Download Income Tax Expense

chapter 16
Income Taxes
1
Learning Objectives
1.
2.
3.
4.
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.
Schedule future tax rates, and determine the
effect on tax assets and liabilities.
2
Learning Objectives
5.
6.
7.
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.
Describe how, with respect to deferred income
taxes, international accounting standards have
converged toward the U.S. treatment.
3
Deferred Income Taxes: An
Overview
The primary goal of
financial accounting is to
provide useful information
to management,
stockholders, creditors, and
other properly interested.
The primary goal of the
income tax system is the
equitable collection of
revenue.
4
Deferred Income Taxes: An
Overview
Two basic considerations in U.S.
corporations computed net income.
1. How to account for revenues
and expenses that have already
been recognized and reported
to shareholders in a company’s
financial statements but will
not affect taxable income until
subsequent years.
5
Deferred Income Taxes: An
Overview
Two basic considerations in U.S.
corporations computed net income.
2. How to account for revenues
and expenses that have already
been reported to the IRS but
will not be recognized in the
financial statements until
subsequent years.
6
Simple 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.
7
Simple Deferred Tax Liabilities
In 2005, Ibanez Company earned revenues of
$30,000. Ibanez has no expenses other than
income taxes. In this case, Ibanez is taxed on
cash received. The company received
$10,000 in 2005 and $20,000 in 2006. The
income tax rate is 40% and it is expected to
remain the same into the foreseeable future.
Continued
8
Simple Deferred Tax Liabilities
Income Tax Expense
Income Taxes Payable
Deferred Tax Liability
12,000
4,000
8,000
$20,000 x
.40
9
Simple Deferred Tax Liabilities
10
Ibanez Company
Income Statement
For the Year Ended December 31, 2005
Revenues
Income tax expense:
Current
Deferred
Net income
$30,000
$4,000
8,000
$18,000
Simple Deferred Tax Asset
• 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.
Realization of a Deferred Tax Asset depends on the
existence of taxable income in future years
11
Simple Deferred Tax Asset
In 2005, Gupta Corporation generated
service revenues totaling $60,000, all
taxable in 2005. No warranty claims
were made in 2005, but Gupta
estimates that in 2006 warranty costs of
$10,000 will incurred for claims related
to 2005 service revenues. Assume a
40% tax rate.
Continued
12
Simple Deferred Tax Asset
Income Tax Expense
Deferred Tax Asset
Income Taxes Payable
20,000
4,000
24,000
$60,000 x
.40
Continued
13
Simple Deferred Tax Asset
Gupta Company
Income Statement
For the Year Ended December 31, 2005
Revenues
Less: Warranty expense
Income before taxes
Income tax expense:
Current
Deferred benefit
Net income
$60,000
10,000
$50,000
$24,000
(4,000) 20,000
$30,000
14
Permanent 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.
15
Illustration of Permanent and
Temporary Differences
For the year ended December 31, 2005,
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.
Continued
16
Illustration of Permanent and
Temporary Differences
17
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
Annual Computation of Deferred
Tax Liabilities and Assets
Advantages of the Asset and
Liability Method
1. 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.
Continued
18
Annual Computation of Deferred
Tax Liabilities and Assets
2. 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.
19
Annual Computation of Deferred
Tax Liabilities and Assets
Identify type and amounts of existing
temporary differences.
Measure the deferred tax
liability for taxable
temporary differences
(use enacted rates).
Measure the deferred tax
asset for deductible
temporary differences
(use enacted rates).
Establish valuation allowance account if more
likely than not ( >50%) some portion or all of
the deferred tax asset will not be realized.
20
21
Example 3: Deferred Tax Liability
For 2005, Roland computes pretax financial
income of $75,000. The only difference
between financial and taxable income is
depreciation. The enacted tax rate is 40%.
The 2005 tax is $24,000 (40% of $60,000).
Financial income subject to tax
$75,000
Deduct temporary difference:
Excess of tax depreciation ($40,000)
over book depreciation ($25,000) (15,000)
Taxable income
$60,000
Continued
22
Income tax expense =
Pre-tax financial income (or financial
income subject to tax i.e. excluding
permanent differences)
X
Tax %
Note – the above is true only if future tax
rates do not change
23
Example 3: Deferred Tax Liability
Journal entry for 2005
Income Tax Expense
30,000
Income Taxes Payable
24,000
Deferred Tax Liability—
Noncurrent
6,000
Continued
24
Example 3: Deferred Tax Liability
For 2006, Roland earned income of $75,000
and the taxable income is $70,000, or a tax of
$28,000.
