2. ACCOUNTING FOR INCOME TAXES
C H A P T E R 19
ACCOUNTING FOR INCOME TAXES
Intermediate Accounting
13th Edition
Kieso, Weygandt, and Warfield

3. Fundamental Differences between Financial and Tax Reporting
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Fundamental Differences between Financial and Tax Reporting

4. Background Deferral approach to tax allocation (APB Opinion 11)
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Background
Deferral approach to tax allocation (APB Opinion 11)
Income tax expense = amount of taxes that would be paid if income statement numbers appeared on the current year's tax return.
Deferred taxes was the plug figure (difference between taxes payable and tax expense).
The effect of subsequent changes in tax rates on deferred tax account were essentially ignored.
Matching Approach

5. 4/5/2017
Background
A method that was proposed theoretically (but has never been GAAP in US)
Assets and liabilities would be recorded NET of any deferred tax related to the item
Net-of-Tax Approach

6. Asset/Liability Measurement Approach
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Background
Liability approach to tax allocation (FASB 96, 109)
Income tax expense = taxes currently payable plus change in deferred taxes.
If tax rates change, the effect on deferred tax amounts affect income tax expense in the year the change is enacted.
If there are no changes in tax rates, income tax expense should be approximately the same as under APB Opinion 11.
Asset/Liability Measurement Approach

7. Fundamentals of Accounting for Income Taxes
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Fundamentals of Accounting for Income Taxes
Financial Statements
Tax Return
IRS
vs.
Exchanges
Investors and Creditors 
Pretax Financial Income
Taxable Income
GAAP
Tax Code 
Income Tax Expense
Income Tax Payable
LO 1 Identify differences between pretax financial income and taxable income.

8. Fundamentals of Accounting for Income Taxes
Illustration: KRC, Inc. reported revenues of $130,000 and expenses of $60,000 in each of its first three years of operations. For tax purposes, KRC reported the same expenses to the IRS in each of the years. KRC reported taxable revenues of $100,000 in 2010, $150,000 in 2011, and $140,000 in What is the effect on the accounts of reporting different amounts of revenue for GAAP versus tax?
LO 1 Identify differences between pretax financial income and taxable income.

9. Book vs. Tax Difference GAAP Reporting Tax Reporting 2010 2011 2012
Illustration 19-2
GAAP Reporting
2010
2011
2012
Total
Revenues
$130,000
$130,000
$130,000
$390,000
Expenses
60,000
60,000
60,000
180,000
Pretax financial income
$70,000
$70,000
$70,000
$210,000
Income tax expense (40%)
$28,000
$28,000
$28,000
$84,000
Illustration 19-3
Tax Reporting
2010
2011
2012
Total
Revenues
$100,000
$150,000
$140,000
$390,000
Expenses
60,000
60,000
60,000
180,000
Pretax financial income
$40,000
$90,000
$80,000
$210,000
Income tax payable (40%)
$16,000
$36,000
$32,000
$84,000
LO 1 Identify differences between pretax financial income and taxable income.

10. Book vs. Tax Difference Comparison
Illustration 19-4
Comparison
2010
2011
2012
Total
Income tax expense (GAAP)
$28,000
$28,000
$28,000
$84,000
Income tax payable (IRS)
16,000
36,000
32,000
84,000
Difference
$12,000
$(8,000)
$(4,000) $0
Are the differences accounted for in the financial statements?
Yes
Year
Reporting Requirement
2010
Deferred tax liability account increased to $12,000
2011
Deferred tax liability account reduced by $8,000
2012
Deferred tax liability account reduced by $4,000
LO 1 Identify differences between pretax financial income and taxable income.

11. Financial Reporting for 2010 – Chelsea Inc.
Balance Sheet
Income Statement
2010
2010
Assets:
Revenues:
Expenses:
Liabilities:
Deferred taxes ,000
Income tax payable 16,000
Income tax expense 28,000
Equity:
Net income (loss)
Where does the “deferred tax liability” get reported in the financial statements?
LO 1 Identify differences between pretax financial income and taxable income.

12. Illustration 19-22 Examples of Temporary Differences
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Temporary Differences
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 Amounts
Future 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 Examples of Temporary Differences
LO 2 Describe a temporary difference that results in future taxable amounts.

