Interperiod Tax Allocation Basics

Define "deferred income tax provision".

1. The amount of income tax expense that is not currently due; 2. Equals the net sum of the change in the deferred tax accounts.

Accounting for Income Taxes - Theoretical Considerations

A. The theoretical considerations of accounting for income taxes include the accrual basis of accounting, the matching principle, and the proper recognition of assets and liabilities. B. Income tax expense is recognized when it is incurred, regardless of when the payment is actually made to the Internal Revenue Service. The process of recognizing income tax expense is called interperiod tax allocation. This process ensures proper matching of income tax expense with revenues.

Accounting for Income Taxes - Theoretical Considerations

C. However, GAAP deemphasizes the matching concept. Rather, it adopted the asset/liability approach for measurement of income tax effects. 1. The emphasis is on the correct measurement of the income tax assets and liabilities. 2. Deferred tax assets and liabilities are now measured directly, along with the income tax liability. 3. Income tax expense is now a derived amount - a plug figure. D. This does not mean that income tax expense for a period does not reflect the income tax cost of transactions in the period. Rather, it means that greater emphasis is placed on measuring the changes in balance sheet accounts than in the income statement account - income tax expense.

According to FASB Statement No. 109, Accounting for Income Taxes, justification for the method of determining periodic deferred tax expense is based on the concept of A. Matching of periodic expense to periodic revenue. B. Objectivity in the calculation of periodic expense. C. Recognition of assets and liabilities. D. Consistency of tax-expense measurements with actual tax-planning strategies.

C. Recognition of assets and liabilities. Correct! FAS 109 adopted the asset/liability approach. The deferred tax expense is the net change in the deferred tax accounts for the year. Deferred tax accounts are measured at the enacted tax rate for the period in which the future temporary differences reverse. Rather than base income tax expense on accounting income adjusted for permanent differences, as was the case before 109, income tax expense is now the sum of current income tax expense (the income tax liability for the year) and the net change in deferred tax accounts. The expense is a residual amount, based on the changes in assets and liabilities. Matching is no longer the conceptual basis for measurement.

Current Income Tax Provision

Current Income Tax Provision -- Also called current portion of income tax expense and current provision for income tax. This term is used in the income statement to refer to the amount of income taxes due for the year. This amount is the same as the income tax liability for the year.

Deductible Items

Deductible Items -- Amounts that cause income tax to decrease. This is an Internal Revenue Code term and typically refers to expenses that cause taxable income to decrease.

Deferred Income Tax Provision

Deferred Income Tax Provision -- The amount of income tax expense that is not currently due. This amount equals the net sum of the change in the deferred tax accounts.

Deferred Tax Asset

Deferred Tax Asset -- The recognized tax effect of future deductible temporary differences. These differences, caused by transactions that have occurred as of the balance sheet date, will cause future taxable income to decrease relative to pretax accounting income.

Deferred Tax Liability

Deferred Tax Liability -- The recognized tax effect of future taxable temporary differences. These differences, caused by transactions that have occurred as of the balance sheet date, will cause future taxable income to increase relative to pretax accounting income.

Accounting for Income Taxes - Theoretical Considerations

E. Summary -- The main effects of applying the asset/liability approach are: 1. Income tax expense for the period reflects the amount that will ultimately be payable on the year's transactions. 2. The income tax payable account, deferred tax asset account, and deferred tax liability account report the remaining tax receivables and obligations facing the firm from transactions that have already occurred as of the balance sheet date. 3. Income tax expense is an amount derived from the changes in the tax-related assets and liabilities. It is no longer a directly computed value.

Example: Accounting for Income Taxes - Theoretical Considerations

Example: If future enacted tax rates have changed, the measurement of the deferred tax assets and liabilities will reflect the future tax rates because those are the rates that will be in effect when the deferred tax assets and liabilities are realized and paid. A pure matching approach would apply the current tax rate to a measure of pretax accounting income and directly measure income tax expense. The deferred tax asset and liability would be derived concepts.

Example: Accounting for Income Taxes

Example:Assume the following year-end income tax accrual entry. For simplicity, we assume that the entire year's tax liability is paid early the following year. Dr:Income Tax Expense 40,000 Dr:Deferred Tax Asset 6,000 Cr:Deferred Tax Liability 9,000 Cr:Income Tax Payable 37,000 Current income tax provision: $ 37,000 (income tax liability) Plus deferred income tax provision 3,000 * Equals total income tax expense $ 40,000 * $9,000 increase in deferred tax liability less $6,000 increase in deferred tax asset

Income Tax Expense

Income Tax Expense -- The account reported in the income statement that measures the income tax cost for the year's transactions. Income tax expense equals the income tax liability plus or minus the net change in the deferred tax accounts for the period.

Income Tax Liability

Income Tax Liability -- The amount of income tax the firm must pay on taxable income for a year. Firms pay this liability in estimated quarterly installments with the last installment due early in the year following the tax year.

