Ch 19 - Accounting for income taxes

Method of accounting for income taxes. Companies recognize on the current-year return a current tax liability/asset for the estimated taxes payable/refundable, and they recognize a deferred tax liability/asset for estimated future tax effects due to temporary differences and tax carryforwards. The measurement of current/deferred tax liabilities/assets is based on provisions of the tax law. Companies establish a valuation allowance account if it is more likely than not that some/all of the deferred tax assets will not be realized.

Asset-liability method

Temporary difference that will result in deductible amounts in future years, when the related book liabilities are settled. They give rise to recording deferred tax assets. Examples are (1) expenses or losses that are deductible after they are recognized in financial income, and (2) revenues or gains that are taxable before they are recognized in financial income

Deductible temporary difference

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

A company reduces a deferred tax asset by a valuation allowance if it is probable that it will not realize some portion of the deferred tax asset.

False

Examples of taxable temporary differences are subscriptions received in advance and advance rental receipts.

False

Companies should classify deferred tax accounts on the balance sheet as current assets or current liabilities.

False Companies should classify deferred tax accounts as a net noncurrent amount on the balance sheet. The net deferred tax asset or net deferred tax liability is therefore reported in the noncurrent section of the balance sheet.

Deductible amounts cause taxable income to be greater than pretax financial income in the future as a result of existing temporary differences.

False Deductible amounts cause taxable income to be less than pretax financial income in the future as a result of existing temporary differences.

A company should add a decrease in a deferred tax liability to income taxes payable in computing income tax expense.

False Deferred tax benefit is a negative component of income tax expense

Pretax financial income is the amount used to compute income taxes payable

False Pretax financial income is also referred to as income before tax, income for financial reporting purposes, or income for book purposes. Companies sometimes include income on their financial statement that is not taxable income so investors can see that the income in question was indeed earned.

Taxable income is a tax accounting term and is also referred to as income before taxes

False Taxable income is a tax accounting term and is also referred to as income for tax purpose

The FASB believes that the deferred tax method is the most consistent method for accounting for income taxes.

False 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.

Under the loss carryback approach, companies must apply a current year loss to the most recent year first and then to an earlier year.

False Under this provision a company pays no income taxes for a year in which it incurs a net operating loss and a company may also carry the net operating loss forward indefinitely to offset future tax income and reduce taxes payable in the future years.

When a change in the tax rate is enacted, the effect is reported as an adjustment to income tax payable in the period of the change.

False When a change in the tax rate is enacted, the effect is reported as an adjustment to income tax expense in the period of the change

The account to which a company records a tax benefit. The company reports this account on the balance sheet as a current asset and reports it on the income statement as an income tax benefit.

Income Tax Refund Receivable

An income-averaging provision in the U.S. tax code that enables companies to carry forward any loss remaining after a two year carryback up to 20 years to offset future taxable income. Or a company may forgo the loss carryback and use only the loss carryforward option, offsetting future taxable income for up to 20 years

Loss carryforward

A financial reporting term, determined according to GAAP and with the purpose of providing useful information to investors and creditors. Also often referred to as income before income taxes, income for financial reporting purposes, or income for book purposes. Pretax financial income is not the same as taxable income, which is income calculated for tax purposes and determined according to the U.S. tax code. The main difference is that companies use the accrual method to report revenues for financial reporting and they use a modified cash basis to report revenues for tax purposes.

Pretax financial income

The elimination of a temporary difference that originated in prior periods and removal of the related tax effect from the deferred tax account

Reversing difference

The result, for accounting as well as tax purposes, of a loss carryback. When a company recognizes a tax loss that gives rise to a tax refund, the company should recognize the associated tax benefit by reporting it as a current asset on the balance sheet and as a benefit due to loss carryback on the income statement.

Tax benefit

A temporary difference between the tax basis of an asset/liability and its reported (carrying or book) amount in the financial statements that will increase taxable income in future years

Taxable amounts

A deferred tax asset represents the increase in taxes refundable in future years as a result of deductible temporary differences existing at the end of the current year.

True

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.

True

A possible source of taxable income that may be available to realize a tax benefit for loss carryforwards is future reversals of existing taxable temporary differences.

True

Companies must consider presently enacted changes in the tax rate that become effective in future years when determining the tax rate to apply to existing temporary differences.

True

Companies should consider both positive and negative evidence to determine whether it needs to record a valuation allowance to reduce a deferred tax asset.

True

Deferred tax expense is the increase in the deferred tax liability balance from the beginning to the end of the accounting period.

True

Permanent differences do not give rise to future taxable or deductible amounts

True

Taxable temporary differences will result in taxable amounts in future years when the related assets are recovered

True

The tax effect of a loss carryforward represents future tax savings and results in the recognition of a deferred tax asset.

True

Companies are permitted to offset any balances in income taxes payable against related income tax refund receivable or prepaid income taxes balances.

