1. Accounting for Income Taxes16
Accounting for Income Taxes
Chapter 16: Accounting for Income Taxes
In this chapter we explore the financial accounting and reporting standards for the effect of income taxes. The discussion defines and illustrates temporary differences, which are the basis for recognizing deferred tax assets and deferred tax liabilities, as well as permanent differences, which have no deferred tax consequences. You will learn how to adjust deferred tax assets and deferred tax liabilities when tax laws or rates change. We also discuss accounting for operating loss carrybacks and carrryforwards and intraperiod tax allocation.
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

2. Deferred Tax Assets and Deferred Tax Liabilities
GAAP is the set of rules for preparing financial statements.
The Internal Revenue Code is the set of rules for preparing tax returns.
Results in . . .
Results in . . .
Usually. . .
Financial statement income tax expense.
IRS income taxes payable.
The goals of financial accounting and tax accounting are not the same. Generally accepted accounting principles is the set of rules for preparing financial statements which are useful to investors and creditors. Congress, through the Internal Revenue Service, and its Internal Revenue Code, is primarily concerned with raising public revenues in a socially acceptable manner, and frequently, with influencing the behavior of taxpayers. A consequence of differences between GAAP and tax rules is that tax payments frequently occur in years different from the revenues and expenses are generated that cause the taxes. The result is that financial statement income tax expense usually does not equal the IRS calculation of income taxes payable.
The objective of accounting for income taxes is to recognize a deferred tax liability or deferred tax asset for the tax consequences of amounts that will become taxable or deductible in future years as a result of transactions or events that already have occurred. This is consistent with the concept of accrual accounting.
The objective of accounting for income taxes is to recognize a deferred tax liability or deferred tax asset for the tax consequences of amounts that will become taxable or deductible in future years as a result of transactions or events that already have occurred.

3. Temporary Differences
The difference in the rules for computing between pre-tax accounting income (according to GAAP) and taxable income (according to the IRS) often causes amounts to be reported in different years.
The difference in the rules for computing pre-tax accounting income (according to GAAP) and taxable income (according to the IRS) often causes amounts to be reported as income in different years. These are called temporary differences.
For example, income from selling properties on an installment basis is reported for financial accounting purposes in the year of the sale. But tax laws permit installment income to be reported on the tax return as it actually is received, by the installment method. This means taxable income might be less that pre-tax accounting income in the year of an installment sale, but higher than accounting income in later years when installment income is collected.
This results in temporary differences.

4. Temporary Differences
Temporary differences will reverse in one or more future periods.
Accounting Income > Taxable Income
Future Taxable Amounts
Deferred Tax Liability
Accounting Income < Taxable Income
Future Deductible Amounts
Deferred Tax Asset
A temporary difference originates in one period and reverses in one of more future periods.
When temporary differences cause accounting income to be greater than taxable income, the result is future taxable amounts and a deferred tax liability.
When temporary differences cause accounting income to be less than taxable income, the result is future deductible amounts and a deferred tax asset.

5. Deferred Tax Liabilities
It is important to understand that a temporary difference originates in one period and reverses, or turns around, in one or more subsequent periods. Consider an example involving an installment sale.
In 2011, Kent Land Management reported $140 million in pretax accounting income which included $40 million from installment sales of property. Pretax income for years 2012 and 2013 was $100 million each year. For the tax return, income from the installment sale will be reported when collected which will be $10 million in 2012 and $30 million in The company is subject to a 40% tax rate. Notice that for each of the year the pretax accounting income is not equal to the taxable income, yet for the total for the three year period for both is $340 million.
A temporary difference originates in one period and reverses, or turns around, in one or more subsequent periods.

