ACCOUNTING FOR INCOME TAXES

CHAPTER 16INCOME TAXES

The concept of deferred taxes Permanent differences: Temporary differences.

Apply the concept & compute: Changes in Enacted Tax rates Use of Valuation Allowance

The Provisions of Tax loss carry-backs/forwards

Financial statement presentation and disclosure 2

Learning Objectives

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FUNDAMENTAL REPORTING Financial & Tax Reporting

FINANCIAL REPORTING- Useful Information

INCOME TAX SYSTEM:Equitable collection of revenue

Tax Code

SEC

Investors and Creditors

FINANCIAL REPORTING

Pretax Financial Income

GAAPIncome Tax Expense

Taxable Income

Income Tax Payable

TAX REPORTING

vs.

Fundamentals of Accounting for Income Taxes

INCOME COMPUTATION:

Two sets of rules

Pretax Financial (Accounting) Income: – according to GAAP (FASB 109)

is income before income taxes for financial reporting purposes

Taxable Income: - according to IRS rules

is the amount of income on which the income tax is based

Therefore the above two income differ

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Depreciation

GAAP: (based on estimated amount)

IRS: The Modified Accelerated Cost Recovery System (MACRS)

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DIFFERENT TAXABLE

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A temporary difference

corporation’s pretax financial income & taxable income that “originates” in one or

more years and

“reverses” in later years.

Temporary DifferencesTIMMING DIFFERENCES

HOW IS ADVANCED SUBSCRIPTION RECORDING ACCORDING TO: GAAP?IRS?For recording expense we need GAAP reportingFor Income tax payment we need IRS rule

Is it possible for a company to have both deferred tax assets and deferred tax liability at the same time?

If so, How? Give Example!

Let’s Illustrate

STOP & THINK!

Examples:Types of Temporary Differences

Deferred tax liabilities result in taxable amounts

in the future.

Deferred tax liabilities result in taxable amounts

in the future.

Deferred tax assets result in deductible

amounts in the future.

Deferred tax assets result in deductible

amounts in the future.

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Some items of revenue and expense that a corporation reports for financial accounting purposes are never reported for income tax

purposes. These permanent differences never reverse in a later accounting period.

Permanent Differences

Examples of permanent book-tax differences Tax-exempt state and local bond interest

income Nondeductible expenses incurred to generate

state and local bond interest income Life insurance proceeds (death benefits) 50% of meals and entertainment Political contributions Fines and penalties Bribes, kickbacks and illegal payments Dividends-received deduction: Certain

deductionsProfessor Vedd

Book-Tax Differences – Permanent

CONT… PART IICHANGES IN TAX RATES

Professor Vedd

ACCOUNTING FOR INCOME TAXES

CHAPTER 16 PART IIINCOME TAXES

DEFERED TAX: WITH CHANGES IN ENACTED TAX RATES

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.

When a change in tax rate is enacted, its effect should be recorded immediately

The effect is reported as an adjustment to tax expense in the period of change

Changes in tax rates are treated just like any other change in estimate, prospectively

See example following slide

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Revision of Future Tax Rates

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 When used to offset earlier taxable income:taxable income:

Called: operating loss Called: operating loss carryback.carryback.

Result: tax refund.Result: tax refund.

When used to offset future taxable income:

Called: operating loss carryforward.

Result: reduced tax payable.

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Accounting for Net Operating Losses

Loss Carryback

Back 2 years and forward 20 years

Losses must be applied to earliest year first

Loss Carryforward

May elect to forgo loss carryback and

Carryforward losses 20 years

A company would most likely choose the carry-forward option for a net operating loss if the company expected higher tax rates in the future compared to the past

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).

Balance Sheet Classification

Deferred tax assets/liabilities are classified as current or noncurrent based on the classification of the related asset

or liability.

INTERPERIOD:is to recognize an asset or liability for the tax consequences of

temporary differences that exist at the balance sheet date.

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INTERPERIOD/INTRAPERIOD INCOME TAX ALLOCATION

INTRAPERIOD:The total income tax expense for a reporting period is allocated among the financial statement items that gave rise to the income tax expense. The following items should be reported net of their respective income tax effects:• Income (or loss) from continuing operations• Discontinued operations• Extraordinary items• Changes in accounting principle• Prior period adjustments (to the beginning retained earnings balance)