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
3
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
5
Depreciation
GAAP: (based on estimated amount)
IRS: The Modified Accelerated Cost Recovery System (MACRS)
Page 6
DIFFERENT TAXABLE
7
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.
11
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
16
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.
18
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.
20
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)