True Page 19-23 last paragraph

A temporary difference arises when a revenue item is reported for tax purposes in a period After it is reported Before it is reported in financial income in financial income a. Yes Yes b. Yes No c. No Yes d. No No

a. Yes Yes

Machinery was acquired at the beginning of the year. Depreciation recorded during the life of the machinery could result in Future Future Taxable Amounts Deductible Amounts a. Yes Yes b. Yes No c. No Yes d. No No

a. Yes Yes

Recognizing a valuation allowance for a deferred tax asset requires that a company a. consider all positive and negative information in determining the need for a valuation allowance. b. consider only the positive information in determining the need for a valuation allowance. c. take an aggressive approach in its tax planning. d. pass a recognition threshold, after assuming that it will be audited by taxing authorities

a. consider all positive and negative information in determining the need for a valuation allowance.

Designed by the IRS to curb excessive tax avoidance, this provision requires companies to compute their potential tax liability under the AMT, adjusting for various preference items that reduce their tax bills under the regular tax code (e.g., accelerated depreciation methods). Companies must then pay the higher of the two tax obligations computed under the AMT and the regular tax code.

alternative minimum tax (AMT)

An average of the graduated rates at which the IRS taxes U.S. corporations. The first $50,000 of taxable income at 15 percent, the next $25,000 at 25 percent, with higher incremental levels of income at rates as high as 39 percent.

average tax rate

Taxable income of a corporation a. differs from accounting income due to differences in intraperiod allocation between the two methods of income determination. b. differs from accounting income because companies use the full accrual method for financial reporting but use the modified cash basis for tax reporting. c. is based on generally accepted accounting principles. d. is reported on the corporation's income statement

b. differs from accounting income because companies use the full accrual method for financial reporting but use the modified cash basis for tax reporting.

Taxable income of a corporation differs from pretax financial income because of Permanent Temporary Differences Differences a. No No b. No Yes c. Yes Yes d. Yes No

c. Yes Yes Numerous items create differences between pretax financial income and taxable income. For purpose of accounting recognition these diferences are temporary and permanent

The deferred tax expense is the a. increase in balance of deferred tax asset minus the increase in balance of deferred tax liability. b. increase in balance of deferred tax liability minus the increase in balance of deferred tax asset. c. increase in balance of deferred tax liability from the beginning to the end of the accounting period. d. decrease in balance of deferred tax asset minus the increase in balance of deferred tax liability.

c. increase in balance of deferred tax liability from the beginning to the end of the accounting period.

The amount of income taxes refundable (payable/paid) for a year, as determined by applying the enacted tax rate to the taxable income or excess of deductions over revenues for the year.

current tax benefit (expense)

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

deductible amounts

The change during the year in a company's deferred tax liabilities and assets. A deferred tax expense results from the increase in the deferred tax liability from the beginning to the end of the accounting period. A deferred tax benefit results from the increase in the deferred tax asset from the beginning to the end of the accounting period; it reduces income tax expense.

deferred tax expense (benefit)

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

The tax rate a company actually pays, computed as total income tax expense for the period divided by pretax financial income. It differs from the enacted tax rate because of deductions and provisions allowed by the tax code.

effective tax rate

The tax rate, passed by Congress, that is expected to apply to future periods. When determining the tax rate to apply to existing temporary differences, a company must consider presently enacted changes in the tax rate that become effective for a particular future year(s).

enacted tax rate

An income-averaging provision in the U.S. tax code that enables companies to carry a net operating loss back two years and receive refunds for income taxes paid in those years. A company must apply the loss to the earlier year first and then to the second year.

loss carryback

A level of likelihood of at least slightly more than 50 percent. This measure is used in connection with a deferred tax asset for all deductible temporary differences. If it is more likely than not that a company will not realize some portion of the deferred tax asset, the company should reduce the deferred tax asset by a valuation allowance.

more likely than not

A loss that occurs for tax purposes in a year when tax-deductible expenses exceed taxable revenues. Under certain circumstances, the federal tax laws permit companies to use the losses of one year to offset the profits of other years, through use of the carryback and carryforward of net operating losses.

net operating loss (NOL)

The initial difference between the book basis and the tax basis of an asset/liability, regardless of whether the tax basis of the asset/liability exceeds or is exceeded by the book basis of the asset or liability. An originating temporary difference may be changed by a later reversing difference, which results in deferred tax expense.

originating temporary difference

A difference between taxable income and pretax financial income that results from items that enter into pretax financial income but never into taxable income, or that enter into taxable income but never into pretax financial income.

permanent difference

Income for tax purposes, determined according to the Internal Revenue Code (the tax code). It is measured as the excess of taxable revenues over tax-deductible expenses and exemptions for the year.

taxable income

Temporary differences that will result in taxable amounts in future years. They give rise to recording deferred tax liabilities. Examples are (1) revenues or gains that are taxable after they are recognized in financial income, and (2) expenses or losses that are deductible before they are recognized in financial income.

taxable temporary difference

The difference between the amounts reported for tax purposes and the book (carrying) amounts reported in the financial statements. The temporary difference will result in taxable amounts or deductible amounts in future years. Taxable amounts increase taxable income in future years; deductible amounts decrease taxable income in future years.

temporary difference

Tax positions for which the tax authorities may disallow in whole or in part, often the result of an aggressive approach in tax planning.

uncertain tax positions

An amount by which a company should reduce the valuation of a deferred tax asset if it is more likely than not that the company will not realize some portion of the deferred tax asset.

valuation allowance