Acct 387 - Chapter 20 1

Deferred Taxes - What Are They?

The Federal tax code is designed to collect revenue and influence behavior, not principally to measure income

Accrual accounting is designed to measure income

Many items properly receive different treatment under the two methods, with tax accounting often being more cash basis

In accrual accounting, all taxes that will eventually be paid as a result of income generated this year should be included in expense this year on the income statement

Deferred taxes arise because of eventual tax expense not equaling tax payable in a given year

Acct 387 - Chapter 20 2

Terms

Temporary Difference - An item that has a tax impact at a different time than a book impact, but will be the same in the end.

Permanent Difference - An item that has a different tax treatment than book treatment that will not reverse

Future deductible amount - An amount that decreases taxable income in the future (and increases it now )

Future taxable amount - An amount that increases taxable income in the future (and decreases it now )

Acct 387 - Chapter 20 3

Calculating Tax Expense

The FASB has endorsed an asset/liability approach to deferred taxes. Thus, to calculate them, we:

1. Determine taxes payable from the tax return

2. Determine the amount of deferred tax assets and liabilities that exist at year end based on future taxable and deductible amounts and adjust them to the appropriate balances.

3. Plug tax expense (in most cases, tax expense should equal the book income adjusted for any permanent differences, times the tax rate).

Acct 387 - Chapter 20 4

YearIncome

Before DepTaxableIncome

TaxPayable

AssetBook Basis

AssetTax

Basis

Future TaxableAmount

DeferredTax

Liability98 500000 250000 166667 250000 87500 333333 250000 83333 29166.5599 500000 150000 166666 350000 122500 166667 100000 66667 23333.4500 500000 100000 166667 400000 140000 0 0 0 0

DepreciationTax Book

Example - Single Temporary Difference

98 Tax Expense 116,667Deferred taxes 29,167Tax payable 87,500

99 Tax Expense 116,664Deferred taxes 5,834

Tax payable 122,50000 Tax Expense 116,667

Deferred taxes 23,333Tax payable 140,000 Ex 1, 4, 8

Acct 387 - Chapter 20 5

Deferred Tax Assets and Valuation Accounts

Some questions exist as to the realizability of a deferred tax asset as the amount depends on the existence of future taxable income.

FASB has concluded that a deferred tax asset should be recognized for all future deductible amounts.

If it is "more likely than not" that some portion of a deferred tax asset will not be realized, a valuation allowance should be established, with the debit to income tax expense.

Ex 13

Acct 387 - Chapter 20 6

Financial Statement Presentation

Income tax expense should be reported showing both the current portion (taxes payable) and deferred portion. Taxes should be shown separately for income from continuing operations, discontinued operations, extraordinary items and cumulative changes in accounting principle. Ex 26

On the balance sheet, deferred taxes should be separated into current and noncurrent amounts, and each should have the assets and liabilities netted.

Assets and liabilities are classified as current based on first identifying them with the underlying asset that gives rise to them, and if that is not possible, based on the date they are expected to reverse.

Acct 387 - Chapter 20 7

Tax Rate Changes

Deferred taxes should be based on the future tax rates in effect at the end of the reporting period.

If future tax rates change, then the balance in the deferred tax accounts must be changed, with the related effect going into income taxes (this could be large).

Ex 16, Pb 4

Acct 387 - Chapter 20 8

Carrybacks and Carryforwards

If a corporation sustains a tax loss for the year, it may carry it back for 2 years or forward for 20 years.

When using a carryback, reduce tax expense by the carryback realized.

When using a carryforward, recognize a deferred tax asset and reduce tax expense.

For carryforwards, a valuation allowance may again be necessary.

Ex 26