19-1 prepared by coby harmon university of california, santa barbara intermediat e accounting...

19-1

Prepared by Prepared by Coby Harmon Coby Harmon

University of California, Santa BarbaraUniversity of California, Santa Barbara

IntermediatIntermediate e

AccountingAccounting

IntermediatIntermediate e

AccountingAccounting

Prepared by Prepared by Coby Harmon Coby Harmon

University of California, Santa BarbaraUniversity of California, Santa BarbaraWestmont CollegeWestmont College

INTERMEDIATE

ACCOUNTINGF I F T E E N T H E D I T I O N

Prepared byCoby Harmon

University of California, Santa BarbaraWestmont College

kikieesosowweeygandtygandtwarfiwarfieeldld

team for successteam for success

19-2

PREVIEW OF CHAPTERPREVIEW OF CHAPTER

Intermediate Accounting15th Edition

Kieso Weygandt Warfield

1919

19-3

6. Describe various temporary and permanent differences.

7. Explain the effect of various tax rates and tax rate changes on deferred income taxes.

8. Apply accounting procedures for a loss carryback and a loss carryforward.

9. Describe the presentation of deferred income taxes in financial statements.

10. Indicate the basic principles of the asset-liability method.

After studying this chapter, you should be able to:

LEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVES

1. Identify differences between pretax financial income and taxable income.

2. Describe a temporary difference that results in future taxable amounts.

3. Describe a temporary difference that results in future deductible amounts.

4. Explain the purpose of a deferred tax asset valuation allowance.

5. Describe the presentation of income tax expense in the income statement.

Accounting for Accounting for Income TaxesIncome Taxes1919

19-4

Corporations must file income tax returns following the

guidelines developed by the Internal Revenue Service (IRS).

Because GAAP and tax regulations differ in a number of ways,

the amounts reported for the following will differ:

income tax expense (GAAP)

income tax payable (Internal Revenue Code).

Accounting for Income Taxes

LO 1

19-5

Tax Code

Financial Statements

Pretax Financial IncomePretax Financial Income

GAAP

Income Tax ExpenseIncome Tax Expense

Taxable Income

Income Taxes Payable

Tax Return

vs.


LO 1

19-6

Illustration: Chelsea, Inc. reported revenues of $130,000 and

expenses of $60,000 in each of its first three years of

operations. For tax purposes, Chelsea reported the same

expenses to the IRS in each of the years. Chelsea reported

taxable revenues of $100,000 in 2014, $150,000 in 2015, and

$140,000 in 2016. What is the effect on the accounts of

reporting different amounts of revenue for GAAP versus tax?


LO 1

19-7

Revenues

Expenses

Pretax financial income

Income tax expense (40%)

$130,000

60,000

$70,000

$28,000

$130,000

2015

60,000

$70,000

$28,000

$130,000

2016

60,000

$70,000

$28,000

$390,000

Total

180,000

$210,000

$84,000

GAAP ReportingGAAP Reporting

Revenues

Expenses

Taxable income

Income tax payable (40%)

$100,000

2014

60,000

$40,000

$16,000

$150,000

2015

60,000

$90,000

$36,000

$140,000

2016

60,000

$80,000

$32,000

$390,000

Total

180,000

$210,000

$84,000

Tax Reporting

2014Illustration 19-2

Illustration 19-3

Book vs. Tax Differences

LO 1

19-8

Income tax expense (GAAP)

Income tax payable (IRS)

Difference

Income tax expense (40%)

$28,000

16,000

$12,000

$28,000

$28,000

2015

36,000

$(8,000)

$28,000

$28,000

2016

32,000

$(4,000)

$28,000

$84,000

Total

84,000

$0

$84,000

Comparison 2014Illustration 19-4

Are the differences accounted for in the financial statements?

