Accounting for Income Taxes

Chapter 16

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA

Copyright2013byTheMcGrawHillCompanies,Inc.Allrightsreserved.

16-2

Deferred Tax Assets and

Deferred Tax Liabilities
GAAP
GAAPis
isthe
theset
set of
of
rules
rulesfor
forpreparing
preparing
financial
financial
statements.
statements.
Results in . . .

Financial
Financial statement
statement
income
incometax
taxexpense.
expense.

The
TheInternal
InternalRevenue
Revenue
Code
Codeis
is the
theset
set of
of
rules
rulesfor
for preparing
preparing
tax
taxreturns.
returns.
Results in . . .
Usually. . .

IRS
IRSincome
income taxes
taxes
payable.
payable.

The
Theobjective
objectiveof
ofaccounting
accounting for
for income
incometaxes
taxes is
isto
to
recognize
recognizeaa deferred
deferredtax
taxliability
liability or
or deferred
deferredtax
taxasset
asset
for
forthe
thetax
taxconsequences
consequencesof
ofamounts
amountsthat
that will
willbecome
become
taxable
taxableor
ordeductible
deductible in
infuture
futureyears
yearsas
asaaresult
resultof
of
transactions
transactionsor
orevents
eventsthat
that already
alreadyhave
haveoccurred.
occurred.

16-3

Temporary Differences
The
The difference
difference in
in the
the rules
rules for
for computing
computing
between
between pretax
pretax accounting
accounting income
income
(according
(according to
to GAAP)
GAAP) and
and taxable
taxable income
income
(according
(according to
to the
the IRS)
IRS) often
often causes
causes
amounts
amounts to
to be
be reported
reported in
in different
different
years.
years.

This results in
temporary
differences.

16-4

Temporary Differences
Temporary
Temporary differences
differences will
will reverse
reverse
in
in one
one or
or more
more future
future periods.
periods.
Accounting Income > Taxable Income

Accounting Income < Taxable Income

Future Taxable Amounts

Future Deductible Amounts

Deferred Tax Liability

Deferred Tax Asset

16-5

Deferred Tax Liabilities

Kent Land Management reported pretax accounting income in 2013, 2014,
and 2015 of $100 million, plus additional 2013 income of $40 million from
installment sales of property. However, the installment sales income is
reported on the tax return when collected, in 2014 ($10 million) and 2015
($30 million). The enacted tax rate is 40% each year.

A temporary difference originates in one period and

reverses, or turns around, in one or more subsequent
periods.

16-6

Deferred Tax Liabilities

Calculate
Calculate income
income tax
tax that
that is
is currently
currently payable:
payable: $100
$100 40%
40% == $40
$40
Calculate
Calculate change
change in
in deferred
deferred tax
tax liability:
liability: ($40
($40 40%)
40%) == $16
$16
Combine
Combine the
the two
two to
to get
get the
the income
income tax
tax expense:
expense: $40
$40 ++ $16
$16 == $56
$56

Income tax expense

Income tax payable
Deferred tax liability

56
40
16

16-7

The FASBs Balance Sheet Approach

16-8

Types of Temporary Differences

Deferred
Deferredtax
taxassets
assets
result
resultin
indeductible
deductible
amounts
amountsin
inthe
thefuture.
future.

Deferred
Deferredtax
taxliabilities
liabilities
result
resultin
intaxable
taxableamounts
amounts
in
inthe
thefuture.
future.

16-9

Deferred Tax Liabilities

Courts Temporary Services reported pretax accounting income in 2013, 2014,
2015, and 2016 of $100 million. In 2013, 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 assets cost is
deducted (by MACRS) over 20132016 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.

A temporary difference originates in one period and

reverses, or turns around, in one or more subsequent

1610

Deferred Tax Liabilities

Calculate
Calculate income
income tax
tax that
that is
is currently
currently payable:
payable: $92
$92 40%
40% == $36.8
$36.8
Calculate
Calculate change
change in
in deferred
deferred tax
tax liability:
liability: ($25
($25 -- $33)
$33) 40%
40% == $3.2
$3.2
Combine
Combine the
the two
two to
to get
get the
the income
income tax
tax expense:
expense: $36.8
$36.8 ++ $3.2
$3.2 == $40
$40