6. Deferred Tax Liabilities
Calculate income tax that is currently payable: $100 × 40% = $40
Calculate change in deferred tax liability: ($40 × 40%) = $16
Combine the two to get the income tax expense: $40 + $16 = $56
Each year, income tax expense comprises both the current and deferred tax consequences of events and transactions already recognized. This means we:
Calculate the income tax that is payable currently. In this case, $100 million times the 40% tax rate, equals $40 million.
Separately calculate the change in the deferred tax liability or asset. In this case, $40 million times the 40% tax rate equals $16 million.
Combine the two to get the income tax expense. In this case, the total tax expense will be $56 million, which is the sum of $40 million and $16 million.
For the journal entry, we will credit the current amount of income tax payable for $40 million.
Because the tax laws permit Kent Land Management to delay reporting the $40 million in installment sale income as part of taxable income, they are able to defer paying the tax on that income. The tax is not avoided, just deferred. In the meantime, the company has a liability for the income tax deferred. The liability originates in 2011 and is paid over the next two years as portions of the installment sale income are included in taxable income. This deferral of $40 of income results in an increase of $16 in the Deferred Tax Liability account, which is recorded as a credit in the journal entry. The Deferred Tax Liability balance represents the future taxes the company will pay in 2012 and The change in the Deferred Tax Liability account is calculated as the total of the future taxable amounts times the enacted tax rate minus the existing balance in the account.
The debit to Income Tax Expense is the combination of the income tax payable and the deferred tax liability.
Income tax expense
Income tax payable
Deferred tax liability

7. The FASB’s Balance Sheet Approach
The previous slides considered the income effects of the installment sales. Another perspective is to consider the balance sheet effect. From our previous example, using GAAP as an accounting basis, a receivable from installment sales of $40 million is created in 2011 when the sale occurs. Yet, using a tax basis, there is no receivable created in Looking at this balance sheet approach we still see a temporary difference of $40 million in This multiplied times the 40% tax rate determines the $16 million deferred tax liability. After the installment payments of $10 million and $30 million are received in 2012 and 2013, the both the receivable from installment sales and the deferred tax liability are reduced to $0.
Of course, the income statement view and the balance sheet view are two different perspectives on the same event. Conceptually, the balance sheet approach strives to establish deferred tax assets and liabilities that meet the definitions of assets and liabilities as provided in the conceptual framework. In recent accounting standards, beyond just accounting for income taxes, it appears that the FASB and the IASB are embracing the “balance sheet approach”, which is also called the “asset/liability approach.”

8. Types of Temporary Differences
Temporary differences can result from either revenues (and gains) or expenses (and losses) which are reported on the income statement and the tax return at different times.
The temporary differences in the purple boxes create deferred tax liabilities because they result in taxable amounts in the future. Items reported in the current income statement, but on later tax return that result in deferred tax liabilities include installment sales of property when the installment method is used for taxes and unrealized gain from recording investments at fair value which is taxable when asset is sold.
Items reported on the tax return before the income statement that result in deferred tax liabilities include accelerated depreciation on the tax return when straight-line is used on the income statement and prepaid expenses that are tax deductible when paid.
The temporary differences in the blue boxes create deferred tax assets because they result in deductible amounts in the future. Items reported in the current income statement, but on later tax return that result in deferred tax assets include estimated expenses and losses that are not tax deductible until paid and unrealized loss from recording investments at fair value or inventory at Lower-of-Cost-or-Market which is tax deductible when the asset is sold.
Items reported on the tax return before the income statement that result in deferred tax assets include rent or subscriptions collected in advance and other revenue collected in advance.
Deferred tax assets result in deductible amounts in the future.
Deferred tax liabilities result in taxable amounts in the future.

9. Deferred Tax Liabilities
Note that deferred tax liabilities can arise from either (a) a revenue being reported on the tax return after the income statement or (b) an expense being reported on the tax return before the income statement.
The previous illustration using installment sales was of the first type. Now let’s consider the second type by considering the impact of straight –line depreciation used on the financial statements as opposed to an accelerated method used for tax purposes.
Courts Temporary Services reported pretax accounting income in 2011, 2012, 2013, and 2014 of $100 million. In 2011, an asset was acquired for $100 million. The asset is depreciated for financial reporting purposes over four years on a straight-line basis (no residual value). For tax purposes the asset’s cost is deducted (by MACRS) over 2011–2014 as follows: $33 million, $44 million, $15 million, and $8 million. No other depreciable assets were acquired. The enacted tax rate is 40% each year.
Note that although the depreciation amounts are different in each year, the total depreciation for the 4 year period is $100 for both methods. Also notice that although the amounts of pretax accounting income and taxable income are different in each year, the total income for the 4 year period is $400.
Notice that this temporary difference originates during more than a single year before it begins to reverse. This usually is true when depreciation is the cause of the temporary difference. Tax laws typically permit the cost of a depreciable asset to be deducted on the tax return sooner than it is reported as depreciation in the income statement.
A temporary difference originates in one period and reverses, or turns around, in one or more subsequent periods.