Year Reporting Requirement

2014

2015

2016

Deferred tax liability account increased to $12,000

Deferred tax liability account reduced by $8,000

Deferred tax liability account reduced by $4,000

YesYes

Book vs. Tax Differences

LO 1

19-9

Balance Sheet

Assets:

Liabilities:

Equity:Income tax expense 28,000

Income Statement

Revenues:

Expenses:

Net income (loss)

2014 2014

Deferred taxes 12,000

Where does the “deferred tax liability” get reported in the financial statements?

Income taxes payable 16,000

Financial Reporting for 2014

LO 1

19-10














19-11

A temporary difference is the difference between the tax basis of an asset or liability and its reported (carrying or book) amount in the financial statements that will result in taxable amounts or deductible amounts in future years.

Future Taxable AmountsFuture Taxable Amounts Future Deductible AmountsFuture Deductible Amounts

Deferred Tax Liability represents the increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year.

Deferred Tax Asset represents the increase in taxes refundable (or saved) in future years as a result of deductible temporary differences existing at the end of the current year.

Illustration 19-22 provides Examples of Temporary Differences

LO 2

Future Taxable and Deductible Amounts

19-12

Illustration: In Chelsea’s situation, the only difference between

the book basis and tax basis of the assets and liabilities relates to

accounts receivable that arose from revenue recognized for book

purposes. Chelsea reports accounts receivable at $30,000 in the

December 31, 2014, GAAP-basis balance sheet. However, the

receivables have a zero tax basis.

Illustration 19-5

LO 2

Future Taxable Amounts

19-13

Chelsea assumes that it will collect the accounts receivable and report

the $30,000 collection as taxable revenues in future tax returns.

Chelsea does this by recording a deferred tax liability.

Illustration 19-6

Illustration: Reversal of Temporary Difference, Chelsea Inc.

LO 2

Future Taxable Amounts

19-14

A deferred tax liability represents the increase in taxes payable

in future years as a result of taxable temporary differences

existing at the end of the current year.

Deferred Tax Liability

Income tax expense (GAAP)

Income tax payable (IRS)

Difference

$28,000

16,000

$12,000

$28,000

2015

36,000

$(8,000)

$28,000

2016

32,000

$(4,000)

$84,000

Total

84,000

$0

2014

Illustration 19-4

LO 2

Deferred Taxes

19-15

Illustration: Because it is the first year of operations for Chelsea,

there is no deferred tax liability at the beginning of the year.

Chelsea computes the income tax expense for 2014 as follows:

Illustration 19-9

LO 2


19-16

Chelsea makes the following entry at the end of 2014 to record

income taxes.

Income Tax Expense 28,000


16,000


12,000LO 2

Deferred Tax LiabilityIllustration 19-9Computation of IncomeTax Expense, 2014

19-17 LO 2


Chelsea makes the following entry at the end of 2015 to record

income taxes.


Deferred Tax Liability 8,000


36,000

Illustration 19-10Computation of Income Tax Expense for 2015

19-18

The entry to record income taxes at the end of 2016 reduces the

Deferred Tax Liability by $4,000. The Deferred Tax Liability account

appears as follows at the end of 2016.

Illustration 19-11

LO 2


19-19 LO 2

19-20

Illustration: Starfleet Corporation has one temporary difference at

the end of 2014 that will reverse and cause taxable amounts of

$55,000 in 2015, $60,000 in 2016, and $75,000 in 2017. Starfleet’s

pretax financial income for 2014 is $400,000, and the tax rate is 30%

for all years. There are no deferred taxes at the beginning of 2014.

Instructions

a) Compute taxable income and income taxes payable for 2014.

b) Prepare the journal entry to record income tax expense,

deferred income taxes, and income taxes payable for 2014.

LO 2


19-21

Illustration: Current Yr.

INCOME: 2014 2015 2016 2017

Financial income (GAAP) 400,000

Temporary Diff. (190,000) 55,000 60,000 75,000

Taxable income (IRS) 210,000 55,000 60,000 75,000

Tax rate 30% 30% 30% 30%

Income tax 63,000 16,500 18,000 22,500

b. Income Tax Expense (plug) 120,000

Income Taxes Payable 63,000


a.a.

a.a.

