Accounting for Income Taxes Flashcards
What are the two main objectives of accounting for income taxes?
To determine taxes payable/refundable for current year
To determine deferred tax liabilities/assets for future years
What is the first basic principle of accounting for income taxes?
Taxes payable/refundable for current year are recorded as “current tax liability/asset”
What is the second basic principle of accounting for income taxes?
Deferred tax liability/asset is estimated for future tax consequences on temporary differences and carryforwards
What is the third basic principle of accounting for income taxes?
Measurement of taxes is based on current tax law – never on anticipated tax laws
What is the fourth basic principle of accounting for income taxes?
Deferred tax assets are reduced by any tax benefits which are not expected to be realized
How much can net operating losses (NOLs) be carried back or carried forward?
Back 2 years
Forward 20 years
What happens if a NOL is carried back or forward?
It offsets taxable income for those years, thus reducing taxes
If done for previous years, it generates a tax refund for the taxes already paid on those profits
What are the two components of income tax expense?
Current tax expense and deferred tax expense
What does an ordinary tax JE look like?
Debit: Income Tax Expense – Current
Credit: Income Tax Payable
What are the JEs for loss carrybacks and carryforwards?
Carryback:
Debit: Income Tax Refund Receivable
Credit: Benefits of Loss Carryback
Carryforward:
Debit: Deferred Tax Asset
Credit: Benefits of Loss Carryforward
Both benefits would be reported in income statement against the net loss
What are the tax JEs for a year partially helped by a loss carryforward?
Debit: Income Tax Expense – Current ($X)
Debit: Income Tax Expense – Deferred ($Y)
Credit: Income Tax Payable ($X)
Credit: Deferred Tax Asset ($Y)
Notice that the deferred tax asset is removed with this entry
Both current and deferred expenses would count against income in income statement
What is the formula to reconcile pretax financial income and taxable income?
Pretax financial income
+ Taxable revenues over book revenues
- Deductible amounts over book expenses
= Taxable income
What is a temporary difference?
Difference between tax basis of an asset/liability and its book amount
Results in taxable or deductible amounts in the future, whenever the reported amount of the item is recovered (asset) or settled (liability)
What are the two kinds of temporary differences?
Taxable TDs – when assets are recovered
Deductible TDs – when liabilities are settled
When pretax financial income is less than taxable income, how is income tax expense recorded?
The difference between the two will be a deferred income tax expense
Debit: Income Tax Expense – current ($X)
Debit: Income Tax Expense – deferred ($Y)
Credit: Income Taxes Payable ($X)
Credit: Deferred Tax Liability ($Y)
What is a timing difference?
Occurs when rev/exp/gains/losses are book-recognized in one year but tax-recognized in another year
Count as temporary differences
What are examples of timing differences?
- earned income that will be paid in a future year (taxable when asset is recovered); unearned revenue (taxable before earned)
- loss contingencies (deductible when liability is settled); prepaid expenses (deductible before accrued)
Really, any difference resulting from accrual vs. cash accounting
What happens if revenue is received before being earned?
There is a tax liability that exceeds the book-revenue’s basis (of zero), and thus when it is earned, it will have a tax deduction
What happens if temporary differences are not linked with any particular assets or liabilities?
Will still result in taxable or deductible amounts for future years
E.g. if a company uses %-of-completion method for books and completed-contract method for taxes, the deferred income will become taxable when the contract is completed
What are permanent differences?
Revenues or expenses that simply aren’t taxed, and thus don’t create deferred tax assets/liabilities
What are examples of permanent differences from revenues?
Interest on municipal bonds
Proceeds from life insurance on an officer
Dividends subject to dividends-received deduction (70%, 80%, or 100%)
What are examples of permanent differences from expenses?
Expenses to generate tax-exempt income
Premiums paid for life insurance on officers
Fines, other costs due to violations of the law
What is an example of a permanent difference from a deduction?
Excess of percentage depletion over the cost of natural resources
What would be the income tax JE for a year with permanent differences in revenue and expenses?
A normal JE
Debit: Income Tax Expense – current
Credit: Income Taxes Payable
The permanent differences don’t affect other years, so there’s no deferred tax assets or liabilities
What is the effective tax rate?
The rate that is paid on pretax financial income
Can differ from 40% (or whatever the enacted rate is) if there are permanent differences, since the 40% rate will be applied towards the taxable income without any deferred taxes
How do you calculate net future taxable (or deductible) amounts?
Take all the temporary amounts, and add them in the opposite way that they affected pretax financial income
E.g. if an excess of warranty expense were recognized in the books over the tax amount, then that expense would be ADDED to pretax financial income to arrive at taxable income – but it would be SUBTRACTED to determine net future taxable (or deductible) amount
How do you calculate tax liabilities or assets from net future taxable (or deductible) amounts?
Net future taxable amount x tax rate = deferred tax liability
Net future deductible amount x tax rate = deferred tax asset
What are deferred tax expenses or benefits?
Changes during the year in deferred tax liabilities and assets