10. Deferred Tax Liabilities
Calculate income tax that is currently payable: $92 × 40% = $36.8
Calculate change in deferred tax liability: ($25 - $33) × 40% = $3.2
Combine the two to get the income tax expense: $ $3.2 = $40
As in the earlier example, the 2011 income tax expense will be comprised to two components, the amount payable now and the amount deferred until later. We use the same method as before:
Calculate the income tax that is payable currently. In this case, $92 million times the 40% tax rate, equals $36.8 million.
Next, calculate the change in the deferred tax liability or asset. In this case, depreciation on the income statement is $25 and on the tax return is $33 million, a difference of $8 million. This $8 million times the 40% tax rate equals $3.2 million.
Combine the two to get the income tax expense. In this case, the total tax expense will be $40 million, which is the sum of $36.8 million and the $3.2 million.
The journal entry will credit the current amount of income tax payable for $36.8 million.
The increase in the Deferred Tax Liability account of $3.2 million is credited to the deferred tax liability account.
And Income Tax Expense is debited for the combination of the income tax payable and the deferred tax liability.
Journal entry at the end of 2011
Income tax expense
Income tax payable
Deferred tax liability

11. Deferred Tax Liabilities
Calculate income tax that is currently payable: $81 × 40% = $32.4
Calculate change in deferred tax liability: (($25 - $44) × 40%)) = $7.6
Combine the two to get the income tax expense: $ $7.6 = $40
Now consider the second year, 2012, when we use the same method as before:
Calculate the income tax that is payable currently. In this case, $81 million times the 40% tax rate, equals $32.4 million.
Next, calculate the change in the deferred tax liability or asset. In this case, depreciation on the income statement is $25 and on the tax return is $44 million, a difference of $19 million. This $19 million times the 40% tax rate equals $7.6 million.
Combine the two to get the income tax expense. In this case, the total tax expense will be $40 million, which is the sum of $32.4 million and the $7.6 million.
The journal entry will credit the current amount of income tax payable for $32.4 million.
The increase in the Deferred Tax Liability account of $7.6 million is credited to the deferred tax liability account.
And Income Tax Expense is debited for the combination of the change in income tax payable and the change in the deferred tax liability.
Journal entry at the end of 2012
Income tax expense
Income tax payable
Deferred tax liability

12. Deferred Tax Liabilities
Calculate income tax that is currently payable: $110 × 40% = $44
Calculate change in deferred tax liability: (($25 - $15) × 40%)) = $4
Combine the two to get the income tax expense: $44 – 4 = $40
Now consider the third year, 2013, and again, we use the same process as before:
Calculate the income tax that is payable currently. In this case, $110 million times the 40% tax rate, equals $44 million.
Next, calculate the change in the deferred tax liability or asset. In 2013, depreciation on the income statement is $25 and on the tax return is $15 million, a difference of $10 million. But this time the amount of depreciation on the income statement is greater than the amount on the tax return. This $10 million times the 40% tax rate equals $4 million, which will reduce (or decrease) the tax liability.
This time the income tax payable of $44 million is offset by the reduction in the deferred tax liability of $4 million to result in total tax expense of $40 million.
The journal entry will credit the current amount of income tax payable for $44 million.
The decrease in the Deferred Tax Liability account of $4 million is debited to the deferred tax liability account.
And Income Tax Expense is debited for $40 million.
Journal entry at the end of 2013
Income tax expense
Deferred tax liability
Income tax payable

13. Deferred Tax Liabilities
Journal entry at the end of 2014
Income tax expense
Deferred tax liability
Income tax payable
The same process would be repeated for 2014 and the resulting journal entry would credit the current amount of income tax payable for $46.8 million. The decrease in the Deferred Tax Liability account of $6.8 million is debited to the deferred tax liability account. And Income Tax Expense is debited for $40 million.
Now consider the Deferred Tax Liability account for the 4 year period. In years 2011 and 2012, the deferred tax liability increased, but in years 2013 and 2014, the liability decreased. At the end of the 4 year period the balance is $0.

