CH. 17 - Accounting for Income Taxes

Question 1

Income tax provision

Answer 1

The income tax provision includes:

-Current-year taxes payable or refundable
-Any changes to future income taxes payable or refundable that result from differences in the timing of when an item is reported on the tax return compared to the financial statement.

An income tax expense is what is on the books

Question 2

Deferred tax asset

Answer 2

the expected future tax benefit attributable to ­deductible temporary differences and carryforwards.

Question 3

Deferred tax liability

Answer 3

the expected future tax cost attributable to ­taxable temporary differences.

Question 4

The income tax provision refers to the _______ income tax process, whereas the ______ or _________ tax provisions refers to the….

Answer 4

The income tax provision refers to the entire income tax process, whereas the current or deferred tax provisions refers to the individual components of the process.

Question 5

How do companies report nonincome taxes in the context of income taxes?

Answer 5

They are computed as expenses in the computation of their net income before taxes

Question 6

Current tax liability (asset)

Answer 6

the amount of taxes payable (refundable) in the current year.

Question 7

ASC 740 has ___ primary objectives. What are they?

Answer 7

2

1. To “recognize the amount of taxes payable or refundable in the current year.” (aka the current tax liability/asset)
2. To “recognize deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns.”

Question 8

Tax carryovers

Answer 8

tax deductions or credits that cannot be used on the current-year tax return and that can be carried forward to reduce ­taxable income or taxes payable in a future year.

Question 9

Deferred tax liabilities represent….

Answer 9

future tax obligations resulting from the reversal of favorable originating book-tax differences.

Question 10

Deferred tax assets represent…

Answer 10

Future tax benefits resulting from the reversal of unfavorable originating book-tax differences.

Question 11

The tax provision process refers to the process of….

Answer 11

Determining the current and deferred income tax expense or (benefit) for the income statement and the tax payable or receivable and deferred tax assets and liabilities for the balance sheet.

Question 12

What is the formula to compute a company’s total income tax expense or benefit?

Answer 12

Total tax expense/benefit=current income tax expense/benefit + deferred income tax expense/benefit

Question 13

How many steps are there in the process to compute a companies federal income tax provision, and what are they?

Answer 13

5

1. Adjust pretax income for permanent differences
2. Identify all temporary differences and carryforwards
3. Calculate the current income tax expense or benefit
4. Recognize the deferred tax assets and liabilities
5. Evaluate the need for a valuation allowance for deferred tax assets
6. Calculate the deferred income tax expense or benefit

Official:
1. Identify all permanent and temporary difference and tax carryover amounts and calculate the current income tax provision (ASC 740 Objective 1)
2. Determine the ending balances in the balance sheet deferred tax asset and liability accounts (ASC 740 Objective 2)
3. Calculate the deferred income tax provision and the total income tax provision
4. Evaluate the need for a valuation allowance for gross deferred tax assets
5. Evaluate the need for an uncertain tax benefit reserve.

Question 14

Permanent book–tax differences

Answer 14

items of income or deductions for either book purposes or tax purposes during the year but not both. Permanent differences do not reverse over time, so over the long run, the total amount of income or deduction for the item is different for book and tax purposes.

Question 15

Permanent book–tax differences

Answer 15

items of income or deductions for either book purposes or tax purposes during the year but not both. Permanent differences do not reverse over time, so over the long run, the total amount of income or deduction for the item is different for book and tax purposes.

Answer 16

the taxpayer’s average rate of taxation on each ­dollar of total income (taxable and nontaxable income). Specifically,

Effective tax rate = total tax/total income

Also (for income tax footnote purposes), the tax rate computed by dividing a company’s income tax provision (expense or benefit) for the year by its pretax income from continuing operations.

Question 17

What are some examples of common permanent book-tax differences?

Answer 17

-Life insurance proceeds
-Tax-exempt interest income
-Nondeductible tax penalties and fines
-tax credits
-Political contributions
-Disallowed business-related meals
-Disallowed premiums on officers life insurance

Question 18

What are some examples of common permanent book-tax differences?

Answer 18

-Life insurance proceeds
-Tax-exempt interest income
-Nondeductible tax penalties and fines
-tax credits
-Political contributions
-Disallowed business-related meals
-Disallowed premiums on officers life insurance
-Dividends-received deductions
-the windfall tax benefit from exercise of nonqualified stock options
-Entertainment expenses
-Tax credits

Question 19

Book equivalent of taxable income

Answer 19

a company’s pretax income from continuing operations adjusted for permanent differences.

Question 20

Temporary book–tax differences

Answer 20

book–tax differences that reverse over time such that, over the long term, corporations recognize the same amount of income or deductions for the items on their financial statements as they recognize on their tax returns.

Question 21

What are some examples of common temporary book-tax differences?

Answer 21

-Depreciation
-Accrued vacation pay
-Prepayments for income
-Installment sale income
-Pension plan deductions
-Accrued contingency losses
-Business interest expense
-Reserves for bad debts (uncollectible accounts)
-Inventory costs capitalized under 263A
-Warranty reserves
-Stock option expense
-Accrued bonuses and other compensation
-Net operating loss and net capital loss carryovers

Question 22

Current income tax expense (benefit)

Answer 22

the amount of taxes paid or payable (refundable) in the current year.

Question 23

Uncertain tax position

Answer 23

a tax return position for which a corporation does not have a high degree of certainty as to its tax consequences.

Question 24

Tax accounting balance sheet

Answer 24

a balance sheet that records a ­company’s assets and liabilities at their tax bases instead of their ­financial accounting bases.

