred Tax Liability represents the future taxes Baxter will pay in 2011.

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Description Debit CreditIncome tax expense 64,000 Deferred tax liability 9,600 Income tax payable 73,600


Income tax expense 64,000 Deferred tax liability 9,600 Income tax payable 73,600

General Journal

Deferred Tax LiabilitiesDeferred Tax LiabilitiesOriginates

2009 2010 2011 TotalAccounting income 300,000$ 200,000$ 200,000$ 700,000$ Installment sale income on the income statement (100,000) (100,000) Installment sale income on the tax return 70,000 30,000 100,000 Taxable income 200,000$ 270,000$ 230,000$ 700,000$

ReversesTemporary DifferenceRecall this

information for Baxter.


2011 Deferred tax liability change = ($0 × 32%) - $9,600 2011 Deferred tax liability change = ($0 × 32%) - $9,600 = $9,600 = $9,600


2011 Deferred tax liability change = ($0 × 32%) - $9,600 2011 Deferred tax liability change = ($0 × 32%) - $9,600 = $9,600 = $9,600

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2010 22,400 32,000 20099,600 Balance

2011 9,600 0 Balance



2012 Total

Future taxable amounts -$ -$


Deferred tax liability -$

Future Taxable Amount

Schedule

The Deferred Tax Liability represents the future taxes Baxter will pay.

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Health Magazine received $150,000 of subscriptions in advance during 2009.

Subscription revenue will be earned equally in 2010, 2011 and 2012 for financial accounting purposes.

The entire $150,000 will be taxed in 2009.

There is additional income of $500,000 in each year. The company is subject to a 30% tax rate in each year.

Deferred Tax AssetsDeferred Tax Assets

Originates2009 2010 2011 2012 Total

Accounting income 500,000$ 550,000$ 550,000$ 550,000$ 2,150,000$ Subscription revenue on the income statement (50,000) (50,000) (50,000) (150,000) Subscription revenue on the tax return 150,000 150,000 Taxable income 650,000$ 500,000$ 500,000$ 500,000$ 2,150,000$


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Calculation of Deferred Tax Asset 2010 2011 2012 TotalFuture deductible amount (50,000)$ (50,000)$ (50,000)$ (150,000)$ Enacted tax rate 30%Deferred tax asset (45,000)$


Now, let’s record the income tax entry for 2009.

This is the computation for the Deferred Tax Asset.




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Description Debit CreditIncome tax expense 150,000 Deferred tax asset 45,000 Income tax payable 195,000


Income tax expense 150,000 Deferred tax asset 45,000 Income tax payable 195,000

General Journal





2009 Deferred tax asset change = [($150,000 × 30%] - $02009 Deferred tax asset change = [($150,000 × 30%] - $0 = $45,000 = $45,000


2009 Deferred tax asset change = [($150,000 × 30%] - $02009 Deferred tax asset change = [($150,000 × 30%] - $0 = $45,000 = $45,000

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2009 45,000 Balance 45,000

Deferred Tax Asset


After posting the entry, the Deferred Tax Asset account will have the desired ending balance of $45,000.




General Journal

Calculation of Deferred Tax Asset 2010 2011 2012 TotalFuture deductible amount (50,000)$ (50,000)$ (50,000)$ (150,000)$ Enacted tax rate 30%Deferred tax asset (45,000)$

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General Journal





2010 Deferred tax asset change = [($100,000) × 30%] - $45,0002010 Deferred tax asset change = [($100,000) × 30%] - $45,000 = ($15,000) = ($15,000)


2010 Deferred tax asset change = [($100,000) × 30%] - $45,0002010 Deferred tax asset change = [($100,000) × 30%] - $45,000 = ($15,000) = ($15,000)

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Deferred Tax AssetsDeferred Tax AssetsIn 2010, the balance in the Deferred Tax Asset should

decrease to $30,000.

2009 45,000 15,000 2010Balance 30,000

Deferred Tax Asset

Can you prepare the entries for 2011 and 2012?

Calculation of Deferred Tax Asset 2011 2012 TotalFuture deductible amount (50,000)$ (50,000)$ (100,000)$ Enacted tax rate 30%Deferred tax asset (30,000)$

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Deferred Tax AssetsDeferred Tax AssetsThis would be the entry for 2011 and 2012.

2009 45,000 15,000 201015,000 201115,000 2012

Balance -

Deferred Tax Asset

At the end of 2012, the balance in the Deferred Tax Asset would be zero.




General Journal

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A valuation allowance account is required when 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.

A valuation allowance account is required when 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.

Valuation AllowanceValuation Allowance

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Nontemporary DifferencesNontemporary 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.

Also called permanent differences.Also called permanent differences.

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Tax Rate ConsiderationsTax 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.

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.

InternalRevenue

Code

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Multiple Temporary DifferencesMultiple 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

Future deductible amounts

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Net Operating Losses (NOL)Net Operating Losses (NOL)

Tax laws often allow a company to use tax NOLs to offset taxable income in earlier or

subsequent periods.

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.

When used to offset earlier taxable income:

Called: operating loss carryback.

Result: tax refund.

