4.3 Income Taxes Flashcards
Selected financial information for the year just ended is shown below.
- Pretax income $5,000,000
- interest received on municipal bonds $600,000
- Gains on the sale of land reported this year but not taxable until next year $1,000,000
- Tax rate for all years 40%
- Beginning balances:
- Income taxes payable $0
- Deferred tax liability $50,000
The total income tax expense reported on the income statement for the year just ended should be
A. $960,000
B. $1,360,000
C. $1,760,000
D. $2,640,000
C. $1,760,000
Taxable income consists of pretax income adjusted for those items that give rise to tax differences. Taxable income is therefore $3,400,000, ($5,000,000 pretax income - $600,000 interest received on municipal bonds - $1,000,000 gains on the sale of land), and current tax expense is 3,400,000 x 40% = 1,360,000.
The interest on municipal bonds is a permanent difference because it is tax-exempt, i.e., it is recognized in GAAP income but never in taxable income. Permanent differences have no deferred tax effects. However, the gain on the sale of land is temporary difference because it is included in GAAP income this year and is included in taxable income in the future. This temporary difference gives rise to a future taxable amount, specifically, a $400,000 deferred tax liability. ($1,000,000 gain x 40%). This credit to the deferred tax liability account is balanced by a debit to income tax expense.
Total income tax expense for the year is therefore $1,760,000 (1,360,000 current portion + 400,000 deferred portion).
Income-tax basis financial statements differ from those prepared under GAAP because they
A. Recognize certain revenue and expense in different reporting periods.
B. Do not include taxable revenues and nondeductible expenses in determining income.
C. Include detailed information about current and deferred income tax liabilities.
D. Contain no disclosures about finance and operating lease transactions.
A. Recognize certain revenue and expense in different reporting periods.
A liability that represents the accumulated difference between the income tax expense reported on the firm’s books and the income tax actually paid is
A. Value-added taxes
B. Taxes payable
C. Deferred taxes
D. Capital gains tax
C. Deferred taxes
Deferred tax liabilities arise when temporary differences in book and taxable income result in future taxable amounts. Deferred tax assets arise when temporary differences in book and taxable income result in future deductible amounts.
__________ arise when temporary differences in book and taxable income result in future taxable amounts
Deferred tax liabilities
_______ arise when temporary differences in book and taxable income result in future deductible amounts.
Deferred tax assets
A tax rate other than the current tax rate may be used to calculate the deferred income tax amount on the statement of financial position if a(n)
A. Further tax rate change is considered more likely than not to occur
B. Election has been made to apply past tax rates
C. Net operating loss carryback exists
D. Future tax rate has been enacted into law
D. Future tax rate has been enacted into law
A tax rate other than the current tax rate may be used to calculate the deferred income tax amount on the statement of financial position if a future tax rate has been enacted into law.
The purpose of interperiod income tax allocation is to
A. Reconcile the tax consequences of permanent and temporary differences that appear on the company’s current financial statements
B. Recognize a tax asset or liability for the tax consequences of temporary differences that exist at the date of the balance sheet
C. Provide proper disclosure of a distribution of earnings to a taxing authority
D. Adjust the income tax expense on the income statement to be consistent with the income tax liability shown on the balance sheet
B. Recognize a tax asset or liability for the tax consequences of temporary differences that exist at the date of the balance sheet
Interperiod tax allocation is designed to recognize a tax asset or liability for the tax consequences of temporary differences that exist between a company’s financial accounting records and its tax records at the balance sheet date. These temporary differences result when the GAAP basis and the tax basis of an asset or liability differ.
A company uses straight-line depreciation for financial reporting purposes, but uses accelerated depreciation for tax purposes. Which of the following account balances would be lower in the financial statements used for tax purposes than it would be in the general purpose financial statements?
A. Cash
B. Accumulated depreciation
C. Retained earnings
D. Gross property, plant, and equipment
C. Retained earnings
Because the tax basis uses an accelerated method, depreciation expense and accumulated depreciation will be greater. Moreover, taxable income will be lower than financial net income. Consequently, tax-basis retained earnings will be less than that in the general purpose financial statements.