LO 2


19-22














19-23

Illustration: During 2014, Cunningham Inc. estimated its warranty

costs related to the sale of microwave ovens to be $500,000, paid

evenly over the next two years. For book purposes, in 2014

Cunningham reported warranty expense and a related estimated

liability for warranties of $500,000 in its financial statements. For

tax purposes, the warranty tax deduction is not allowed until paid.

Illustration 19-12

Future Deductible Amounts

LO 3

19-24

When Cunningham pays the warranty liability, it reports an expense

(deductible amount) for tax purposes. Cunningham reports this future

tax benefit in the December 31, 2014, balance sheet as a deferred tax

asset.

Illustration 19-13

Illustration: Reversal of Temporary Difference.

2014 2015 2016


LO 3

19-25

A deferred tax asset represents the increase in taxes

refundable (or saved) in future years as a result of deductible

temporary differences existing at the end of the current year.

Deferred Tax Asset


LO 3

19-26

Illustration: Hunt Co. accrues a loss and a related liability of

$50,000 in 2014 for financial reporting purposes because of

pending litigation. Hunt cannot deduct this amount for tax

purposes until the period it pays the liability, expected in 2015. Illustration 19-14

Deferred Tax Asset

LO 3

19-27

Assume that 2014 is Hunt’s first year of operations, and income tax

payable is $100,000, compute income tax expense.Illustration 19-16

Deferred Tax Asset

Prepare the entry at the end of 2014 to record income taxes.


Deferred Tax Asset 20,000

Income Taxes Payable 100,000 LO 3

19-28

Computation of Income Tax Expense for 2015.Illustration 19-17

Deferred Tax Asset

Prepare the entry at the end of 2015 to record income taxes.


Deferred Tax Asset20,000

Income Taxes Payable 140,000 LO 3

19-29

The entry to record income taxes at the end of 2015 reduces the

Deferred Tax Asset by $20,000.

Illustration 19-18

Deferred Tax Asset

LO 3

19-30

Illustration: Columbia Corporation has one temporary difference at

the end of 2014 that will reverse and cause deductible amounts of

$50,000 in 2015, $65,000 in 2016, and $40,000 in 2017. Columbia’s

pretax financial income for 2014 is $200,000 and the tax rate is 34%

for all years. There are no deferred taxes at the beginning of 2014.

Columbia expects to be profitable in the future.

Instructions

a) Compute taxable income and income taxes payable for 2014.

b) Prepare the journal entry to record income tax expense, deferred

income taxes, and income taxes payable for 2014.

Deferred Tax Asset

LO 3

19-31

Illustration Current Yr.

INCOME: 2014 2015 2016 2017


Temporary Diff. 155,000 (50,000) (65,000) (40,000)

Taxable income (IRS) 355,000 (50,000) (65,000) (40,000)

Tax rate 34% 34% 34% 34%

Income tax 120,700 (17,000) (22,100) (13,600)

b. Income Tax Expense 68,000



a.a.

a.a.

Deferred Tax Asset

Advance slide in presentation mode to reveal answers. LO 3

19-32 LO 3

19-33














19-34

Deferred Tax Asset—Valuation Allowance

A company should reduce a deferred tax asset by a valuation

allowance if it is more likely than not that it will not realize

some portion or all of the deferred tax asset.

“More likely than not” means a level of likelihood of at least

slightly more than 50 percent.

LO 4


19-35

Illustration: Callaway Corp. has a deferred tax asset balance of

$150,000 at the end of 2014 due to a single cumulative temporary

difference of $375,000. At the end of 2015 this same temporary

difference has increased to a cumulative amount of $500,000.

Taxable income for 2015 is $850,000. The tax rate is 40% for all

years. No valuation account is in existence at the end of 2014.

Instructions

Assuming that it is more likely than not that $30,000 of the deferred

tax asset will not be realized, prepare the journal entries required for

2015.

LO 4


19-36

Illustration: Current Yr.

