19 Accounting for Income Taxes

Question 1

List the formula for computing the effect of a permanent difference on the effective tax rate.

Answer 1

Product of permanent difference and stated rate divided by pretax accounting income

Question 2

When is a valuation allowance created for a deferred tax asset?

Answer 2

When there is a 50% or less chance of the deferred tax asset being fully realized

Question 3

Compute the ending valuation allowance if the total future deductible difference is $4,000, the tax rate is 30%, and only $1,000 of future taxable income is assured.

Answer 3

$900 (deferred tax asset balance is $1,200, but only $300 is expected to be realized)

Question 4

What is the classification of the valuation allowance for deferred tax assets?

Answer 4

The classification is contra deferred tax asset.

Question 5

List the evidence suggesting the need of a valuation allowance.

Answer 5

History of unused net operating losses
History of operating losses
Losses expected in future years
Very unfavorable contingencies

Question 6

How is the amount of a valuation allowance determined?

Answer 6

Enough to reduce deferred tax asset to amount that has a better than 50% chance of being realized.

Question 7

List the two categories of temporary differences.

Answer 7

1. Taxable temporary differences
2. Deductible temporary differences

Question 8

Are originating or future reversing temporary differences used in determining the ending balance in deferred tax accounts?

Answer 8

Future reversing temporary differences are used.

Question 9

What book versus tax differences does the computation of income tax liability consider?

Answer 9

It considers current-period temporary and permanent differences.

Question 10

What temporary difference causes future taxable income to exceed future book income?

Answer 10

A taxable temporary difference.

Question 11

If future enacted tax rates are not the same as the current rate and future temporary differences originated in the current period, which rate(s) do(es) income tax expense reflect?

Answer 11

Both current and future enacted tax rates are reflected.

Question 12

Are current-year or future permanent differences used in the current-year tax accrual entry?

Answer 12

Current-year differences are used.

Question 13

What general effect does a permanent difference have on income tax expense?

Answer 13

The effect of a permanent difference on income tax expense is the same as its effect on the income tax liability for the period.

Question 14

List some common permanent differences.

Answer 14

Tax-free interest income
Life insurance expense premiums on key employee
Proceeds from life insurance on key employee
Dividends received deduction
Fines and penalties

Question 15

How do permanent differences affect the tax accrual entry?

Answer 15

Taxable income excludes them; this exclusion is reflected in income tax expense—a plug figure.

Question 16

What effect does a change in tax status from taxable to nontaxable have on deferred tax accounts?

Answer 16

Close the accounts against income tax expense (e.g., closing a deferred tax asset increases income tax expense).

Question 17

What effect do future taxable differences have on the ending deferred tax asset for a firm with an unused net operating loss carryforward?

Answer 17

They have no effect; taxable differences yield deferred tax liabilities.

Question 18

What is the general expression for the change in deferred tax asset for a period for a net operating loss (NOL) carryforward that is not fully used up in the period?

Answer 18

End-of-period sum of future deductible differences plus unused NOL carryforward, times future enacted tax rate, less beginning deferred tax asset

Question 19

What is the required ending balance of a deferred tax asset when there are future deductible differences and an unused net operating loss (NOL) carryforward?

Answer 19

It is the product of the future enacted tax rate and the sum of future deductible differences plus unused NOL carryforward.

Question 20

What is the ending balance of a deferred tax asset for a net operating loss (NOL) carryforward?

Answer 20

It is the product of the enacted future tax rate and NOL remaining to carryforward.

Question 21

What effect does an originating deductible difference have on the tax accrual entry?

Answer 21

It increases the required ending deferred tax asset balance.

Question 22

Describe the general effect of a net operating loss (NOL) on the ending deferred tax asset balance for the carryforward.

Answer 22

Include in the ending DTA the full NOL multiplied by the future enacted tax rate.

Question 23

List the sources for realizing a deferred tax asset.

Answer 23

Expectation of future taxable income
Future taxable differences
Tax planning strategies

Question 24

What does a history of unused net operating losses suggest?

Answer 24

It suggests that the deferred tax asset will not be realized.

Question 25

What effect does a reversing taxable difference have on the tax accrual entry?

Answer 25

It decreases the required ending deferred tax liability balance.

Question 26

How is the required ending deferred tax liability balance expressed?

Answer 26

It is the product of the sum of future taxable differences and the future enacted tax rate.

Question 27

How is income tax expense for a period computed?

Answer 27

It is a derived amount or plug figure, the net change caused by the changes in deferred tax accounts and the income tax liability.

Question 28

What is the general formula for computing income tax expense?

Answer 28

Income tax liability +/− Change in the deferred tax accounts

Question 29

How is the change in the deferred tax liability account for a period computed?

Answer 29

Required ending deferred tax liability balance – Beginning deferred tax liability balance

Question 30

What is the effect of a nontaxable revenue on income tax expense?

Answer 30

Income tax expense is not increased.

Question 31

What is the effect of a nondeductible expense on income tax expense?

Answer 31

Income tax expense is not reduced.

Question 32

What is the minimum probability of sustaining an uncertain tax position required to reduce income tax expense for an uncertain tax position?

Answer 32

Greater than 50%

Question 33

Describe the accounting effect when the probability of sustaining an uncertain tax position is equal to or greater than the minimum for reducing income tax expense.

Answer 33

Recognize a reduction in income tax expense for the largest amount for which the cumulative probability of realization exceeds 50%, and recognize an additional liability for the unrecognized portion.

Question 34

Describe the account effect when the probability of sustaining an uncertain tax position is less than the minimum for reducing income tax expense.

Answer 34

Report a liability for the uncertain tax position in addition to the income tax liability.

Question 35

Define “uncertain tax position.”

Answer 35

A position taken on the firm’s tax return that reduces income tax but that may be challenged by the taxing authorities

Question 36

Describe the accounting effect when the actual tax benefit is greater than expected in a later year.

Answer 36

Reduce the income tax expense for the difference between the benefit recognized in the previous year and the actual benefit.

Question 37

What tax rate is used for computing the tax liability?

Answer 37

The current tax rate

Question 38

What tax rate should be used when computing the change in the deferred tax accounts?

Answer 38

Enacted future tax rates (which would be the same as the current tax rate if rates have not been changed)

Question 39

What type of difference is caused by the liability for a warranty?

Answer 39

Deductible difference.

Question 40

If book depletion is $4,000 and tax depletion is $12,000, what is the amount of the permanent difference?

Answer 40

$8,000.