13. Future Taxable Amounts and Deferred Taxes
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, 2010, GAAP-basis balance sheet. However, the receivables have a zero tax basis.
Illustration 19-5
LO 2 Describe a temporary difference that results in future taxable amounts.

14. Future Taxable Amounts and Deferred Taxes
Illustration: Reversal of Temporary Difference, Chelsea Inc.
Illustration 19-6
KRC assumes that it will collect the accounts receivable and report the $30,000 collection as taxable revenues in future tax returns. KRC does this by recording a deferred tax liability.
LO 2 Describe a temporary difference that results in future taxable amounts.

15. Future Taxable Amounts and Deferred Taxes
Deferred Tax Liability – Chelsea Inc.
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.
Illustration 19-4
2010
2011
2012
Total
Income tax expense (GAAP)
$28,000
$28,000
$28,000
$84,000
Income tax payable (IRS)
16,000
36,000
32,000
84,000
Difference
$12,000
$(8,000)
$(4,000) $0
LO 2 Describe a temporary difference that results in future taxable amounts.

16. Future Taxable Amounts and Deferred Taxes
Deferred Tax Liability – Chelsea Inc.
Illustration: Because it is the first year of operations for KRC, there is no deferred tax liability at the beginning of the year. KRC computes the income tax expense for 2010 as follows:
Illustration 19-9
LO 2 Describe a temporary difference that results in future taxable amounts.

17. Future Taxable Amounts and Deferred Taxes
Deferred Tax Liability
Illustration: Chelsea Inc. makes the following entry at the end of 2010 to record income taxes.
Income Tax Expense 28,000
Income Tax Payable 16,000
Deferred Tax Liability 12,000
LO 2 Describe a temporary difference that results in future taxable amounts.

18. Future Taxable Amounts and Deferred Taxes
Deferred Tax Liability – Chelsea Inc.
Illustration: Computation of Income Tax Expense for 2011.
Illustration 19-10
LO 2 Describe a temporary difference that results in future taxable amounts.

19. Future Taxable Amounts and Deferred Taxes
Deferred Tax Liability
Illustration: Chelsea Inc. makes the following entry at the end of 2011 to record income taxes.
Income Tax Expense 28,000
Deferred Tax Liability 8,000
Income Tax Payable 36,000
LO 2 Describe a temporary difference that results in future taxable amounts.

20. South Carolina Corporation
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South Carolina Corporation
E19-1 South Carolina Corporation has one temporary difference at the end of 2007 that will reverse and cause taxable amounts of $55,000 in 2008, $60,000 in 2009, and $65,000 in South Carolina’s pretax financial income for 2007 is $300,000, and the tax rate is 30% for all years. There are no deferred taxes at the beginning of 2007.
Instructions
Compute taxable income and income taxes payable for 2007.
Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2007.

21. South Carolina Corporation
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South Carolina Corporation a. a.
Blank for student version

22. South Carolina Corp. (Solution)
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South Carolina Corp. (Solution) a. a.
Leave this solution in student version
LO 2 Describe a temporary difference that results in future taxable amounts.

23. 4/5/2017
Columbia Corporation
Columbia Corporation has one temporary difference at the end of 2007 that will reverse and cause deductible amounts of $50,000 in 2008, $65,000 in 2009, and $40,000 in Columbia’s pretax financial income for 2007 is $200,000 and the tax rate is 34% for all years. There are no deferred taxes at the beginning of Columbia expects to be profitable in the future.
Instructions
Compute taxable income and income taxes payable for 2007.
Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2007.

24. 4/5/2017
Columbia Corporation a. a.
BLANK ONLY FOR STUDENT VERSION

25. Income Statement Presentation
Formula to Compute Income Tax Expense
Illustration 19-20
Income tax payable or refundable
Change in deferred income tax
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).
LO 5 Describe the presentation of income tax expense in the income statement.

26. Income Statement Presentation
Given the previous information related to KRC Inc., KRC reports its income statement as follows.
Illustration 19-21
LO 5 Describe the presentation of income tax expense in the income statement.