Financial income subject to tax
$75,000
Deduct temporary difference:
Excess of tax depreciation ($30,000)
over book depreciation ($25,000) (5,000)
Taxable income
$70,000
Tax @ 40%
$28,000
Continued
25
Example 3: Deferred Tax Liability
Journal entry for 2006
Income Tax Expense
30,000
Income Taxes Payable
28,000
Deferred Tax Liability—
Noncurrent
2,000
Continued
$5,000 x .40
26
Example 3: Deferred Tax Liability
Depreciation expense in
2007 is the same for both
financial and tax, so the
entry is simple.
Income Tax Exp.
30,000
Income Taxes Pay.
30,000
27
Example 3: Deferred Tax Liability
For 2008, Roland earned income of $75,000
and the taxable income is $95,000, or a tax of
$38,000.
Financial income subject to tax
$75,000
Add temporary difference:
Excess of book depreciation
($25,000) over tax depreciation
($5,000)
20,000
Taxable income
$95,000
Tax @ 40%
$38,000
Continued
28
Example 3: Deferred Tax Liability
Journal entry for 2008
Income Tax Expense
Deferred Tax Liability—
Noncurrent
Income Taxes Payable
30,000
8,000
38,000
$30,000 +
$8,000
29
Changes in Tax Rates
• If changes in future tax rates hare enacted, the
deferred tax liability (or asset) is measured using
the enacted tax rate for future years when the
temporary difference is expected to reverse.
• Subsequent changes in tax rates after a deferred
tax/liability has already been computed, requires
an adjustment to the income tax expense for the
year of the change e.g. for a tax reduction, the
adjustment entry would be
• Dr. Deferred Tax Liability
– Cr. Income Tax Expenses
30
Example 4: 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.
31
Example 4: Deferred Tax Asset
For 2005, Sandusky Inc. computes pretax
financial income of $22,000. The only difference
between financial and taxable income is the
recognition of warranty expense. Accrued
warranty expense for 2005 was $18,000; no
actual warranty expenditures were made in 2005.
The warranty obligation is considered one-third
current and two-thirds noncurrent.
Continued
32
Example 4: Deferred Tax Asset
Taxable income in 2005 is calculated as
follows:
Financial income subject to tax
$22,000
Add temporary difference:
Excess of warranty expense
($18,000) over warranty
deductions ($0)
18,000
Taxable income
$40,000
Tax ($40,000 x .40)
$16,000
Continued
33
Example 4: Deferred Tax Asset
Journal entry for 2005
Income Tax Expense
8,800
Deferred Tax Asset—Current 2,400
Deferred Tax Asset—
Noncurrent
4,800
Income Taxes Payable
16,000
Continued
34
Example 4: Deferred Tax Asset
In the years 2006 through 2008, taxable income
would be $16,000, computed as follows:
Financial income subject to tax
Reversal of temporary difference:
Excess of warranty deductions
(1/3 x $18,000) over warranty
expense ($0)
Taxable income
Tax ($16,000 x .40)
$22,000
(6,000)
$16,000
$ 6,400
35
Example 4: Deferred Tax Asset
Journal entry for 2006
Income Tax Expense
Deferred Tax Asset—
Current
Income Taxes Payable
8,800
2,400
6,400
Deferred Tax Asset—
Current
2,400
Deferred Tax Asset—
Noncurrent
2,400
Continued
36
Example 4: Deferred Tax Asset
Journal entry for 2007
Income Tax Expense
Deferred Tax Asset—
Current
Income Taxes Payable
Deferred Tax Asset—
Current
Deferred Tax Asset—
Noncurrent
8,800
2,400
6,400
2,400
2,400
37
Example 4: Deferred Tax Asset
Journal entry for 2008
Income Tax Expense
Deferred Tax Asset—
Current
Income Taxes Payable
8,800
2,400
6,400
Example 5: Deferred Tax
Liabilities and Assets
For 2005, Hsieh reported pretax financial
income of $38,000. As of December 31, 2005,
the actual depreciation expense was $25,000
and the actual warranty expense was $18,000.
For income tax reporting, these expenses were
$40,000 and $0, respectively.
Continued
38
Example 5: Deferred Tax
Liabilities and Assets
Taxable income in 2005 is calculated as
follows:
Financial income subject to tax
$38,000
Add (deduct) temporary difference:
Excess of warranty expense
over warranty deductions
18,000
Excess of tax depreciation over
book depreciation
(15,000)
Taxable income
$41,000
Tax ($41,000 x .40)
$16,400
Continued
39
Example 5: Deferred Tax
Liabilities and Assets
Journal entry for 2005
Income Tax Expense
15,200
Deferred Tax Asset—Current 2,400
Deferred Tax Asset—
Noncurrent
4,800
Deferred Tax Liability—
Noncurrent
6,000
Income Taxes Payable
16,400
40
Valuation Allowance for Deferred
Tax Assets
Statement No. 109 stipulates that
both positive and negative
evidence be considered when
determining whether deferred tax
assets will be fully realized.