When used to offset future taxable income:

Called: operating loss carryforward.

Result: reduced tax payable.

When used to offset future taxable income:

Called: operating loss carryforward.

Result: reduced tax payable.

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Net Operating Losses (NOL)Net Operating Losses (NOL)

Current Year

-1-2

Carryback Period

+3+2+1 . . . +20+4 +5

Carryforward Period

The NOL may first be applied against taxable income from two previous years.

Unused NOL may be carried forward for 20 years.

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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Net Operating Losses (NOL) Net Operating Losses (NOL)

In 2009 Garson, Inc. incurred an $85,000 net operating loss. The company is subject to a

30% tax rate. In 2007, Garson reported taxable income of $20,000, and in 2008,

taxable income was $10,000. The company elects to carryback the NOL.

In 2009 Garson, Inc. incurred an $85,000 net operating loss. The company is subject to a

30% tax rate. In 2007, Garson reported taxable income of $20,000, and in 2008,

taxable income was $10,000. The company elects to carryback the NOL.

Tax year

Taxable Income

Tax rate Taxes Paid

2007 20,000$ 30% 6,000$

2008 10,000 30% 3,000

Let’s look at the tax benefits of the operating loss carryback and carryforward.

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Current Year2007 2008 2009

Operating loss (85,000)$

Loss carryback (20,000)$ (10,000)$ 30,000 Loss carryforward 55,000 (55,000)$ Subtotal (20,000)$ (10,000)$ -$ (55,000)$ Enacted tax rate 30% 30% 30% 30%Tax refund (6,000)$ (3,000)$ -$

Deferred tax asset (16,500)$

Prior YearsFuture

Deductible Amounts

Description Debit CreditReceivable--income tax refund 9,000 Deferred tax asset 16,500 Income tax benefit-- operating loss 25,500

Description Debit CreditReceivable--income tax refund 9,000 Deferred tax asset 16,500 Income tax benefit-- operating loss 25,500

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Operating loss before income taxes (85,000)$ Benefit of NOL carryback 9,000 Benefit of NOL carryforward 16,500 Net loss (59,500)$

Garson, Inc.Partial Income Statement

For the Year Ended December 31, 2009Operating loss before income taxes (85,000)$ Benefit of NOL carryback 9,000 Benefit of NOL carryforward 16,500 Net loss (59,500)$

Garson, Inc.Partial Income Statement

For the Year Ended December 31, 2009

The deferred tax asset account created by the benefit of the carryforward will be used to lower

income taxes payable in future years.

The deferred tax asset account created by the benefit of the carryforward will be used to lower

income taxes payable in future years.

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Disclose the following:Total of all deferred tax

liabilities. Total of all deferred tax

assets.Total valuation allowance

recognized.Net change in valuation

account.Approximate tax effect of

each type of temporary difference (and carryforward).

Disclose the following:Total of all deferred tax

liabilities. Total of all deferred tax

assets.Total valuation allowance

recognized.Net change in valuation

account.Approximate tax effect of

each type of temporary difference (and carryforward).

Deferred tax assets/liabilities are classified as

current or noncurrent based

on the classification of the related asset

or liability.

Deferred tax assets/liabilities are classified as

current or noncurrent based

on the classification of the related asset

or liability.

Balance Sheet ClassificationBalance Sheet Classification

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Current portion of tax expense (benefit)Deferred portion of tax expense (benefit), with

separate disclosure for Portion that does not include the effect of

the following separately disclosed amounts. Operating loss carryforwards. Adjustments due to changes in tax laws or

rates. Adjustments to the beginning-of-the-year

valuation allowance due to revised estimates.

Investment tax credits.

Current portion of tax expense (benefit)Deferred portion of tax expense (benefit), with

separate disclosure for Portion that does not include the effect of

the following separately disclosed amounts. Operating loss carryforwards. Adjustments due to changes in tax laws or

rates. Adjustments to the beginning-of-the-year

valuation allowance due to revised estimates.

Investment tax credits.

Additional DisclosuresAdditional Disclosures

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Coping with Uncertainty in Income TaxesCoping with Uncertainty in Income Taxes

FASB Interpretation No. 48 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.

Not “more likely than not” = none of the tax benefit is allowed to be recorded

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Intraperiod Tax AllocationIntraperiod Tax Allocation

SFAS No. 109 requires intraperiod tax allocation for:• Income from continuing

operations.• Discontinued operations.• Extraordinary items.

SFAS No. 109 requires intraperiod tax allocation for:• Income from continuing

operations.• Discontinued operations.• Extraordinary items.

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Conceptual ConcernsConceptual Concerns

Should deferred taxes be recognized?

Should deferred taxes be recognized for only some items?

Should deferred taxes be discounted?

Should classification be based on the timing of temporary difference reversals?

Some accountants disagree with the FASB’s approach to accounting for income taxes.

McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. ACCOUNTING FOR INCOME TAXES Chapter 16.

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Transcript of McGraw-Hill /Irwin© 2009 The McGraw-Hill Companies, Inc. ACCOUNTING FOR INCOME TAXES Chapter 16.