INCOME: 2013 2014 2015


Temporary difference 375,000 125,000 (500,000)

Taxable income (IRS) 375,000 850,000 (500,000) -

Tax rate 40% 40% 40% 40%

Income tax 150,000 340,000 (200,000) -





Allowance for Deferred Tax Asset 30,000

LO 4


19-37

Balance Sheet Presentation

Assets: 2014

Deferred tax asset 200,000$

Allowance for deferred tax (30,000)

Deferred tax asset, net 170,000

LO 4


19-38














19-39

Income Taxes

Payable Or

Refundable

Change In

Deferred Income

Taxes

Income Tax

Expense or

Benefit

++-- ==

In the income statement or in the notes to the financial

statements, a company should disclose the significant

components of income tax expense (current and deferred).

Formula to Compute Income Tax ExpenseIllustration 19-20

LO 5

Income Statement Presentation


19-40

Income Statement Presentation

Given the previous information related to Chelsea Inc.,

Chelsea reports its income statement as follows.Illustration 19-21

LO 5

19-41














19-42

Taxable temporary differences - Deferred tax liability

Deductible temporary differences - Deferred tax

Asset

Temporary Differences

LO 6

Specific Differences


19-43 LO 6


Revenues or gains are taxable after they are recognized in financial income.

An asset (e.g., accounts receivable or investment) may be recognized for revenues or

gains that will result in taxable amounts in future years when the asset is recovered.

Examples:

1.Sales accounted for on the accrual basis for financial reporting purposes and on the

installment (cash) basis for tax purposes.

2.Contracts accounted for under the percentage-of-completion method for financial

reporting purposes and a portion of related gross profit deferred for tax purposes.

3.Investments accounted for under the equity method for financial reporting purposes

and under the cost method for tax purposes.

4.Gain on involuntary conversion of nonmonetary asset which is recognized for financial

reporting purposes but deferred for tax purposes.

5.Unrealized holding gains for financial reporting purposes (including use of the fair

value option), but deferred for tax purposes.

Illustration 19-22Examples of TemporaryDifferences

19-44 LO 6


Expenses or losses are deductible after they are recognized in financial income.

A liability (or contra asset) may be recognized for expenses or losses that will result in

deductible amounts in future years when the liability is settled. Examples:

1.Product warranty liabilities.

2.Estimated liabilities related to discontinued operations or restructurings.

3.Litigation accruals.

4.Bad debt expense recognized using the allowance method for financial reporting

purposes; direct write-off method used for tax purposes.

5.Stock-based compensation expense.

6.Unrealized holding losses for financial reporting purposes (including use of the fair

value option), but deferred for tax purposes.


19-45 LO 6


Revenues or gains are taxable before they are recognized in financial income.

A liability may be recognized for an advance payment for goods or services to be

provided in future years. For tax purposes, the advance payment is included in taxable

income upon the receipt of cash. Future sacrifices to provide goods or services (or

future refunds to those who cancel their orders) that settle the liability will result in

deductible amounts in future years. Examples:

1.Subscriptions received in advance.

2.Advance rental receipts.

3.Sales and leasebacks for financial reporting purposes (income deferral) but reported

as sales for tax purposes.

4.Prepaid contracts and royalties received in advance.


19-46 LO 6


Expenses or losses are deductible before they are recognized in financial income.

The cost of an asset may have been deducted for tax purposes faster than it was

expensed for financial reporting purposes. Amounts received upon future recovery of

the amount of the asset for financial reporting (through use or sale) will exceed the

remaining tax basis of the asset and thereby result in taxable amounts in future

years. Examples:

1.Depreciable property, depletable resources, and intangibles.

2.Deductible pension funding exceeding expense.

3.Prepaid expenses that are deducted on the tax return in the period paid.


19-47 LO 6

Originating and Reversing Aspects of Temporary

Differences.

Originating temporary difference is the initial difference

between the book basis and the tax basis of an asset or liability.

Reversing difference occurs when eliminating a temporary

difference that originated in prior periods and then removing the

related tax effect from the deferred tax account.


19-48

Permanent differences result from items that (1) enter into

pretax financial income but never into taxable income or (2)

enter into taxable income but never into pretax financial income.