41
Net Operating Loss (NOL)
Carryback
42
Carryback Election
Year
-2
Year
+20
Loss
Year
Carryforward Election
Net Operating Loss (NOL)
Carryback
Year
Income
(Loss)
Tax Rate
Income
Tax
2004
2005
2006
$10,000
14,000
(19,000)
35%
30
30
$3,500
4,200
0
Journal Entry in 2006:
Income Tax Refund Receivable
6,200
Income Tax Benefit From NOL
Carryback (Income Tax Expense)
6,200
[$3,500 + (30% x $9,000)]
43
44
Accounting for NOL Carryforward
Continuing with the Prairie Company
illustration, assume that in 2007 the firm
incurred an operating loss of $35,000.
Year
Income
(Loss)
Tax Rate
2006
2007
$(19,000)
(35,000)
30%
30%
Continued
Income
Tax
$0
0
45
Accounting for NOL Carryforward
The only loss remaining against
which operating income can be
applied is $5,000 from 2005 ($14,000
– $9,000). This leaves $30,000 to be
carried forward from 2007 as a future
tax benefit of $9,000 ($30,000 x .30).
Continued
46
Accounting for NOL Carryforward
The journal entry at the end of 2007 to record the
tax benefits would be as follows:
Income Tax Refund Receivable
Deferred Tax Asset—NOL
Carryforward
Income Tax Benefit from NOL
Carryback
Income Tax Benefit from NOL
Carryforward
1,500
9,000
1,500
9,000
47
Accounting for NOL Carryforward
The firm reports a taxable income of $50,000
in 2008. 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.
Journal Entry:
Income Tax Expense
Income Taxes Payable
Deferred Tax Asset—NOL
Carryforward
15,000
6,000
9,000
48
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?
49
Accounting for NOL Carryforward
Journal Entry:
Income Tax Refund Receivable
1,500
Deferred Tax Asset—NOL
Carryforward
9,000
Income Tax Benefit from NOL
Carryback
1,500
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.
Financial Statement
Presentation and Disclosure
The following items must appear in the
income statement or an accompanying note:
•
•
•
•
Current tax expense or benefit
Deferred tax expense or benefit
Investment tax credits
Government grants recognized as tax
reductions
Continued
50
Financial Statement
Presentation and Disclosure
The following items must appear in the
income statement or an accompanying note:
• Benefits of NOL carryforwards
• Adjustments of a deferred tax liability or asset for
enacted changes in tax laws or rates or a change
in the tax status of an enterprise
• Adjustments in beginning-of-the-year valuation
allowance because of a change in circumstances
51
Deferred Taxes and the Statement
of Cash Flows
Callazo Company had the following information
for 2005:
Revenue (all cash)
$30,000
Income tax expense:
Current
$10,300
Deferred
1,700 (12,000)
Net income
$18,000
Cash paid for income taxes during 2005 totaled
$13,300.
Continued
52
Deferred Taxes and the Statement
of Cash Flows
Income tax refund receivable
Income taxes payable
Deferred tax liability
12/31/05
$2,000
0
9,700
12/31/05
$
0
1,000
8,000
Analysis
Income Statement
Revenue (all cash),
$30,000
Adjustment
No adjustment
Continued
SCF
$30,000 cash
collected from
customers
53
Deferred Taxes and the Statement
of Cash Flows
54
Analysis
Income Statement
Income tax
expense—current
$(10,300)
Adjustment
–$2,000—
Increase in
tax receivable
–$1,000—
Decrease in
taxes payable
Continued
SCF
$(13,300) Cash
paid for taxes
Deferred Taxes and the Statement
of Cash Flows
Analysis
Income Statement
Income tax
expense—deferred
$(1,700)
Adjustment
+$2,000—
Increase in
deferred tax
liability
Continued
SCF
No effect
55
Deferred Taxes and the Statement
of Cash Flows
Analysis
Income Statement
Adjustment
Net income, $18,000 –$1,300
Continued
Collazo Company
Statement of Cash Flows
(Direct Approach)
Cash collected from customers
Income taxes paid
Cash provided by operating activities
SCF
$16,700 Cash
flow from
operations
$30,000
(13,300)
$16,700
56
Deferred Taxes and the Statement
of Cash Flows
Collazo Company
Statement of Cash Flows
(Indirect Approach)
Net income
Decrease in income tax refund receivable
Decrease in income taxes payable
Increase in deferred tax liability
Cash provided by operating activities
$18,000
(2,000)
(1,000)
1,700
$16,700
57
International Accounting for
Deferred Taxes
• 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.
58
chapter 16
The End
59