Accounting for Income Taxes

Question 1

ASC 740 adopts what sort of approach in computing the GAAP income tax provision (expense)?

Answer 1

Balance Sheet Approach

Question 2

The total income tax expense reported on the GAAP income statement is split into what two components?

Answer 2

• Current tax expense

- Deferred tax expense

Question 3

What is current tax expense based on?

Answer 3

• Based on the amount of income taxes paid or payable for a year determined by applying enacted tax laws to TI for the year

Question 4

What is deferred tax expense based on?

Answer 4

• Based on net change to deferred tax assets and liabilities based on temporary differences b/w financial and tax accounting methods that arise in the current period

Question 5

The amount of future taxes payable is reflected as what?

Answer 5

Deferred tax liability

Question 6

The amount of future taxes saved is reflected as what?

Answer 6

Deferred tax asset

Question 7

What does ASC 740 apply to?

Answer 7

• Income taxes levied by federal, state & local, and foreign governments

Question 8

How does ASC 740 define a temporary difference?

Answer 8

• Difference b/w tax and financial reporting basis of an asset or liability that will result in either (i) future taxable amounts or (ii) future deductible amounts when the reported amount of the asset is recovered or the liability is settled

Question 9

How is deferred tax liability computed?

Answer 9

DTL = future taxable amount(s) * tax rate

Question 10

When do permanent book-tax differences occur?

Answer 10

• When a revenue or expense item is included in only book income or TI (i.e. item does not appear in both)

Question 11

Give an example of a common permanent difference.

Answer 11

• Interest income on state and local municipal bonds
• Disallowed (50%) meals and entertainment expenses
• Dividends received deduction
• Corporate owned life insurance premiums paid (not deductible)
• Corporate owned life insurance proceeds received (not taxed)
• Payments related to penalties or fines
• Permanently reinvested foreign earnings
• Political contributions
• Domestic production activities deduction (Sec. 199)
• Excess tax deduction on non-qualified stock options (special treatment through SE)

Question 12

What will permanent book-tax differences affect?

Answer 12

• Affects current tax payable b/c such items affect the computation of taxable income

Question 13

When do temporary book-tax differences occur?

Answer 13

• Occur when a revenue or expense item is reported in a different period for book income than it is for taxable income

Question 14

Where do deferred tax liabilities generally appear on the Schedule M-1?

Answer 14

Right side

Question 15

Where do deferred tax assets generally appear on the Schedule M-1?

Answer 15

Left Side

Question 16

Give an example of a common temporary difference.

Answer 16

• Installment method sales for tax but not for book
• Excess tax depreciation over book depreciation
• Prepaid revenue recorded for tax but not book purposes
• Tax deferred like-kind exchanges
• Basis differences due to corporate acquisitions
• Accrued expenses
• Accrued contingency losses
• NOL and capital loss carryovers

Question 17

Do timing differences affect GAAP tax expense?

Answer 17

No

Question 18

Do permanent differences affect GAAP tax expense?

Answer 18

Yes

Question 19

Why would a business have a deferred tax valuation allowance account?

Answer 19

• Created if there’s more than 50% probability that company will not realize some portion of deferred tax assets

Question 20

In general, uncertain tax positions will cause what?

Answer 20

• A liability (liability for uncertain tax position or tax reserve)

Question 21

How do you calculate effective tax rate?

Answer 21

GAAP tax expense divided by pre-tax GAAP income

Question 22

Given a base case, how does the financial accounting change if the entire cost of the assets can be depreciated in the first year for tax purposes as opposed to over several years?

Answer 22

• While this change reduces the PV of taxes paid, it has no effect on income statement
• Total GAAP tax expense is still the same
• Timing of tax payments do no affect the tax expense or ETR but does change the split between current and deferred tax expense and the classification of the tax payable

Question 23

What are two common journal entries when recording total tax expense?

Answer 23

1) Debit current tax expense; credit total tax payable

2) Debit DTE; credit DTL
or Debit DTA; credit DTE

Question 24

In the accounting for income tax material, what are the seven key steps we follow?

Answer 24

1) Complete tax column to compute US federal tax liability
2) Use T- accounts to compute net DTA/DTL change for the year
3) Complete book column to compute total income tax expense
4) Make JEs to record total tax expense
5) Split tax expense into current and deffered portions as required in the tax footnote
6) Compute ETR
7) Reconcile tax due under statutory tax rate to tax provision amount

Question 25

If the book basis of the bad debt allowance account exceeds tax basis of the allowance, what does this create?

Answer 25

DTA

Question 26

What is one of the goals of ASC 740, FIN48?

Answer 26

To increase consistency in reporting of uncertain tax positions by establishing a min. threshold a tax position must meet in order to be recognized in the financial statements

Question 27

In reference to ASC 740, FIN48, the standard uses a mechanical two-step process to determine what?

Answer 27

1) Recognition: if a risky (or uncertain) tax position should be recognized in GAAP financial statements (using more likely than not test)
2) Measurement: how much of the tax benefit should be recognized (measured as largest amount of benefit, determined on a cumulative probability basis, that is more likely than not to be realized upon ultimate settlement)

Question 28

Does the fresh start benefit create a temporary or permanent difference?

Answer 28

Permanent

Question 29

The journal entry to record the additional taxes due to the fresh start savings would be what?

Answer 29

Dr. Current income tax expense

Cr. Liability for uncertain tax position

Question 30

How often to uncertain tax positions need to be updated?

Answer 30

Annually

Question 31

ASC 740-10-25-3d disallows recognition of a DTL relating to goodwill that is not what?

Answer 31

Disallows recognition of DTL relating to goodwill that is not deductible for tax purposes