14. Deferred Tax Assets
RDP Networking reported pretax accounting income in 2011, 2012, and 2013 of $70 million, $100 million, and $100 million, respectively. The 2011 income statement includes a $30 million warranty expense that is deducted for tax purposes when paid in 2012 ($15 million) and 2013 ($15 million). The income tax rate is 40% each year.
Deferred tax assets are recognized for the future tax benefits of temporary differences that create future deductible amounts. Unlike most assets, management views deferred tax assets to be undesirable relative to deferred tax liabilities. The reason is that deferred tax liabilities result from having lower taxable income (and thus lower tax) now. However, deferred tax assets result from taxable income (and tax) being higher now than later. It is more desirable to delay paying taxes (any expense for that matter) as long as possible.
Deferred tax assets can result from (1) estimated expenses that are recognized in income statements when incurred but deducted on tax returns in later years when actually paid and (2) revenues that are taxed when collected but recognized in income statements in later years when actually earned. An example of the first type is provided in this slide.
RDP Networking reported pretax accounting income in 2011, 2012, and 2013 of $70 million, $100 million, and $100 million, respectively. The 2011 income statement includes a $30 million warranty expense that is deducted for tax purposes when paid in 2012 ($15 million) and 2013 ($15 million). The income tax rate is 40% each year.
Note that although the warranty expense amounts are different in each year, the total amount for the 3 year period is $30 for both methods. Also notice that although the amounts of pretax accounting income and taxable income are different in each year, the total income for the 3 year period is $270.

15. Deferred Tax Assets Journal entry at the end of 2011
Calculate income tax that is currently payable: $100 × 40% = $40
Calculate change in deferred tax asset: $30 × 40% = $12
Combine the two to get the income tax expense: $40 – 12 = $28
As in the earlier examples, the 2011 income tax expense will be comprised to two components, the amount payable now and the amount deferred until later. We use the same method as before:
Calculate the income tax that is payable currently. $100 million times the 40% tax rate, equals $40 million.
Next, calculate the change in the deferred tax asset. In this case, the warranty expense on the income statement is $30 and on the tax return is $0, a difference of $30 million. This $30 million times the 40% tax rate equals $12 million, a deferred tax asset.
In this case, the total tax expense will be $28 million.
The journal entry will credit the current amount of income tax payable for $40 million.
The increase in the Deferred Tax Asset account of $12 million is debited to the deferred tax asset account.
And Income Tax Expense is debited for $28 million.
Journal entry at the end of 2011
Income tax expense
Deferred tax asset
Income tax payable

16. Deferred Tax Assets Journal entry at the end of 2012 and 2013
Income tax expense
Deferred tax asset
Income tax payable
The journal entries for 2012 and 2013 are calculated in the same manner and both will reduce (or reverse) the deferred tax asset, by crediting the asset.
The deferred tax account for the three year period will show the initial asset recorded for $12 million in 2011, and reduced by $6 million in each of the two following years. At the end of the 3 years the balance is $0.

17. Valuation Allowance
A valuation allowance account is needed if it is more likely than not that some portion of the deferred tax asset will not be realized.
The deferred tax asset is then reported at its estimated net realizable value.
A valuation allowance account is needed when it is more likely than not that some portion of the deferred tax asset will not be realized.
The deferred tax asset is then reported at its estimated net realizable value, similar to the manner that Accounts Receivable are reduced by the Allowance for uncollectible accounts.

18. Permanent Differences
Created when an income item is included in taxable income or accounting income but will never be included in the computation of the other.
Example: Interest on tax-free municipal bonds is included in accounting income but is never included in taxable income.
Permanent differences are created when an income item is included in taxable income or accounting income but will never be included in the computation of the other. An example is interest on tax-free municipal bonds that is included in accounting income but is never included in taxable income.
Permanent differences are disregarded when determining both the tax payable currently and the deferred tax asset or liability.
Permanent differences are disregarded when determining both the tax payable currently and the deferred tax asset or liability.