Permanent differences affect only the period in which they occur.

They do not give rise to future taxable or deductible amounts.

There are no deferred tax consequences to be recognized.

LO 6


19-49 LO 6

Permanent Differences

Items are recognized for financial reporting purposes but not for tax purposes.

Examples:

1.Depreciable property, depletable resources, and intangibles.

2.Examples:

3.Interest received on state and municipal obligations.

4.Expenses incurred in obtaining tax-exempt income.

5.Proceeds from life insurance carried by the company on key officers or employees.

6.Premiums paid for life insurance carried by the company on key officers or employees

(company is beneficiary).

7.Fines and expenses resulting from a violation of law.

Illustration 19-24Examples of PermanentDifferences

Items are recognized for tax purposes but not for financial reporting purposes.

Examples:

1.“Percentage depletion” of natural resources in excess of their cost.

2.The deduction for dividends received from U.S. corporations, generally 70% or 80%.

19-50

Do the following generate: Future Deductible Amount = Deferred Tax Asset Future Taxable Amount = Deferred Tax Liability Permanent Difference

1. The MACRS depreciation system is used for tax

purposes, and the straight-line depreciation method

is used for financial reporting purposes.

2. A landlord collects some rents in advance. Rents

received are taxable in the period when they are

received.

3. Expenses are incurred in obtaining tax-exempt

income.

Future Taxable Future Taxable AmountAmount

LO 6


Liability

Future Deductible Future Deductible AmountAmount

Asset

Permanent Permanent DifferenceDifference

Illustration

19-51

Do the following generate: Future Deductible Amount = Deferred Tax Asset Future Taxable Amount = Deferred Tax Liability Permanent Difference

4. Costs of guarantees and warranties are estimated

and accrued for financial reporting purposes.

5. Installment sales of investments are accounted for

by the accrual method for financial reporting

purposes and the installment-sales method for tax

purposes.

6. Proceeds are received from a life insurance

company because of the death of a key officer (the

company carries a policy on key officers).

Future Deductible Future Deductible AmountAmount

LO 6


Asset

Future Taxable Future Taxable AmountAmount

Liability

Permanent Permanent DifferenceDifference

Illustration

19-52

Illustration: Havaci Company reports pretax financial income of $80,000 for 2014. The following items cause taxable income to be different than pretax financial income.

1. Depreciation on the tax return is greater than depreciation on the income statement by $16,000.

2. Rent collected on the tax return is greater than rent earned on the income statement by $27,000.

3. Fines for pollution appear as an expense of $11,000 on the income statement.

Havaci’s tax rate is 30% for all years, and the company expects to report taxable income in all future years. There are no deferred taxes at the beginning of 2014.

LO 6


19-53

Illustration: Current Yr. Deferred Deferred

INCOME: 2014 Asset Liability

Financial income (GAAP) 80,000$

Excess tax depreciation (16,000) 16,000$

Excess rent collected 27,000 (27,000)$

Fines (permanent) 11,000

Taxable income (IRS) 102,000 (27,000) 16,000 -

Tax rate 30% 30% 30%

Income tax 30,600$ (8,100)$ 4,800$ -





LO 6


Advance slide in presentation mode to reveal answers.

19-54














19-55

A company must consider presently enacted changes in the tax

rate that become effective for a particular future year(s) when

determining the tax rate to apply to existing temporary

differences.

In determining the appropriate enacted tax rate for a given year,

companies must use the average tax rate.

Future Tax Rates

LO 7

Tax Rate Considerations


19-56

When a change in the tax rate is enacted, companies should

record its effect on the existing deferred income tax accounts

immediately.

A company reports the effect as an adjustment to income tax

expense in the period of the change.

Revision of Future Tax Rates

LO 7

Tax Rate Considerations


19-57














19-58

Net operating loss (NOL) = tax-deductible expenses exceed

taxable revenues.

The federal tax laws permit taxpayers to use the losses of one

year to offset the profits of other years (loss carryback and

loss carryforward).

