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2
Understand the concept of deferred taxes and the distinction between permanent and temporary differences.
Compute the amount of deferred tax liabilities and assets.
Explain the provisions of tax loss carrybacks and carryforwards, and be able to account for these provisions.
Learning Objectives
3
Schedule future tax rates, and determine the effect on tax assets and liabilities.
Determine appropriate financial statement presentation and disclosure associated with deferred tax assets and liabilities.
Comply with income tax disclosure requirements associated with the statement of cash flows.
Learning Objectives
4
Learning Objectives
Describe how, with respect to deferred income taxes, international accounting standards have converged toward the U.S. treatment.
EXPANDED MATERIALS Perform intraperiod tax allocation.
5
Deferred Tax Liabilities
Defined: Income taxes expected to be paid on future taxable amounts resulting from temporary differences between financial and taxable income.
Defined: Income taxes expected to be paid on future taxable amounts resulting from temporary differences between financial and taxable income.
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Deferred Tax Liabilities
• Examples– Revenues (or gains) taxable after they are
recognized for financial reporting, such as receivables from installment sales.
– Expenses (or losses) deductible for tax purposes before they are recognized for financial reporting purposes, such as accelerated tax depreciation.
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Deferred Tax Assets
Defined: An expected benefit in the form of tax savings on future deductible amounts resulting from deductible temporary differences between financial and taxable income.
Defined: An expected benefit in the form of tax savings on future deductible amounts resulting from deductible temporary differences between financial and taxable income.
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• Examples
– Expenses (or losses) that are deductible for tax purposes after they are recognized for financial reporting purposes, such as warranty expenses.
– Revenues (or gains) that are taxable before they are recognized for financial reporting purposes, such as subscriptions received in advance.
Deferred Tax Assets
9Permanent and Temporary Differences
• Permanent Differences: Nondeductible expenses or nontaxable revenues that are recognized for financial reporting purposes but are never part of taxable income.
• Temporary Differences: Differences between pretax financial income and taxable income arising from business events that are recognized for both financial and tax purposes, but in different time periods.
10Illustration of Permanent and Temporary Differences
For the year ended December 31, 2002, Monroe Corporation reported net income before taxes of $420,000. This amount
includes $20,000 of nontaxable revenues and $5,000 of nondeductible expenses. The depreciation method used for tax purposes
allowed a deduction that exceeded the book approach by $30,000.
For the year ended December 31, 2002, Monroe Corporation reported net income before taxes of $420,000. This amount
includes $20,000 of nontaxable revenues and $5,000 of nondeductible expenses. The depreciation method used for tax purposes
allowed a deduction that exceeded the book approach by $30,000.
11Illustration of Permanent and Temporary Differences
Pretax income from income statement $420,000 Add (deduct) permanent differences:
Nontaxable revenues $(20,000)Nondeductible expenses 5,000 (15,000)
Financial income subject to tax $405,000 Add (deduct) temporary differences:
Excess of tax depreciation over book depreciation (30,000)
Taxable income $375,000 Tax on taxable income (income taxes payable): $375,000 x .35 $131,250
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Because the assets and liabilities recorded under this method are in agreement with the FASB definitions of financial statement elements, the method is conceptually consistent with other standards.
Because the assets and liabilities recorded under this method are in agreement with the FASB definitions of financial statement elements, the method is conceptually consistent with other standards.
Advantages of the Asset and Liability Method
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The asset and liability method is a flexible method that recognizes changes in circumstances and adjusts the reported amounts accordingly. This flexibility may improve the predictive value of the financial statements.
The asset and liability method is a flexible method that recognizes changes in circumstances and adjusts the reported amounts accordingly. This flexibility may improve the predictive value of the financial statements.
Advantages of the Asset and Liability Method
14Annual Computation of Deferred Tax Liabilities and Assets
Identify type and amounts of existing temporary differences.
Establish valuation allowance account if more likely than not some portion or all of the deferred tax asset will not be realized.
Establish valuation allowance account if more likely than not some portion or all of the deferred tax asset will not be realized.
Measure the deferred tax liability for taxable
temporary differences (use enacted rates).
Measure the deferred tax liability for taxable
temporary differences (use enacted rates).