19. U.S. GAAP vs. IFRS
Despite the similar approaches for accounting for income taxes under IFRS and U.S. GAAP, differences in reported amounts for deferred taxes are among the most frequent between the two reporting approaches.
For loss contingencies, IFRS uses a “more likely than not” threshold, which is lower than the U.S. “probable” requirement. As a result, under the lower threshold of IFRS, a loss contingency and a deferred tax asset sometimes is recorded for IFRS but not for U.S. GAAP.
For example, U.S. GAAP requires a loss contingency be accrued if it is both probable and can be reasonably estimated. Accruing a loss contingency leads to a deferred tax asset.
Despite the similar approaches for accounting for income taxes under IFRS and U.S. GAAP, differences in reported amounts for deferred taxes are among the most frequent between the two reporting approaches. The reason is that a great many of the nontax differences between IFRS and U.S. GAAP affect deferred taxes as well.
For example, U.S. GAAP requires a loss contingency be accrued if it is both probable and can be reasonably estimated. Accruing a loss contingency leads to a deferred tax asset.
For loss contingencies, IFRS uses a “more likely than not” threshold, which is lower than the U.S. “probable” requirement. As a result, under the lower threshold of IFRS, a loss contingency and a deferred tax asset is sometimes recorded for IFRS but not for U.S. GAAP.

20. Tax Rate Considerations
Deferred tax assets and liabilities should be determined using the future tax rates, if known.
The deferred tax asset or liability must be adjusted if a change in a tax law or rate occurs.
To measure the deferred tax liability or asset, we multiply the temporary difference by the currently enacted tax rate that will be effective in the year(s) the temporary difference reverses. We do not base calculations on anticipated legislation that would alter the company’s tax rate. A conceptual case can be made that expected rate changes should be anticipated when measuring the deferred tax liability or asset. However, this is one of many examples of the frequent trade-off between relevance and reliability. In this case, the FASB chose to favor reliability by waiting until an anticipated change actually is enacted into law before recognizing its tax consequences.

21. Multiple Temporary Differences
It would be unusual for any but a very small company to have only a single temporary difference in any given year.
Categorize all temporary differences according to whether they create …
Future taxable amounts
Future deductible amounts
It would be unusual for any but a very small company to have only a single temporary difference in any given year. Having multiple temporary differences doesn’t change any of the principles you have learned so far in connection with single differences. All that’s necessary is to categorize all temporary differences according to whether they create future taxable amounts or future deductible amounts. The total of the future taxable amounts is multiplied by the future tax rate to determine the appropriate balance for the deferred tax liability, and the total of the future deductible amounts is multiplied by the future tax rate to determine the appropriate balance for the deferred tax asset.

22. Net Operating Losses (NOL)
Tax laws often allow a company to use tax NOLs to offset taxable income in earlier or subsequent periods.
When used to offset earlier taxable income:
Called: operating loss carryback.
Result: tax refund.
When used to offset future taxable income:
Called: operating loss carryforward.
Result: reduced tax payable.
A net operating loss is negative taxable income: tax-deductible expenses exceed taxable revenues. Tax laws permit the operating loss to be used to reduce taxable income in other, profitable years. Offsetting operating profits with operating losses is achieved by either a carryback of the loss to prior years or a carryforward of the loss to later years, or both. In essence, the tax deductible expenses that can’t be deducted this year because they exceed taxable revenues can be deducted in other years. When a net operating loss is used to offset earlier taxable income it is called an operating loss carryback and results in a tax refund. When a net operating loss is used to offset future taxable income it is called an operating loss carryforward and results in reduced tax payable.

23. Net Operating Losses (NOL)
Carryback Period +3 +2 +1
. . .
+20 +4 +5
Carryforward Period -1 -2
Current Year
The NOL may first be applied against taxable income from two previous years.
Unused NOL may be carried forward for 20 years.
The net operating loss may first be applied against taxable income from two previous years. Unused net operating losses may be carried forward for 20 years.