27. Temporary Differences (1)
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Temporary Differences (1)
Revenues and gains, recognized in financial income, are later taxed for income tax purposes.
Installment sales
Expenses and losses are deducted for income tax purposes before they are recognized in financial income.
MACRS depreciation
Goodwill deduction on tax return
Taxable temporary differences
Revenues or gains that are taxable after they are recognized on books:
Installment method for tax returns, accrual method for financial accounting purposes
Completed contract method for tax returns, percentage of completion method for financial accounting purposes (now uncommon)
Expenses or losses that are deductible before they are recognized on books:
Accelerated depreciation for tax returns, straight-line for financial accounting purposes
Goodwill, deductible on tax return but not an expense for GAAP. However, impairment of goodwill, if it occurs, would cause the write-down of goodwill and a loss on GAAP financial statements
Business combinations (goodwill): if assigned values of identifiable assets are higher than their tax basis, the difference is a taxable temporary difference and the related deferred tax liability would increase the goodwill to be recorded
A reduction in the tax basis of depreciable assets because of tax credits (under 1982 law, it was possible to get a larger investment tax credit if the depreciable basis of the assets were reduced),; similar result if we capitalize interest for book purposes but deduct it on tax return as paid.
Called “taxable temporary differences”

28. Temporary Differences (2)
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Temporary Differences (2)
Revenues and gains are taxed for income tax purposes before they are recognized in financial income.
Subscription revenue
Prepaid rent
Expenses and losses, recognized in financial income, are later deducted for income tax purposes.
Warranty expense
Called “deductible temporary differences”

29. Summary of Temporary Differences
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Summary of Temporary Differences
Transaction
When recorded
in books
on tax return
Deferred
tax effect
Rev or Gain
Earlier
Later
Liability
Rev or Gain
Later
Earlier
Asset
Exp or Loss
Earlier
Later
Asset
Exp or Loss
Later
Earlier
Liability

30. Permanent Differences
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Permanent Differences
Sources of Permanent Differences
Some items
are recorded
in Books
but NEVER
on tax return
Other items
are NEVER
recorded in books
but recorded
on tax return
No deferred tax effects
for permanent differences

31. Permanent Differences: Examples
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Permanent Differences: Examples
Items, recognized for financial accounting purposes, but not for income tax purposes:
Interest revenue on Municipal Bonds
Life insurance premiums and proceeds when corporation is beneficiary
Fines and penalties
Items, recognized for tax purposes, but not for financial accounting purposes:
Dividend exclusion
Statutory depletion

32. Deferred Tax Asset & Deferred Tax Liability: Sources
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Deferred Tax Asset & Deferred Tax Liability: Sources
Deferred taxes may be a:
Deferred tax liability, or
Deferred tax asset
Deferred tax liability arises due to net taxable amounts in the future.
Deferred tax asset arises due to net deductible amounts in the future.

33. Valuation Allowance for Deferred Tax Assets
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Valuation Allowance for Deferred Tax Assets
If the deferred tax asset appears doubtful, a Valuation Allowance account is needed.
Journal entry:
Income Tax Expense $$
Allowance to Reduce Deferred Tax Asset to Expected Realizable Value $$
The entry records a potential future tax benefit that is not expected to be realized in the future.

34. 4/5/2017
What Tax Rate to Apply
Basic Rule: Apply the yearly tax rate to calculate deferred tax effects.
If future tax rates change: use the enacted tax rate expected to apply in the future year.
If new rates are not yet enacted into law for future years, the current rate should be used.
The appropriate enacted rate for a year is the average tax rate [based on graduated tax brackets].

35. Let’s do an example Second Best Company
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Let’s do an example
Second Best Company
Working paper style – working paper blank will be provided on Exam 2
Do first two years and then stop and talk about NOL (next few slides) before going to year 3 where this is an NOL

36. 4/5/2017

37. Balance Sheet Presentation
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Balance Sheet Presentation
The deferred tax classification relates to its underlying asset or liability.
Classify the deferred tax amounts as current or non-current.
Presentation is
NET amount related to current items
If DR>CR, current deferred tax asset
If DR<CR, current deferred tax liability
NET amount related to noncurrent items
If DR>CR, noncurrent deferred tax asset
If DR<CR, noncurrent deferred tax liability

38. Net Operating Loss (NOL)
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Net Operating Loss (NOL)
Net operating loss is tax terminology.
A net operating loss occurs when tax deductions for a year exceed taxable revenues.
Net loss or operating loss is a financial accounting term.