Define "pretax accounting income".

Income before income tax for financial accounting purposes determined by applying GAAP.

Define "taxable income".

Income before tax for tax purposes.

Rein Inc. reported deferred tax assets and deferred tax liabilities at the end of 2003 and at the end of 2004. According to FASB Statements No. 109 Accounting for Income Taxes, for the year ended 2004, Rein should report deferred income tax expense or benefit equal to the

The net amount of deferred tax expense or benefit is that amount that is not recognized in current period income. A simple equation describes the total tax effects for a period: income tax expense or benefit + deferred income tax expense or benefit = current tax liability. The deferred income tax expense or benefit can further be described as the net change in both types of deferred tax accounts.

Define "interperiod tax allocation".

The process of measuring and recognizing the total income tax consequences of transactions in the year.

Three Types of Differences - Between GAAP and Income Tax Law

Three Types of Differences - Between GAAP and Income Tax Law A. The three main categories of differences between the two reporting systems in terms of their effect on accounting for income taxes are: 1. Permanent differences; 2. Temporary differences; and 3. Net operating losses. B. For interperiod tax allocation, temporary differences are the most important.

(Start of CPAexcel Exam Questions) Nala Inc. reported deferred tax assets and deferred tax liabilities at the end of 2004 and at the end of 2005. According to FASB 109, for the year ended 2005, Nala should report deferred income tax expense or benefit equal to the

Total income tax expense is the sum of the current and deferred portions. The current portion is the income tax liability for the year. The deferred portion is the net sum of the changes in the deferred tax accounts. Consider the tax-accrual entry for a year, assuming no estimated tax payments have been made: Dr:income tax expense 20 Dr:Deferred tax asset 3 Cr:Deferred tax liability 5 Cr:income tax payable 18 Total income tax expense = 20 = current tax expense + deferred tax expense Deferred tax asset = $18 + $2 The $2 deferred tax expense equals the increase in the deferred tax liability of $5, less the increase in the deferred tax asset of $3.

Interperiod Tax Allocation

Interperiod Tax Allocation -- The process of measuring and recognizing the total income tax consequences of transactions in the year. Only temporary differences and net operating loss carryforwards enter into this process. Interperiod tax allocation gives rise to deferred tax accounts because the total tax consequence of the period's transactions is not equal to the current income tax liability. The current tax liability (measured at the current tax rate) measures a part of that total, but there will be additional tax consequences in the future because of transactions that have occurred as of the balance sheet date. Hence the need for the deferred tax accounts. Deferred tax accounts are measured at the future enacted tax rate.

Net Operating Loss

Net Operating Loss -- Negative taxable income (strictly a tax term). A net operating loss can be carried back 2 years to reduce taxable income in those years for a refund of taxes, and carried forward 20 years to reduce taxable income and therefore the tax liability in future years.

Permanent Difference

Permanent Difference -- An amount that appears in the tax return or income statement but never both. These include items of revenue or expense that are never taxable or deductible; also taxable and deductible items that never appear in the income statement. This type of difference is also called a nontemporary difference. Example: A fine or penalty is never deductible but is treated as an expense or loss for income statement purposes. Permanent differences do not enter into the process of interperiod tax allocation. They have no deferred tax consequences.

Pretax Accounting Income

Pretax Accounting Income -- Income before income tax for financial accounting purposes determined by applying GAAP. This subtotal title is not used on the income statement (which uses subtotals such as income from continuing operations, income before extraordinary items, and others). Rather, for convenience and to focus on the issues, pretax accounting income traditionally has been used as a single measure of income before tax for accounting purposes. "Pretax financial income" is the term used by FASB for this amount.

Taxable Income

Taxable Income -- Income before tax for tax purposes. This is the analogue of pretax accounting income. Taxable income is the amount to which the tax rates are applied in determining the income tax liability for the year.

Taxable Items

Taxable Items -- Amounts that cause income tax to increase. This is an Internal Revenue Code term and typically refers to revenues that cause taxable income to increase.

(Start of CPAexcel Flashcards) What causes income tax to increase?

Taxable items.

Temporary Difference

Temporary Difference -- An item of revenue or expense that, over the total life of the item, will affect pretax accounting income and taxable income in the same total amount, but will be recognized in different amounts in any given year for financial reporting and tax purposes. Example:Depreciation can be different in any given year for income reporting and tax purposes, but total depreciation is the same over the life of the asset under the two reporting systems.

Define "income tax expense".

The account reported in the income statement that measures the income tax cost for the year's transactions.

Define "deferred income tax".

The amount of income tax expense that is not currently due.

Define "income tax liability".

The amount of income tax the firm must pay on taxable income for a year.

Define "current income tax provision".

The amount of income taxes due for the year (same as income tax liability).