Journal entry at the end of 2013

Income tax expense
Income tax payable
Deferred tax liability

40.0
36.8
3.2

1611

Deferred Tax Liabilities

Calculate
Calculate income
income tax
tax that
that is
is currently
currently payable:
payable: $81
$81 40%
40% == $32.4
$32.4
Calculate
Calculate change
change in
in deferred
deferred tax
tax liability:
liability: (($25
(($25 -- $44)
$44) 40%))
40%)) == $7.6
$7.6
Combine
Combine the
the two
two to
to get
get the
the income
income tax
tax expense:
expense: $32.4
$32.4 ++ $7.6
$7.6 == $40
$40

Journal entry at the end of 2014

Income tax expense
Income tax payable
Deferred tax liability

40.0
32.4
7.6

1612

Deferred Tax Liabilities

Calculate
Calculate income
income tax
tax that
that is
is currently
currently payable:
payable: $110
$110 40%
40% == $44
$44
Calculate
Calculate change
change in
in deferred
deferred tax
tax liability:
liability: (($25
(($25 -- $15)
$15) 40%))
40%)) == $4
$4
Combine
Combine the
the two
two to
to get
get the
the income
income tax
tax expense:
expense: $44
$44 44 == $40
$40

Journal entry at the end of 2015

Income tax expense
Deferred tax liability
Income tax payable

40
4
44

1613

Deferred Tax Liabilities

Journal entry at the end of 2016
Income tax expense
Deferred tax liability
Income tax payable

40.0
6.8
46.8

1614

Deferred Tax Assets

1615

Deferred Tax Assets

Calculate
Calculate income
income tax
tax that
that is
is currently
currently payable:
payable: $100
$100 40%
40% == $40
$40
Calculate
Calculate change
change in
in deferred
deferred tax
tax asset:
asset: $30
$30 40%
40% == $12
$12
Combine
Combine the
the two
two to
to get
get the
the income
income tax
tax expense:
expense: $40
$40 12
12 == $28
$28

Journal entry at the end of 2013

Income tax expense
Deferred tax asset
Income tax payable

28
12
40

1616

Deferred Tax Assets

Journal entry at the end of 2014 and 2015
Income tax expense
Deferred tax asset
Income tax payable

40
6
34

1617

Valuation Allowance

A
A valuation
valuation allowance
allowance
account
account is
is needed
needed if
if it
it is
is
more
more likely
likely than
than not
not that
that
some
some portion
portion of
of the
the deferred
deferred
tax
tax asset
asset will
will not
not be
be realized.
realized.
The
The deferred
deferred tax
tax asset
asset is
is
then
then reported
reported at
at its
its
estimated
estimated net
net realizable
realizable
value.
value.

1618

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 disregarded when

determining both the tax payable currently and
the deferred tax asset or liability.

1619

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 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 sometimes
is recorded for IFRS but not for
U.S. GAAP.

1620

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.

1621

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

1622

Net Operating Losses (NOL)

Tax
Tax laws
laws often
often allow
allow aa company
company to
to use
use tax
tax
NOLs
NOLs to
to offset
offset taxable
taxable income
income in
in earlier
earlier or
or
subsequent
subsequent periods.
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.

1623

Net Operating Losses (NOL)

Carryback
Period
-2

-1

Carryforward
Period
+1 +2 +3 +4 +5

Current
Year

. . . +20

The
The NOL
NOL may
may first
first be
be applied
applied against
against taxable
taxable
income
income from
from two
two previous
previous years.
years.
Unused
Unused NOL
NOL may
may be
be carried
carried forward
forward for
for 20
20
years.
years.

1624

Operating Loss Carryforward

Journal entry at the end of 2013

Deferred tax asset
Income tax benefit-operating loss

50
50

1625

Operating Loss Carryback

The
The carryback
carryback of
of the
the NOL
NOL must
must be
be applied
applied to
to
the
the earlier
earlier year
year first
first and
and then
then to
to the
the next
next year.
year.
Any
Any remaining
remaining NOL
NOL may
may be
be carried
carried forward.
forward.

1626

Operating Loss Carryback

Journal entry at the end of 2013

Receivableincome tax refund
Deferred tax asset
Income tax benefit-operating loss

29
20
49

1627

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.

1628

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).

Operating Loss
Carryforwards
Amounts.
Expiration dates.

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

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.
If the tax benefit is not more likely
than not, then none of the tax
benefit is allowed to be recorded.

1629

1630

Intraperiod Tax Allocation

Income Statement:
Income from continuing operations.
Discontinued operations.
Extraordinary items.

Other Comprehensive Income:

Investments.
Postretirement benefit plans.
Derivatives.
Foreign currency translation.

1631

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.

1632

End of Chapter 16