24. Operating Loss Carryforward
Let’s consider an example of a loss carryforward. During 2011, its first year of operations, American Laminating Corporation reported an operating loss of $125 million for financial reporting and tax purposes. The enacted tax rate is 40%.
The $125 million loss can be used as a loss carryforward to future amounts. This results in deferred tax asset of $50 million.
The income tax benefit of an operating loss carryforward is recognized for accounting
purposes in the year the operating loss occurs. In this case, the net after-tax operating loss reflects the
future tax savings and would be $75 million (the Operating loss of $125 minus the Income tax benefit—operating loss $50.
Deferred tax asset
Income tax benefit-operating loss 50

25. Operating Loss Carryback
The carryback of the NOL must be applied to the earlier year first and then to the next year.
Any remaining NOL may be carried forward.
Let’s consider an operating loss carryback.
During 2011, American Laminating Corporation reported an operating loss of $125 million
for financial reporting and tax purposes. The enacted tax rate is 40% for Taxable
income, tax rates, and income taxes paid are detailed on that above schedule.
An operating loss must be applied to the earlier year first and then brought forward to the next year. If any of the loss remains after reducing taxable income to zero in the two previous years, the remainder is carried forward to future years as an operating loss carryforward.

26. Operating Loss Carryback
An operating loss must be applied to the earlier year first and then brought forward to the next year. If any of the loss remains after reducing taxable income to zero in the two previous years, the remainder is carried forward to future years as an operating loss carryforward.
In this case, the loss carryback to 2009 and 2010 resulted in a Tax refund of $29 million. The remaining portion of the net operating loss will be used as a carryforward to future years and resulted in a deferred tax asset of $20 million. The income tax benefit of both an operating loss carryback and an operating loss carry forward is recognized for accounting purposes in the year the operating loss occurs and in this case totals $49 million.
Notice that the income tax benefit ($49 million) is less than it was when we assumed a
carryforward only ($50 million). This is because the tax rate in one of the carryback years
(2009) was lower than the carryforward rate (40%).
Receivable—income tax refund
Deferred tax asset
Income tax benefit-operating loss 49

27. Balance Sheet Classification
Deferred tax assets/liabilities are classified as current or noncurrent based on the classification of the related asset or liability.
A deferred tax asset that is not related to a specific asset or liability should be classified according to when the underlying temporary difference is expected to reverse.
Deferred tax assets/liabilities are classified as current or noncurrent based on the classification of the related asset or liability. A deferred tax asset that is not related to a specific asset or liability should be classified according to when the underlying temporary difference is expected to reverse.

28. Disclosure Notes Deferred Tax Assets and Deferred Tax Liabilities
Total of all deferred tax liabilities.
Total of all deferred tax assets.
Total valuation allowance recognized.
Net change in valuation account.
Approximate tax effect of each type of temporary difference (and carryforward).
Income Tax Expense
Current portion of the tax expense (or benefit).
Deferred portion of the tax expense (or benefit) with separate disclosures of amounts attributable to several specific items.
Disclosure in the notes should include information about deferred tax assets and deferred tax liabilities, about operating loss carryforwards, and about income tax expense.
Additional disclosures that are required pertaining to deferred tax assets and deferred tax liabilities on the balance sheet should reveal the:
• Total of all deferred tax liabilities.
• Total of all deferred tax assets.
• Total valuation allowance recognized for deferred tax assets.
• Net change in the valuation allowance.
• Approximate tax effect of each type of temporary difference (and carryforward).
Disclosures for operating loss carryforwards should include the amounts and expiration
dates for any operating loss carryforwards.
Disclosures also are required pertaining to the income tax expense reported in the income statement. Disclosure notes should reveal the:
Current portion of the tax expense (or tax benefit).
Deferred portion of the tax expense (or tax benefit), with separate disclosure of amounts attributable to:
• Portions that do not include the effect of separately disclosed amounts.
• Operating loss carryforwards.
• Adjustments due to changes in tax laws or rates.
• Adjustments to the beginning-of-the-year valuation allowance due to revised
Estimates, and
• Tax credits.
Operating Loss Carryforwards
Amounts.
Expiration dates.