Accounting for Net Operating Losses

LO 8

19-59

Loss Carryback

Back 2 years and forward 20 years

Losses must be applied to earliest year first

Illustration 19-29

LO 8


19-60

Loss Carryforward

May elect to forgo loss carryback and

Carryforward losses 20 years

Illustration 19-30

LO 8


19-61

Illustration: Conlin Corporation had the following tax information.

Taxable Tax TaxesYear Income Rate Paid

2012 300,000$ 35% 105,000$

2013 325,000 30% 97,500

2014 400,000 30% 120,000

In 2015 Conlin suffered a net operating loss of $480,000, which it

elected to carry back. The 2015 enacted tax rate is 29%.

Prepare Conlin’s entry to record the effect of the loss carryback.

LO 8


19-62

Illustration: 2012 2013 2014 2015

Financial income 300,000$ 325,000$ 400,000$

Difference

Taxable income (loss) 300,000 325,000 400,000 (480,000)

Rate 35% 30% 30% 29%

Income tax 105,000$ 97,500$ 120,000$

NOL Schedule

Taxable income 300,000$ 325,000$ 400,000$ (480,000)

Carryback (325,000) (155,000) 480,000

Taxable income 300,000 - 245,000 -

Rate 35% 30% 30% 29%

Income tax (revised) 105,000$ -$ 73,500$ -

Refund 97,500$ 46,500$ $144,000$144,000

LO 8Advance slide in presentation mode to reveal answers.


19-63

Journal Entry for 2015

Income Tax Refund Receivable 144,000

Benefit Due to Loss Carryback

144,000

LO 8

Illustration: 2012 2013 2014 2015

NOL Schedule

Taxable income 300,000$ 325,000$ 400,000$ (480,000)

Carryback (325,000) (155,000) 480,000

Taxable income 300,000 - 245,000 -

Rate 35% 30% 30% 29%

Income tax (revised) 105,000$ -$ 73,500$ -

Refund 97,500$ 46,500$


19-64

Illustration: Rode Inc. incurred a net operating loss of $500,000

in 2014. Combined income for 2012 and 2013 was $350,000. The

tax rate for all years is 40%. Rode elects the carryback option.

Prepare the journal entries to record the benefits of the loss

carryback and the loss carryforward.

LO 8


19-65

Illustration: 2012-2013 2014 2015

Financial income 350,000$

Difference

Taxable income (loss) 350,000 (500,000)

Rate 40% 40%

Income tax 140,000$

NOL Schedule

Taxable income 350,000$ (500,000)

Carryback (350,000) 350,000

Taxable income - (150,000)

Rate 40% 40%

Income tax (revised) -$ (60,000)

LO 8


Advance slide in presentation mode to reveal answers.

19-66

Illustration: 2012-2013 2014 2015

Financial income 350,000$

Difference

Taxable income (loss) 350,000 (500,000)

Rate 40% 40%

Income tax 140,000$

NOL Schedule

Taxable income 350,000$ (500,000)

Carryback (350,000) 350,000


Rate 40% 40%


LO 8


Journal Entries for 2014


Benefit Due to Loss Carryback

140,000

19-67

Illustration: 2012-2013 2014 2015

NOL Schedule

Taxable income 350,000$ (500,000)

Carryback (350,000) 350,000


Rate 40% 40%


LO 8




Benefit Due to Loss Carryforward

60,000

19-68 LO 8


Illustration: Rode Inc. incurred a net operating loss of $500,000

in 2014. Combined income for 2012 and 2013 was $350,000. The

tax rate for all years is 40%. Rode elects the carryback option.

Assume that it is more likely than not that the entire net operating

loss carryforward will not be realized in future years. Prepare all

the journal entries necessary at the end of 2014.

19-69


LO 8



Benefit Due to Loss Carryback140,000


Benefit Due to Loss Carryforward60,000

Benefit Due to Loss Carryforward 60,000

Allowance for Deferred Tax Asset60,000

Advance slide in presentation mode to reveal journal entry to recognize the valuation allowance.

