19.01 Accounting for Income Taxes

Question 1

What is interperiod tax allocation?

Answer 1

The process of recognizing income tax expense and associated deferred tax accounts is called interperiod tax allocation. It is the application of accrual accounting to the measurement of income tax effects on the financial statements.

Question 2

What are the two components of income tax expense under GAAP?

Answer 2

Current tax expense (benefit) - based on taxable income
Deferred tax expense (benefit) - based on temporary differences

Question 3

How do you calculate the current income tax expense (benefit)?

Answer 3

Taxable income x Current income tax rate = Current tax expense (benefit)

Question 4

How is the current income tax expense (benefit) reported on the FS?

Answer 4

Reported in income tax payable on the balance sheet

Question 5

How do you calculate the deferred income tax expense (benefit)?

Answer 5

Ending net deferred tax asset/liability +/- Beginning net deferred tax asset/liability = Deferred tax expense (benefit)H

Question 6

How is the deferred income tax expense (benefit) reported on the FS?

Answer 6

Reported in deferred tax asset or deferred tax liability on the balance sheet

Question 7

What are the two types of differences that must be adjusted for to arrive at taxable income?

Answer 7

Permanent differences and Temporary differences

Question 8

What are permanent differences?

Answer 8

An item that appears in the tax return or income statement but not both.; it never reverses. Permanent differences are not allocated, therefore, they do not impact interperiod tax allocation.

Question 9

What are temporary differences?

Answer 9

An item that is taxable or deductible on the tax return in a different period than that reported on the books; reverses over time.

Question 10

What is the calculation of taxable income and current tax expense?

Answer 10

Pretax income per financial reporting
+/- Permanent differences
+/- Temporary differences
= Taxable income
x Current enacted tax rate
= Current tax expense/liability
- Tax prepayments
= Net income tax payable

Question 11

What are examples of permanent differences?

Answer 11

Tax-free interest income - taxable/deductible? No / include in pretax? Yes
Life insurance expense - taxable/deductible? No / include in pretax? Yes
Life insurance proceeds - taxable/deductible? No / include in pretax? Yes
Certain fines/penalties - taxable/deductible? No / include in pretax? Yes
Dividends received deduction - taxable/deductible? Portion included / include in pretax? Entire amount included

Question 12

What are examples of temporary differences?

Answer 12

Depreciation for book versus tax - typically leads to lower taxable income because depreciation is accelerated
Investments accounted for under the equity method for book purposes - typically leads to higher book income
Use of the installment sales method for tax purposes - typically leads to lower taxable income because cash is not taxable until received
Prepaid expenses - typically leads to lower taxable income as expenses are deductible when initially paid
Goodwill - typically leads to lower taxable income because for tax purposes, goodwill is amortized over 15 years but tested annually for impairment under GAAP.

Question 13

When do deferred tax liabilities arise?

Answer 13

DTL, or taxable temporary differences, arise when book expense is less than tax expense or when book revenue is greater than tax revenue. In both scenarios, the item increases book income for the period, relative to taxable income.

Question 14

When do deferred tax assets arise?

Answer 14

DTA, or deductible temporary differences, arise when book expense is more than tax expense or when book revenue is less than tax revenue. In both scenarios, the item decreases book income for the period, relative to taxable income.

Question 15

What are examples of deferred tax assets?

Answer 15

Warranty expense - typically leads to higher taxable income because the expense is not deductible until paid
Rent, royalty, and interest received in advance - typically leads to higher taxable income because the cash is taxable when initially received
Credit loss expense - typically leads to higher taxable income because the direct write-off method is used for tax purposes and the allowance method is used for GAAP.

Question 16

True or false: if only permanent differences exist, no deferred tax asset or liability will be recognized.

Answer 16

True. DTAs and DTLs are created from temporary differences.

Question 17

What is a deferred tax asset valuation allowance?

Answer 17

A DTA is an asset only if it has future benefit. A DTA will reduce income tax payments in the future, but only if there is taxable income in the future to reduce. When there is not a sufficient probability of realizing the deferred tax asset, a valuation allowance is recorded to reduce the DTA to the amount expected to be realized.
When a company has a DTA, it must determine if it is more likely than not (i.e., 50% or more likelihood) that some or all of the asset will not be realized (e.g. due to insufficient future taxable income). If that is the case, a DTA valuation allowance is established for the portion that is not expected to be realized.

Question 18

When may a deferred tax asset valuation allowance be recorded?

Answer 18

A valuation allowance may need to be recorded if any of the following are present: a history of unused net operating losses; a history of operating losses; losses expected in future years; very unfavorable contingencies.

Question 19

What are uncertain tax positions?

Answer 19

Uncertain tax positions (UTPs) are those that may not be sustainable on audit by the IRS. Examples include uncertain deductions, tax credits, and revenue exemptions.
The firm includes the uncertain position in its tax return, thus reducing its income tax liability, but there remains uncertainty about the actual benefit of that deduction. These UTPs must be reviewed to determine if potential accruals and disclosure are required in the FS.

Question 20

What is the effective tax rate?

Answer 20

The effective tax rate (EFT) can be derived from the information reported in a company’s financial statements. The ETR is used to determine the actual tax percentage a corporation pays on its pretax book income. The ETR is calculated as follows: Total income tax expense / Pretax book income

Question 21

What classification is given to deferred tax assets/liabilities?

Answer 21

All deferred tax assets and liabilities are classified as noncurrent amounts on the balance sheet.

Question 22

What disclosures are required?

Answer 22

The components of the net DTA/DTL (including valuation allowance) reported on the balance sheet; The significant components of income tax expense arising from continuing operations; Adjustments to DTA/DTLs resulting from changes in tax laws, tax rates, or the entity’s tax status; Information about temporary differences, including the approximate tax effect and carryforward that affects DTA/DTLs; Adjustments to the valuation allowance due to changes in judgment about the realizability of DTAs; Amounts of operating loss carryforwards and tax credit carryforwards along with their expiration dates; Quantitative and qualitative disclosures related to UTPs.