29. Coping with Uncertainty in Income Taxes
Two-step Decision Process
Step 1. A tax benefit may be reflected in the financial statements only if it is “more likely than not” that the company will be able to sustain the tax return position, based on its technical merits.
Step 2. A tax benefit should be measured as the largest amount of benefit that is cumulatively greater than 50 percent likely to be realized.
Few expense items in the income statement rival the size of the income tax expense line, and few are subject to the complexities and differing interpretations inherent in reporting income tax expense. As you might imagine, most companies strive to legitimately reduce their overall tax burden and to reduce or delay cash outflows for taxes. Even without additional efforts to reduce taxes, most companies’ tax returns will include many tax positions that are subject to multiple interpretations. That is, the position management takes with respect to an element of tax expense might differ from the position the IRS or the tax court might take on that same item. Despite good faith positions taken in preparing tax returns, those judgments may not ultimately prevail if challenged by the IRS. Managements’ tax positions frequently are subjected to legal scrutiny before the uncertainty ultimately is resolved.
To deal with that uncertainty, companies are allowed to recognize in the financial statements the tax benefit of a position it takes only if it is “more likely than not” (greater than 50% chance) to be sustained if challenged. Guidance also prescribes how to measure the amount to be recognized. The decision, then, is a “two-step” process.
Step 1. A tax benefit may be reflected in the financial statements only if it is “more likely than not” that the company will be able to sustain the tax return position, based on its technical merits.
Step 2. A tax benefit should be measured as the largest amount of benefit that is “cumulatively greater than 50 percent likely to be realized.”
If in step one it is determined that the more-likely-than-not criterion is not met, this means that none of the tax benefit is allowed to be recorded. In measuring the amount, use the largest amount that has a greater than 50 percent chance of being realized.
If the tax benefit is not “more likely than not,” then none of the tax benefit is allowed to be recorded.

30. Intraperiod Tax Allocation
Income Statement:
Income from continuing operations.
Discontinued operations.
Extraordinary items.
Other Comprehensive Income:
Investments.
Postretirement benefit plans.
Derivatives.
Foreign currency translation.
You should recall that an income statement reports certain items separately from income (or loss) from continuing operations when such items are present. Specifically, (a) discontinued operations and (b) extraordinary items are given a place of their own in the income statement to better allow the user of the statement to isolate irregular components of net income from those that represent ordinary, recurring business operations. Presumably, this permits the user to more accurately project future operations without neglecting events that affect current performance. Following this logic, each component of net income should reflect the income tax effect directly associated with that component.
Consequently, the total income tax expense for a reporting period should be allocated among the income statement items that gave rise to it. Each of the following items should be reported net of its respective income tax effects:
• Income (or loss) from continuing operations.
• Discontinued operations.
• Extraordinary items.
Allocating income tax expense or benefit also applies to components of comprehensive income reported separately from net income. The other comprehensive income (OCI) items relate to investments, postretirement benefit plans, derivatives, and foreign currency translation. When these OCI items are reported in a statement of comprehensive income and then accumulated in shareholders’ equity, they are reported net of their respective income tax effects in the same way as for discontinued operations and extraordinary items.
Finally, IFRS does not report extraordinary items separately. As a result, according to IFRS the only income statement item reported separately net of tax is discontinued operations.

31. U.S. GAAP vs. IFRS
The approach for accounting for intraperiod tax allocation is the same under IFRS and U.S. GAAP, but the categories used on the income statement are different.
GAAP separately reports both discontinued operations and extraordinary items on the income statement and each are shown net of tax.
IFRS does not separately report extraordinary items on the income statement. As a result, the only income statement item reported separately net of tax using IFRS is discontinued operations.
The approach for accounting for intraperiod tax allocation is the same under IFRS and U.S. GAAP, but the categories used on the income statement are different.
GAAP separately reports both discontinued operations and extraordinary items on the income statement and each are shown net of tax.
IFRS does not report extraordinary items separately on the income statement. As a result, the only income statement item reported separately net of tax using IFRS is discontinued operations.

32. End of Chapter 16
End of chapter 16.