19-70

Whether the company will realize a deferred tax asset depends on

whether sufficient taxable income exists or will exist within the

carryforward period.

LO 8


Valuation Allowance Revisited

Illustration 19-37Possible Sources ofTaxable Income

19-71 LO 8



Illustration 19-38Evidence to Consider in Evaluating the Need for a Valuation Account

19-72 LO 8

19-73














19-74

Balance Sheet

Financial Statement Presentation

An individual deferred tax liability or asset is classified as current or noncurrent based on the classification of the related asset or liability for financial reporting purposes.

Companies should classify deferred tax accounts on the balance sheet in two categories:

one for the net current amount, and

one for the net noncurrent amount.

LO 9

19-75

Balance Sheet

LO 9

ILLUSTRATION 19-39Classification of Temporary Differences as Current or Noncurrent

19-76

Income Statement

Companies should allocate income tax expense (or benefit) to continuing operations, discontinued operations, extraordinary items, and prior period adjustments.

Companies should disclose the significant components of income tax expense attributable to continuing operations (current tax expense, deferred tax expense, etc.).

LO 9

Financial Statement Presentation

19-77














19-78

The FASB believes that the asset-liability method (sometimes

referred to as the liability approach) is the most consistent

method for accounting for income taxes.

LO 10

Review of the Asset-Liability Method

Illustration 19-42Basic Principles of theAsset-Liability Method

19-79

Illustration 19-43Procedures for Computingand Reporting DeferredIncome Taxes

LO 10

Review of the Asset-Liability Method

19-80

Fiscal Year-2013

Allman Company, which began operations at the beginning of 2013,

produces various products on a contract basis. Each contract

generates a gross profit of $80,000. Some of Allman’s contracts

provide for the customer to pay on an installment basis. Under these

contracts, Allman collects one-fifth of the contract revenue in each of

the following four years. For financial reporting purposes, the company

recognizes gross profit in the year of completion (accrual basis); for tax

purposes, Allman recognizes gross profit in the year cash is collected

(installment basis).

LO 11 Understand and apply the concepts and procedures of interperiod tax allocation.

APPENDIXAPPENDIX 19A COMPREHENSIVE EXAMPLE OF INTERPERIOD COMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONTAX ALLOCATION

19-81

Fiscal Year-2013Presented below is information related to Allman’s operations for 2013.

1. In 2013, the company completed seven contracts that allow for the customer to pay on an installment basis. Allman recognized the related gross profit of $560,000 for financial reporting purposes. It reported only $112,000 of gross profit on installment sales on the 2013 tax return. The company expects future collections on the related installment receivables to result in taxable amounts of $112,000 in each of the next four years.

2. At the beginning of 2013, Allman Company purchased depreciable assets with a cost of $540,000. For financial reporting purposes, Allman depreciates these assets using the straight-line method over a six-year service life. For tax purposes, the assets fall in the five-year recovery class, and Allman uses the MACRS system.

LO 11


19-82

Fiscal Year-2013

LO 11

3. The company warrants its product for two years from the date of completion of a contract. During 2013, the product warranty liability accrued for financial reporting purposes was $200,000, and the amount paid for the satisfaction of warranty liability was $44,000. Allman expects to settle the remaining $156,000 by expenditures of $56,000 in 2014 and $100,000 in 2015.


19-83

Fiscal Year-2013

LO 11

4. In 2013 nontaxable municipal bond interest revenue was $28,000.

5. During 2013 nondeductible fines and penalties of $26,000 were paid.

6. Pretax financial income for 2013 amounts to $412,000.

7. Tax rates enacted before the end of 2013 were:

2013 50%

2014 and later years 40%

8. The accounting period is the calendar year.

9. The company is expected to have taxable income in all future years.


19-84

Taxable Income and Income Taxes Payable-2013

LO 11

The first step is to determine Allman Company’s income tax payable

for 2013 by calculating its taxable income.