Measure the deferred tax asset for deductible
temporary differences (use enacted rates).
Measure the deferred tax asset for deductible
temporary differences (use enacted rates).
15
• Rodney’s Burger Barn had GAAP income of $4,200. Rodney identified the following possible differences between GAAP and Taxable income:– Interest from municipal bonds $ 100– Premium for Life Insurance on Joe $ 50– Straight-Line Depreciation $ 100– MACRS Depreciation $ 200– Franchising Fees Earned $ 500– Cash Franchising Fees Received $ 800
• Rodney’s enacted tax rate is 40%.
Example: Computation of Deferred Tax Liabilities and Assets
16Annual Computation of Deferred Tax Liabilities and Assets
Identify type and amounts of existing temporary differences.
Establish valuation allowance account if more likely than not some portion or all of the deferred tax asset will not be realized.
Establish valuation allowance account if more likely than not some portion or all of the deferred tax asset will not be realized.
Measure the deferred tax liability for taxable
temporary differences (use enacted rates).
Measure the deferred tax liability for taxable
temporary differences (use enacted rates).
Measure the deferred tax asset for deductible
temporary differences (use enacted rates).
Measure the deferred tax asset for deductible
temporary differences (use enacted rates).
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Difference Temporary/Permanent
Type
Interest on bonds PermanentReduction inTaxable Income
Life Insurance PermanentIncrease inTaxable Income
NetDepreciation Temporary
Deferred TaxLiability
Net FranchisingFees Temporary
Deferred TaxAsset
Example: Identifying Type(s)of Differences for Rodney’s
18Example: Identifying Amountof Differences for Rodney’s
Pretax income $4,200 Add (deduct) permanent differences: Interest on municipal bonds $(100)
Life insurance 50 (50) Income subject to tax $4,150 Add (deduct) temporary differences:
Net depreciation ($100 - $200) $(100) Net fran. revenue ($800 - $500) 300 200
Taxable income $4,350
19Annual Computation of Deferred Tax Liabilities and Assets
Identify type and amounts of existing temporary differences.
Identify type and amounts of existing temporary differences.
Establish valuation allowance account if more likely than not some portion or all of the deferred tax asset will not be realized.
Establish valuation allowance account if more likely than not some portion or all of the deferred tax asset will not be realized.
Measure the deferred tax liability for taxable
temporary differences (use enacted rates).
Measure the deferred tax liability for taxable
temporary differences (use enacted rates).
Measure the deferred tax asset for deductible
temporary differences (use enacted rates).
Measure the deferred tax asset for deductible
temporary differences (use enacted rates).
20Example: Measure DeferredTax Liabilities for Rodney’s
Depreciation for financial income $100
Depreciation for taxable income 200
Net deferred amount $100
Tax rate x 40%
Deferred tax liability $ 40
21Annual Computation of Deferred Tax Liabilities and Assets
Identify type and amounts of existing temporary differences.
Identify type and amounts of existing temporary differences.
Establish valuation allowance account if more likely than not some portion or all of the deferred tax asset will not be realized.
Establish valuation allowance account if more likely than not some portion or all of the deferred tax asset will not be realized.
Measure the deferred tax liability for taxable
temporary differences (use enacted rates).
Measure the deferred tax liability for taxable
temporary differences (use enacted rates).
Measure the deferred tax asset for deductible
temporary differences (use enacted rates).
Measure the deferred tax asset for deductible
temporary differences (use enacted rates).
22Example: Measure DeferredTax Assets for Rodney’s
Franchising revenue for
financial revenue $(500)
Franchising revenue for taxable
revenue 800
Net deferred amount $ 300
Tax rate x 40%
Deferred tax asset $ 120
23
Deferred Tax Asset
Some possible sources of taxable income to be considered in evaluating the realistic value of a deferred tax asset are: Future reversals of existing taxable
temporary differences.
Future taxable income exclusive of reversing temporary differences.
Taxable income in prior (carryback) years.