39. NOL Rule (subject to change)
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NOL Rule (subject to change)
NOL for each tax year is computed.
The NOL of one year can be applied to offset taxable income of other years, possibly resulting in tax refunds
Current rule: NOLs can be:
carried back 2 years and carried forward 20 years (carryback option),
or carried forward 20 years (carryforward only)

40. NOL Carryback Tax years 2001 2002 2003 2004 2005 2006 2007 Expect
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NOL Carryback
Tax years
next
NOL
2004
Apply first
Loss carryforward
20 years forward
Expect
tax refund
here
Record all
tax effects here
Expect
tax
shield
here

41. NOL Carryforward Tax years 2001 2002 2003 2004 2053 2006 2007 NOL 2004
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NOL Carryforward
Tax years
NOL
2004
Loss carryforward
20 years forward
Forgo 2
year rule
Record all
tax effects here
Expect
tax
shield
here

42. 4/5/2017
Zoop Inc. (NOL)
Zoop Inc. incurred a net operating loss of $500,000 in Taxable income was $200,000 for 2005 and $200,000 for The tax rate for all years is 40%. Zoop elects the carryback option. Prepare the journal entries to record the benefits of the loss carryback and the loss carryforward.
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.

43. 4/5/2017
Zoop Inc. (NOL)

44. Zoop Inc. (NOL) - Solution
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Zoop Inc. (NOL) - Solution
Leave in the student version
Deferred Tax Asset
$160,000

45. Zoop Inc. (NOL) - Solution
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Zoop Inc. (NOL) - Solution
Zoop’s Journal Entries for 2007
Leave in the student version
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.

46. 4/5/2017
Zoop Inc. (Variation)
Now assume that it is more likely than not that the entire net operating loss carryforward will not be realized by Zoop Inc. in future years. Prepare all the journal entries necessary at the end of 2007.
LO 8 Apply accounting procedures for a loss carryback and a loss carryforward.

47. Zoop Inc. (Variation) - Solution
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Zoop Inc. (Variation) - Solution
Zoop Inc. - Journal Entries for 2007

48. Valuation Allowance Revisited
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Valuation Allowance Revisited
Whether the company will realize a deferred tax asset depends on whether sufficient taxable income exists or will exist within the carryforward period.
Text Illustration Possible Sources of Taxable Income
If any one of these sources is sufficient to support a conclusion that a valuation allowance is unnecessary, a company need not consider other sources.
Text Illustration Evidence to Consider in Evaluating the need for a Valuation Account

49. Valis Corporation (NOL)
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Valis Corporation (NOL)
Valis Corporation had the following tax information.
In 2007 Valis suffered a net operating loss of $450,000, which it elected to carry back. The 2007 enacted tax rate is 29%. Prepare Valis’s entry to record the effect of the loss carryback.
LO 8 Apply procedures for a loss carryback and a loss carryforward.

50. Valis Corporation – Solution (NOL)
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Valis Corporation – Solution (NOL)
Student version (without solution)

51. Valis Corporation – Solution (NOL)
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Valis Corporation – Solution (NOL)
Valis Corp - Journal Entry for 2007

52. Example: Revision of Future Tax Rate
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Example: Revision of Future Tax Rate
At the end of 2002, the corporate tax rate is changed from 40% to 35%. The new rate is effective January 1, 2004.
The deferred tax account (1/1/2002) is as follows:
Excess tax depreciation: $3 million
Deferred tax liability: $1.2 million
Related taxable amounts are expected to occur equally over 2003, 2004, and 2005.
Provide the journal entry to reflect the change.

53. Example: Revision of Future Tax Rate
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Example: Revision of Future Tax Rate
The deferred tax liability end of 2005 is as follows:
Future tax inc $1,000,000 1,000,000 1,000,000
Tax rate % % %
Deferred tax $400, , ,000
liability
Entry:
Deferred Tax Liability $100, Income Tax Expense $100,000*
*$1,200,000 – $1,100,000

54. Intraperiod Tax Allocation
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Intraperiod Tax Allocation
Income tax expense, is allocated to:
Continuing operations
Discontinued operations
Extraordinary items
Prior period adjustments
Other comprehensive income
Disclose other significant components, such as:
current tax expense,
deferred tax expense/benefit, etc.
} Income Statement
Intraperiod Tax Allocation
Income Statement
Income tax expense or benefit for the year shall be allocated among continuing operations, discontinued operations, extraordinary items, other comprehensive income, and items charged or credited directly to shareholders' equity (paragraph 36).
FAS109, Par. 35