Illustration 19A-1

Illustration 19A-2


19-85

Computing Deferred Income Taxes – End of 2013

LO 11

Illustration 19A-3

Illustration 19A-4


19-86

Deferred Tax Expense (Benefit) and the Journal Entry to Record Income Taxes - 2013

LO 11

Illustration 19A-5Computation of Deferred Tax Expense (Benefit), 2013

Computation of Net Deferred Tax Expense, 2013 Illustration 19A-6


19-87

Deferred Tax Expense (Benefit) and the Journal Entry to Record Income Taxes - 2013

LO 11

Illustration 19A-7

Computation of Total Income Tax Expense, 2013

Journal Entry for Income Tax Expense, 2013




50,000


186,400


19-88

Companies should classify deferred tax assets and liabilities as

current and noncurrent on the balance sheet based on the

classifications of related assets and liabilities.

Financial Statement Presentation - 2013

LO 11

Illustration 19A-8


19-89

Balance Sheet Presentation of Deferred Taxes, 2013

Financial Statement Presentation - 2013

LO 11

Illustration 19A-9


Income statement for 2013 reports the following. Illustration 19A-10

19-90 LO 12 Compare the accounting for income taxes under GAAP and IFRS.

RELEVANT FACTS - Similarities

Similar to GAAP, IFRS uses the asset and liability approach for recording deferred taxes.

19-91

RELEVANT FACTS - Differences

The classification of deferred taxes under IFRS is always non-current. As indicated in the chapter, GAAP classifies deferred taxes based on the classification of the asset or liability to which it relates.

Under IFRS, an affirmative judgment approach is used, by which a deferred tax asset is recognized up to the amount that is probable to be realized. GAAP uses an impairment approach. In this approach, the deferred tax asset is recognized in full. It is then reduced by a valuation account if it is more likely than not that all or a portion of the deferred tax asset will not be realized.

IFRS uses the enacted tax rate or substantially enacted tax rate. (“Substantially enacted” means virtually certain.) For GAAP, the enacted tax rate must be used.

LO 12

19-92

RELEVANT FACTS - Differences

The tax effects related to certain items are reported in equity under IFRS. That is not the case under GAAP, which charges or credits the tax effects to income.

GAAP requires companies to assess the likelihood of uncertain tax positions being sustainable upon audit. Potential liabilities must be accrued and disclosed if the position is “more likely than not” to be disallowed. Under IFRS, all potential liabilities must be recognized. With respect to measurement, IFRS uses an expected-value approach to measure the tax liability, which differs from GAAP.

LO 12

19-93

Which of the following is false?

a. Under GAAP, deferred taxes are reported based on the

classification of the asset or liability to which it relates.

b. Under IFRS, some potential liabilities are not recognized.

c. Under GAAP, the enacted tax rate is used to measure deferred

tax assets and liabilities.

d. Under IFRS, all deferred tax assets and liabilities are classified

as non-current.

IFRS SELF-TEST QUESTION

LO 12

19-94

Which of the following statements is correct with regard to IFRS and GAAP?

a. Under GAAP, all potential liabilities related to uncertain tax positions

must be recognized.

b. The tax effects related to certain items are reported in equity under

GAAP; under IFRS, the tax effects are charged or credited to income.

c. IFRS uses an affirmative judgment approach for deferred tax assets,

whereas GAAP uses an impairment approach for deferred tax assets.

d. IFRS classifies deferred taxes based on the classification of the asset

or liability to which it relates.


LO 12

19-95

Under IFRS:

a. “probable” is defined as a level of likelihood of at least slightly

more than 60%.

b. a company should reduce a deferred tax asset when it is likely

that some or all of it will not be realized by using a valuation

allowance.

c. a company considers only positive evidence when determining

whether to recognize a deferred tax asset.

d. deferred tax assets must be evaluated at the end of each

accounting period.


LO 12

19-96

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19-1 prepared by coby harmon university of california, santa barbara intermediat e accounting...

Documents

income tax returns

income statement

tax differences

tax reporting

tax regulations

tax purposes

tax rate changes

deferred tax liability