24
Deferred Tax Asset
A typical journal entry to record the deferred portion of income tax expense is:Deferred Tax Asset--Current xxxDeferred Tax Asset--Noncurrent xxx
Allowance to Reduce Deferred Tax Asset to Realizable Value-- Current xxxAllowance to Reduce Deferred Tax Asset to Realizable Value--Noncurrent xxx
Deferred Tax Liability--Noncurrent xxx
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Taxable Income
Pretax financial income
+/- Permanent differences
= Financial income subject to tax
+/- Temporary differences
= Taxable income
Commonly Confused Commonly Confused Relationships:Relationships:Commonly Confused Commonly Confused Relationships:Relationships:
Income Statement
26Net Operating Losses (NOL)--Alternative Elections
LossYear
Year-2
Year+20
Carryback Election
Carryforward Election
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Accounting for NOL Carryback
Journal Entry in 2003:
Income Tax Refund Receivable 6,200
Income Tax Benefit From NOL Carryback 6,200
[$3,500 + (30% x $9,000)]
Year Tax RateIncome
Tax
2001 $10,000 35% $3,500
2002 14,000 30% 4,200
2003 (19,000) 30% 0
Income (Loss)
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The only loss remaining against which operating income can be applied is $5,000
from 2002. This leaves $30,000 to be carried forward from 2004 as a future tax
benefit of $9,000 ($30,000 x .30).
The only loss remaining against which operating income can be applied is $5,000
from 2002. This leaves $30,000 to be carried forward from 2004 as a future tax
benefit of $9,000 ($30,000 x .30).
Accounting for NOL Carryforward
Year Income (Loss) Tax Rate
IncomeTax
2003 $(19,000) 30% $0
2004 (35,000) 30% 0
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Journal Entry:
Deferred Tax Asset--NOL Carryforward 9,000
Income Tax Benefit From NOL
Carryforward 9,000
Accounting for NOL Carryforward
The journal entry recorded at the end of 2004 indicates that is more likely than not that the carryforward benefit will be realized in full.
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Journal Entry:
Income Tax Expense 15,000Income Taxes Payable 6,000
Deferred Tax Asset--NOL
Carryforward 9,000
Accounting for NOL Carryforward
The firm reports a taxable income of $50,000 in 2005. The tax carryforward allows
management to deduct the carryforward from the $15,000 tax ($50,000 x .30) that would be
due without the carryforward.
31
Accounting for NOL Carryforward
What if, due to a declining market, management believes that losses will continue in the future and the tax benefit will
not be realized?
32
Accounting for NOL Carryforward
Journal Entry:
Deferred Tax Asset--NOL Carryforward 9,000
Allowance to Reduce Deferred Tax
Assets to Realizable Value--NOL
Carryforward 9,000
As a result of this entry, the deferred tax asset is zero--the expected
realizable value.
As a result of this entry, the deferred tax asset is zero--the expected
realizable value.
33Presentation inFinancial Statements
Balance Sheet
Classify deferredtaxes as current ornoncurrent based onasset or liability towhich they relate.Report a net currentand a net noncurrentamount.
Income Statement
Report current taxexpense (benefit)and deferred taxexpense (benefit) andtotal income taxexpense (benefit).
34Financial StatementPresentation and Disclosure
• Current tax expense or benefit
• Deferred tax expense or benefit
• Investment tax credits
• Government grants recognized as tax reductions
The following items must appear in the income statement or an accompanying note:
The following items must appear in the income statement or an accompanying note:
ContinuedContinued
35Financial StatementPresentation and Disclosure
• Benefits of NOL carryforwards
• Adjustments of a deferred tax liability or asset (for enacted laws or rate changes)
• Adjustments in beginning-of-the-year valuation allowance (for a change in circumstances)
The following items must appear in the income statement or an accompanying note:
The following items must appear in the income statement or an accompanying note:
36Approaches to Deferred Tax Accounting
• No-Deferral Approach: Ignore the differences and report income tax expense equal to the amount of tax payable for the year.
• Comprehensive Recognition Approach: Deferred taxes are included in the computation of income tax expense and reported on the balance sheet.
• Partial Recognition Approach: A deferred tax liability is recorded only to the extent that the deferred taxes are actually expected to be paid in the future.
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Intraperiod Tax Allocation
Using interperiod tax allocation, the income tax effect of each special item is reported with the individual item rather
than being included with income tax expense related to current operations.
Using interperiod tax allocation, the income tax effect of each special item is reported with the individual item rather
than being included with income tax expense related to current operations.