Fundamentals of Accounting for Income Taxes - Part I

CHAPTER 20

Fundamentals of Accounting for Income Taxes - Part I

1. What is pretax financial income? What rules are followed in determining pretax financial income?

1. What is taxable income? What rules are followed in determining taxable income?

1. How is Income Tax Payable calculated? How is the account classified on the balance sheet?

1. Define each of the following terms:
2. Temporary differences

1. Taxable amounts (also called future taxable amounts)

1. Deductible amounts (also called future deductible amounts)

1. Deferred tax liability

1. Deferred tax asset

1. Deferred tax expense

1. Deferred tax benefit

1. Originating temporary differences

1. Reversing temporary differences

1. Permanent differences

1. Effective tax rate formula

1. What are the two primary objectives of accounting for income taxes?

TEMPORARY DIFFERENCES BETWEEN

FINANCIAL REPORTING AND INCOME TAX LAWS

FINANCIAL REPORTINGINCOME TAX LAWS

1. Installment sales:

Reported as revenue when the sale is made.Reported as revenue when collected.

(Receivable is recorded on books.)(No receivable on tax books.)

2. Warranty Costs:

Expense is recorded when product is sold.Expense is deducted when cash paid.

(Warranty liability on books.)(No liability on tax books.)

3. Litigation liability:

Recorded when it is probable that a loss hasDeducted when paid.

occurred.

(Liability on books.)(No liability on tax books.)

4. Bad Debt Expense:

Recognized using allowance method.Recognized using direct-write-off method.

(Book value of AR = AR – allowance.)(No allowance recorded.)

5. Revenue received in advance:

Recorded as revenue when earned.Recorded as revenue when cash received.

(Liability on books.)(No liability on tax books.)

6. Depreciation Expense:

Use of straight-line method.Use of MACRS (accelerated method).

(Asset book value based on SL method.)(Asset tax book value based on MACRS.)

7. Prepaid Expenses:

Expense is recorded when asset expires.Expense is deducted when cash paid.

(Asset on books.)(No asset on tax books.)

PERMANENT DIFFERENCES BETWEEN

FINANCIAL REPORTING AND INCOME TAX LAWS

ITEMS RECOGNIZED FOR FINANCIAL REPORTING BUT NOT FOR TAX PURPOSES:

1. Interest received on state and municipal obligations

2. Proceeds from life insurance carried by the company on key officers or employees

3. Premiums paid for life insurance carried by the company on key officers or employees (company is

beneficiary)

4. Fines and expenses resulting from a violation of the law

5. Expenses incurred in obtaining tax exempt income

ITEMS RECOGNIZED FOR INCOME TAX BUT NOT FOR FINANCIAL REPORTING PURPOSES:

1. Deduction for dividends received from U.S. corporations (generally 70-80%)
2. Goodwill amortization

1. For each temporary difference listed on the previous page (items 1-7), indicate whether financial income (FI) is greater than (>) or less than (<) taxable income (TI) in the year the difference originates. Then indicate whether it is a taxable or deductible temporary difference and whether it creates a deferred tax liability or deferred tax asset by placing an X in the appropriate box.

1. How do permanent differences affect deferred taxes?

1. When should an Allowance to Reduce Deferred Tax Asset to Expected Realizable Value be recorded?

Work Brief Exercises 1 – 8.

Chapter 20 – part 2

Read pages 1072 – 1087 and answer the following questions.

1. What is a net operating loss (NOL)?

1. If a company elects to carryback an NOL, how far back (how many years) can the loss be taken? What account is debited for the tax effects of an NOL carryback?

1. If a company elects to carryforward an NOL, how far forward can the loss be taken? What account is debited for the tax effects of an NOL carryforward?

1. Work Brief Exercise 11 (page 1098) related to NOLs:
2. Use the information as presented in BE-11.

1. Use the information presented in BE-11 but assume instead that the loss in 2002 is $800,000. Prepare the entry.

1. Use the information in BE-11 but assume instead that the loss in 2002 is $1,200,000. Prepare the entry.

1. Assume that for part (c), that it is more likely than not that $100,000 of the NOL will not be realized in future years. Prepare any additional entries necessary to account for this.

1. Assume that in 2003, the company earns taxable income of $500,000 and the tax rate is still 29%. There are no temporary differences other than the NOL. Record the entries related to income taxes.

1. Deferred tax accounts are reported on the balance sheet as assets and liabilities. They should be classified as a net current amount and a net noncurrent amount. How are individual deferred tax assets and liabilities classified as current or noncurrent?

1. If a deferred tax asset/liability is not related to an account on the balance sheet (for example an NOL carryforward), how do you determine whether the deferred tax account is current or noncurrent?

1. For each of the following, indicate whether the related deferred tax account is current or noncurrent and whether it is a deferred tax asset or liability. For items 1, 2, 5 and 7, assume that these fall within the company’s normal operating cycle. The company expects to settle the litigation (#3) within the next year.