Advanced Accounting Chapter 19 PDF

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Summary of Chapter 19 of the Intermediate Accounting textbook. Has book summary, class notes, and examples....

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Chapter 19 – Accounting for Income Taxes: Accounting for Income Taxes  Corporations must file income tax returns following the guidelines developed by the Internal Revenue Service (IRS).  Because GAAP and tax regulations differ in a number of ways, the amounts reported for the following will differ: o income tax expense (GAAP). o income tax payable (Internal Revenue Code).

 Future Taxable and Deductible Amounts  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: o 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. o 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. Book vs. Tax Differences

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 o We account for these differences in the financial statements o Record the difference in the tax liability – deferred tax liability

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o Future Taxable Amounts o Deferred Tax Liability 

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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.

Presentation on Financial Statements:

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At the end of 2017 to record income taxes: Income Tax Expense 28,000 Income Taxes Payable 16,000 Deferred Tax Liability 12,000 At the end of 2018 to record income taxes: Income Tax Expense 28,000 Deferred Tax Liability 8,000 Income Taxes Payable 36,000 o Deferred tax liability reported on B/S is $4,000 At the end of 2019 to record income taxes: Income Tax Expense 28,000 Deferred Tax Liability

4,000

Income Taxes Payable 

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32,000

The entry to record income taxes at the end of 2019 reduces the Deferred Tax Liability by $4,000. The Deferred Tax Liability account appears as follows at the end of 2019. o Financial Statement Effects:

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o

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o We want to defer the liability because we want the money in our pocket to invest, rather than giving to IRS Example 2: Starfleet Corporation has one temporary difference at the end of 2017 that will reverse and cause taxable amounts of $55,000 in 2018, $60,000 in 2019, and $75,000 in 2020. Starfleet’s pretax financial income for 2017 is $400,000, and the tax rate is 30% for all years. There are no deferred taxes at the beginning of 2017. o Compute taxable income and income taxes payable for 2017. o Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2017.

o Deferred Tax Assets:  A 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.

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Example: o Hunt Company has revenues of $900,000 for both 2017 and 2018. It also has operating expenses of $400,000 for each of these years. In addition, Hunt accrues a loss and related liability of $50,000 for financial reporting purposes because of pending litigation. Hunt cannot deduct this amount for tax purposes until it pays the liability, expected in 2018. As a result, a deductible amount will occur in 2018 when Hunt settles the liability, causing taxable income to be lower than pretax financial information. Illustration 19-18 shows the GAAP and tax reporting over the two years.

o o Hunt can compute the deferred tax asset by preparing a schedule that indicates the future deductible amounts due to deductible temporary differences.

 o Assume that 2017 is Hunt’s first year of operations, and income tax payable is $100,000, compute income tax expense.

 Prepare the entry at the end of 2017 to record income taxes. Income Tax Expense 80,000 Deferred Tax Asset 20,000 Income Taxes Payable 100,000 o Computation of Income Tax Expense for 2018. 

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Prepare the entry at the end of 2018 to record income taxes. Income Tax Expense 160,000 Deferred Tax Asset 20,000 Income Taxes Payable 140,000

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Example: o Columbia Corporation has one temporary difference at the end of 2017 that will reverse and cause deductible amounts of $50,000 in 2018, $65,000 in 2019, and $40,000 in 2020. Columbia’s pretax financial income for 2017 is $200,000 and the tax rate is 34% for all years. There are no deferred taxes at the beginning of 2017. Columbia expects to be profitable in the future.  Compute taxable income and income taxes payable for 2017. 

Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2017.

 Accounting for Income Taxes 

Deferred Tax Asset—Valuation Allowance

o A company should reduce a deferred tax asset by a valuation allowance if it is more

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likely than not that it will not realize some portion or all of the deferred tax asset. o “More likely than not” means a level of likelihood of at least slightly more than 50 percent. Example: o Callaway Corp. has a deferred tax asset balance of $150,000 at the end of 2017 due to a single cumulative temporary difference of $375,000. At the end of 2018 this same temporary difference has increased to a cumulative amount of $500,000. Taxable income for 2018 is $850,000. The tax rate is 40% for all years. No valuation account is in existence at the end of 2017. o Assuming that it is more likely than not that $30,000 of the deferred tax asset will not be realized, prepare the journal entries required for 2018.

 o Balance Sheet Presentation: A s s e ts : D e f e r r e d ta x a s s e t

2018

$

A llo w a n c e f o r d e f e r r e d t a x D e fe rre d ta x a s s e t, n e t

 Additional Considerations  Income Statement Presentation o Formula to Compute Income Tax Expense

2 0 0 ,0 0 0 (3 0 ,0 0 0 ) 1 7 0 ,0 0 0

 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). o Given the previous information related to Chelsea Inc., Chelsea reports its income 

statement as follows.

o Accounting for income taxes  Specific Differences o Originating and Reversing Aspects of Temporary Differences.  Originating temporary difference is the initial difference between the book basis and the tax basis of an asset or liability.  Reversing difference occurs when eliminating a temporary difference that originated in prior periods and then removing the related tax effect from the deferred tax account o Permanent differences result from items that (1) enter into pretax financial income but never into taxable income or (2) enter into taxable income but never into pretax financial income o Permanent differences affect only the period in which they occur. They do not give rise to future taxable or deductible amounts. There are no deferred tax consequences to be recognized.

 o Illustration: 

Do the following generate:  Future Deductible Amount = Deferred Tax Asset  Future Taxable Amount = Deferred Tax Liability  Permanent Difference

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 o Illustration: Havaci Company reports pretax financial income of $80,000 for 2017. The following items cause taxable income to be different than pretax financial income.  Depreciation on the tax return is greater than depreciation on the income statement by $16,000.  Rent collected on the tax return is greater than rent earned on the income statement by $27,000.  Fines for pollution appear as an expense of $11,000 on the income statement. o Havaci’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 2017.

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 Temporary Differences o Taxable temporary differences - Deferred tax liability o Deductible temporary differences - Deferred tax Asset

Tax Rate Considerations  Future Tax Rates o A company must consider presently enacted changes in the tax rate that become

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effective for a particular future year(s) when determining the tax rate to apply to existing temporary differences. o In determining the appropriate enacted tax rate for a given year, companies must use the average tax rate. Revision of Future Tax Rates o When a change in the tax rate is enacted, companies should record its effect on the existing deferred income tax accounts immediately. o A company reports the effect as an adjustment to income tax expense in the period of

the change. Net Operating Losses   

Net operating loss (NOL) = tax-deductible expenses exceed taxable revenues. The federal tax laws permit taxpayers to use the losses of one year to offset the profits of other years (loss carryforward). Valuation Allowance Revisited o Whether the company will realize a deferred tax asset depends on whether sufficient taxable income exists or will exist within the carryforward period.

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