300171 Deferred Income Taxes 3D Flashcards
A company has a 22% investment in another company that it accounts for using the equity method. Which of the following disclosures should be included in the company’s annual financial statements?
The company’s accounting policy for the investment
The names and ownership percentages of the other stockholders in the investee company
The reason for the company’s decision to invest in the investee company
Whether the investee company is involved in any litigation
Question #300171
The company’s accounting policy for the investment
Accounting policy disclosure includes the selection of accounting principles from existing acceptable methods. This would include the company’s use of the equity method. The equity method must be used if the company has significant influence over the company whose stock has been acquired. Generally, 20% ownership is evidence of significant influence, but it is possible that other factors would indicate otherwise. Consequently, the use of the equity is the selection of an accounting principle from existing alternatives (equity method or cost method).
Asset Liability Method
The asset/liability method is the method prescribed by FASB ASC 740-10 for recognizing deferred tax liability or asset. It emphasizes the balance sheet item—the deferred tax liability or asset is computed first (independently) and the tax expense is then computed as the change in the liability (asset). The balance sheet item (usually a liability) is the basis and determinate of the expense. Reversal of the deferred tax item is directly related to the settlement of the liability (payment date) or the recovery of the asset (life).
The asset/liability method prescribes the use of future tax rates (i.e., rates that will be in effect when the temporary difference reverses) to compute the amount of the deferred tax liability. It provides for the adjustment of the deferred tax liability due to changes in the tax law. The asset/liability method does not require that deferred tax liability be discounted (for the time value of money).
(Contrast with the deferred method.)
Deferred Tax
Deferred tax is the amount of future tax consequences attributable to temporary differences that will result in net taxable amounts (deductions) in future years, as computed currently. Recognition and measurement generally does not anticipate the tax consequences of losses or expenses (gains or revenue) that may be incurred (earned) in future years. (Valuation allowances of deferred tax assets may depend on future estimated income.)
Deferred tax is generally computed by multiplying the amount of the temporary difference by the current income tax rate (future tax rates if different from the present rates).
A deferred tax liability is a credit balance (a future taxable amount) and a deferred tax asset is a debit balance (a future deductible amount). The liability will be paid (asset will be recovered) in future years.
FASB ASC 740-10-20
Tax Rate
A tax rate is the percentage applied to taxable income to compute tentative income tax payable.
Temporary Difference
A temporary difference is a difference between the tax basis of an asset or liability and its reported amount in the financial statements that will result in taxable or deductible amounts in future years when the reported amount of the asset or liability is recovered or settled, respectively. Temporary differences arise from items that are treated differently under GAAP than under the tax law, and the difference will reverse (create an offsetting amount) in the future, such as installment sales, warranty expense, and depreciation expense under different methods.
Characteristics of temporary differences:
- They will be recognized in both accounting income and taxable income.
- They give rise to deferred income tax liability (DTL) or a deferred tax asset (DTA) due to differences in the timing of the recognition.
- They will reverse in one or more future periods.
Some events recognized in financial statements do not have tax consequences, such as certain revenues that are exempt from taxation and certain expenses that are not deductible. Events that do not have tax consequences give rise to permanent differences.
FASB ASC Glossary
2341.08
The measurement of deferred tax liabilities and assets is done using the enacted tax rate or rates expected to apply to taxable income in the periods in which the deferred tax liability or asset is expected to be settled or realized. Due to the significant reduction in the corporate tax rate, the FASB issued Accounting Standards Update (ASU) 2018-02 related to the Tax Cuts and Jobs Act of 2017.
FASB ASC 740-10-05-7
