(27) Income Taxes Flashcards
LOS 30. a: Describe the differences between accounting profit and taxable income and define key terms, including deferred tax assets, deferred tax liabilities, valuation allowance, taxes payable, and income tax expense.
Taxable income: income subject to tax based on the tax return
Accounting profit: Pretax income from the income statement based on financial accounting standards
LOS 30. a: Describe the differences between accounting profit and taxable income and define key terms, including deferred tax assets, deferred tax liabilities, valuation allowance, taxes payable, and income tax expense.
Deferred tax assets: Balance sheet asset value that results when taxes payable (tax return) are greater than income tax expense (income statement) and the difference is expected to reverse in future periods.
LOS 30. a: Describe the differences between accounting profit and taxable income and define key terms, including deferred tax assets, deferred tax liabilities, valuation allowance, taxes payable, and income tax expense.
Deferred tax liabilities: Balance sheet liabilities value that results when income tax expense (income statement) is greater than taxes payable (tax return) and the difference is expected to reverse in future periods.
LOS 30. a: Describe the differences between accounting profit and taxable income and define key terms, including deferred tax assets, deferred tax liabilities, valuation allowance, taxes payable, and income tax expense.
Valuation allowance: Reduction of deferred tax assets (contra account) based on the likelihood that the future tax benefit will not be realized.
LOS 30. a: Describe the differences between accounting profit and taxable income and define key terms, including deferred tax assets, deferred tax liabilities, valuation allowance, taxes payable, and income tax expense.
Taxes payable: The tax liability from the tax return. Note that this term also refers to a liability that appears on the balance sheet for taxes due but not yet paid.
LOS 30. a: Describe the differences between accounting profit and taxable income and define key terms, including deferred tax assets, deferred tax liabilities, valuation allowance, taxes payable, and income tax expense.
Income tax expense: Expense recognized in the income statement that includes taxes payable and changes in deferred tax assets and liabilities.
LOS 30. b: Explain how deferred tax liabilities and assets are created and the factors that determine how a company’s deferred tax liabilities and assets should be treated for purposes of financial analysis.
A deferred tax liability is created when income tax expense (income statement) is higher than taxes payable (tax return). Deferred tax liabilities occur when revenues (or gains) are recognized in the income statement before they are taxable on the tax return, or expenses (or losses) are tax deductible before they are recognized in the income statement
LOS 30. b: Explain how deferred tax liabilities and assets are created and the factors that determine how a company’s deferred tax liabilities and assets should be treated for purposes of financial analysis.
A deferred tax asset is created when taxes payable (tax return) are higher than income tax expense (income statement). Deferred tax assets are recorded when revenues (or gains) are taxable before they are recognized in the income statement, when expense (or losses) are recognized in the income statement before they are tax deductible, or when tax loss carryforwards are available to reduce future taxable income
LOS 30. b: Explain how deferred tax liabilities and assets are created and the factors that determine how a company’s deferred tax liabilities and assets should be treated for purposes of financial analysis.
Deferred tax liabilities that are not expected to reverse, typically because of expected continued growth in capital expenditures, should be treated for analytical purposes as equity. If deferred tax liabilities are expected to reverse, they should be treated for analytical purposes as liabilities.
LOS 30. c: Calculate the tax base of a company’s assets and liabilities.
An asset’s tax base is its value for tax purposes. The tax base for a depreciable fixed asset is its cost minus any depreciation or amortization previously taken on the tax return. When an asset is sold, the taxable gain or loss on the sale is equal to the sale price minus the asset’s tax base.
LOS 30. c: Calculate the tax base of a company’s assets and liabilities.
A liability’s tax base is its value for tax purposes. When there is a difference between the book value of a liability on a firm’s financial statements and its tax base that will result in future taxable gains or losses when the liability is settled, the firm will recognize a deferred tax asset or liability to reflect this future tax or tax benefit.
LOS 30. d: Calculate income tax expense, income taxes payable, deferred tax assets, and deferred tax liabilities, and calculate and interpret the adjustment to the financial statements related to a change in the income tax rate.
If taxable income is less than pretax income and the cause of the difference is expected to reverse in future years, a DTL is created. If taxable income is greater than pretax income and the difference is expected to reverse in future years, a DTA is created.
The balance of the DTA or DTL is equal to the difference between the tax base and the carrying value of the asset or liability, multiplied by the tax rate.
Income tax expense and taxes payable are related through the change in the DTA and the change in the DTL: income tax expense = taxes payable + ΔDTL – ΔDTA.
LOS 30. e: Evaluate the impact of tax rate changes on a company’s financial statements and ratios.
When a firm’s income tax rate increases (decreases), deferred tax assets and deferred tax liabilities are both increased (decreased) to reflect the new rate. Changes in these values will also affect income tax expense.
An increase in the tax rate will increase both a firm’s DTL and its income tax expense. A decrease in the tax rate will decrease both a firm’s DTL and its income tax expense.
An increase in the tax rate will increase a firm’s DTA and decrease its income tax expense. A decrease in the tax rate will decrease a firm’s DTA and increase its income tax expense.
LOS 30. f: Distinguish between temporary and permanent differences in pre-tax accounting income and taxable income.
A temporary difference is a difference between the tax base and the carrying value of an asset or liability that will result in taxable amounts or deductible amounts in the future.
A permanent difference is a difference between taxable income and pretax income that will not reverse in the future. Permanent differences do not create DTAs or DTLs.
LOS 30. g: Describe the valuation allowance for deferred tax assets–when it is required and what impact it has on financial statements.
If it is more likely than not that some or all of a DTA will not be realized (because of insufficient future taxable income to recover the tax asset), then the DTA must be reduced by a valuation allowance. The valuation allowance is a contra account that reduces the DTA value on the balance sheet. Increasing the valuation allowance will increase income tax expense and reduce earnings. If circumstances change, the DTA can be revalued upward by decreasing the valuation allowance, which would increase earnings.