55. Other Items Affected Comprehensive income items
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Other Items Affected
Comprehensive income items
Holding gain/loss on AFS securities
Certain gains/losses related to foreign currency and derivatives
Pension & post-retirement benefit amounts not yet recognized on income statement
Correction of error/change in accounting principle that affects beginning retained earnings
Expenses for employee stock-based compensation
Existing deferred amounts in quasi-reorganization

56. Special Reporting Issues
Divide by weighted-average shares outstanding
EPS
LO 6

57. Review of the Asset-Liability Method
Companies apply the following basic principles:
Recognize a current tax liability or asset for the estimated taxes payable or refundable.
Recognize a deferred tax liability or asset for the estimated future tax effects attributable to temporary differences and carryforwards using enacted tax rate.
Base the measurement of current and deferred taxes on provisions of the enacted tax law. Do not anticipate future changes in tax laws.
Reduce the measurement of deferred tax assets (create allowance account), if necessary, by the amount of any tax benefits that, companies do not expect to realize.

58. Deferred Taxes
IAS 12 vs FAS 109
versus

59. Which Tax Rate to Use Enacted or substantively enacted tax rat
IFRS
US GAAP
Enacted or substantively enacted tax rat
Enacted tax rates

60. Deferred Tax Assets
IFRS
US GAAP
Don’t recognize at all unless it is “more likely than not” to be usable in the future
Use an allowance account to reduce to net realizable value
Uses same “more likely than not” criteria

61. Balance Sheet Presentation
IFRS
US GAAP
Always is noncurrent
Plans to revise to do it the FASB way
Current items netted
Noncurrent items netted

62. The classification of deferred taxes under iGAAP is always noncurrent.
Under iGAAP, an affirmative judgment approach is used, by which a deferred tax asset is recognized up to the amount that is probable to be realized. U.S. GAAP uses an impairment approach.
iGAAP uses the enacted tax rate or substantially enacted tax rate. (“Substantially enacted” means virtually certain.) For U.S. GAAP, the enacted tax rate must be used.

63. The tax effects related to certain items are reported in equity under iGAAP. That is not the case under U.S. GAAP, which charges or credits the tax effects to income.
U.S. 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 iGAAP, all potential liabilities must be recognized. With respect to measurement, iGAAP uses an expected-value approach to measure the tax liability, which differs from U.S. GAAP.

64. 4/5/2017
Essential Knowledge
Be able to tell a permanent difference from a temporary difference
Know the impact of temporary differences:
Is it a future deductible item?
Is it a future taxable item?
Textbook Illustrations & 19-24:
If all else fails, memorize!
I’ll also provide a “study guide” for Exam 2

65. Specific Differences Do the following generate:
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Specific Differences
Do the following generate:
Future Deductible Amount = Deferred Tax Asset
Future Taxable Amount = Deferred Tax Liability
A 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.
STUDENT VERSION
3. Expenses are incurred in obtaining tax-exempt income.
4. Costs of guarantees and warranties are estimated and accrued for financial reporting purposes.
LO 6 Describe various temporary and permanent differences.

66. Specific Differences Do the following generate:
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Specific Differences
Do the following generate:
Future Deductible Amount = Deferred Tax Asset
Future Taxable Amount = Deferred Tax Liability
A Permanent Difference
5. Sales of investments are accounted for by the accrual method for financial reporting purposes and the installment 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).
STUDENT VERSION – DOES NOT HAVE THE ANSWER
7. Estimated losses on pending lawsuits and claims are accrued for books. These losses are tax deductible in the period(s) when the related liabilities are settled..
LO 6 Describe various temporary and permanent differences.

67. First Place Example Go to Excel and work the problem
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First Place Example
Go to Excel and work the problem
Identify temporary and permanent differences
Compute tax payable (or refund)
Compute change in deferred taxes and income tax expense
Show where deferred tax will be reported on the balance sheet

68. 4/5/2017

69. 4/5/2017
Review Problem
Zurich Company reports pretax financial income of $70,000 for 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 $22,000. (3) Fines for pollution appear as an expense of $11,000 on the income statement.
Zurich’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 2007.
Instructions Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2007.

70. Review Problem – Abbreviated Working Paper
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Review Problem – Abbreviated Working Paper
Click to open Excel template

71. 4/5/2017
COPYRIGHT
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