Question 25

What is the formal definition for temporary book-tax differences under ASC 740?

Answer 25

“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.”

Question 26

What are the key facts in identifying taxable and deductible temporary book-tax differences?

Answer 26

-ASC 740 defines a temporary difference as a difference between the financial reporting and tax basis of an asset or liability that will create a future tax liability or benefit when the difference reverses
-A taxable temporary difference results from an excess of book carrying value over tax basis for assets and from an excess of tax basis over book carrying value for liabilities
-The future tax cost associated with a taxable temporary difference is recorded on the balance sheet as a deferred tax liability
-A deductible temporary difference results from an excess of tax basis over book carrying value for assets and from an excess of book carrying value over a tax basis for liabilities
-The future tax benefit associated with a deductible temporary difference is recorded on the balance sheet as a deferred tax asset.

Question 27

Taxable temporary differences

Answer 27

book–tax differences that will result in taxable amounts in future years when the related deferred tax liability is settled.

Question 28

What are the sources of taxable temporary book-tax difference?

Answer 28

1. Revenues or gains that are taxable after they are recognized in financial income
2. Expenses or losses that are deductible before they are recognized in financial income

Question 29

What are the sources of taxable temporary book-tax difference?

Answer 29

1. Revenues or gains that are taxable after they are recognized in financial income
2. Expenses or losses that are deductible before they are recognized in financial income

Question 30

What are the sources of deductible temporary book-tax differences?

Answer 30

1. Revenues or gains that are taxable before they are recognized in financial income
2. Expenses or losses that are deductible after they are recognized in financial income

Question 31

Deductible temporary differences

Answer 31

book–tax differences that will result in tax deductible amounts in future years when the related deferred tax asset is recovered.

Question 32

Enacted tax rate

Answer 32

the statutory tax rate that will apply in the current or a future period

Question 33

What are the key facts for computing the deferred income tax expense (benefit)?

Answer 33

-Identify current-year changes in taxable and deductible temporary differences
-Determine ending balances in each deferred tax asset and liability balance sheet account
-Identify carryovers (NOLs, net capital loss, charitable contributions) not on the balance sheet
-The current year deferred income tax expense on benefit is the difference between the deferred tax asset and liability balances at the beginning of the year and the end of the year, as well as change in tax carryovers.

Question 34

What are the key facts in determining whether a valuation allowance is needed?

Answer 34

-A valuation allowance is required if it is more likely than not that some or all of the deferred tax asset will not be realized in the future
-To make this determination, a company must determine its sourcesd of future (or past) taxable income
-Taxable income in carryback years
-Reversing taxable temporary differences in future years
-Expected taxable income in future years from other than reversing taxable temporary differences
-Expected taxable income in future taxable years from implementing tax planning strategies
-A company must evaluate positive and negative evidence in deciding whether a valuation allowance is needed
-A company must monitor whether increases or decreases should be made to the valuation allowance account every quarter.

Question 35

True or false: ASC 740 required that a company evaluate each of its gross deferred inncome tax assets on the balance sheet and assess the likelihood the expected tax benefit will be realized in a future period.

Answer 35

True!

Question 36

Valuation allowance

Answer 36

the portion of a deferred tax asset for which management determines it is more likely than not that a tax benefit will not be realized on a future tax return.

Question 37

Valuation allowances operating as….

Answer 37

contra accounts to the deferred income tax assets on the balance sheet

Question 38

What are the four sournces of potential future taxable income that ASC 740 identifies?

Answer 38

1. future reversals of existing taxable temporary differences (objective)
2. Taxable income in prior carryback year(s) (objective)
3. Expected future taxable inclome exclusive of reversing temporary differences and carryovers (subjective)
4. Tax planning strategies (subjective)

Question 39

In the case of NOL carryovers from years beginning after December 31, 2017, only ___% of the reversing taxable temporary differences can be used as a source sof future taxable income because these NOL carryovers can only offset up to _______ % of taxable income

Answer 39

In the case of NOL carryovers from years beginning after December 31, 2017, only 80% of the reversing taxable temporary differences can be used as a source of future taxable income because these NOL carryovers can only offset up to 80 % of taxable income

Question 40

How are valuation allowances handled in prior carryback year(s)?

Answer 40

A company does not record a valuation allowance if the tax benefit from the realization of a deferred income tax asset can be carried back to a prior year that has sufficient taxable income (or capital gain net income in the case of a net capital loss carryback)

Question 41

What are some tax planning strategies a company could implement to create taxable income needed to absorb a deferred tax asset?

Answer 41

1. Selling and leasing back operating assets
2. Changing inventory accounting methods (ie from LIFO to FIFO)
3. Refraining from making voluntary contributions to the company pension plan
4. Electing to capitalize certain expenditures (ie R&D costs) rather than deduct them currently
5. Selling noncore assets
6. Converting tax-exempt investments into taxable investments
7. Electing the alternative depreciation method (ie straight-line instead of declining balance)

Question 42

What are examples of negative evidence pointing to the fact that it is more likely than not that a deferred income tax asset will not be realized in the future?

Answer 42

1. Cumulative (book) losses in recent years
2. A history of net operating losses, net capital losses, and credits expiring unused
3. An expectation of losses in the near future
4. Unsettled circumstances that, if resolved unfavorably, will result in losses from continuing operating s in future years (e.g. the loss of a patent or a highly profitable drug).

• as a general rule, “recent years” with regards to cumulative book losses are interpretated as a rolling 12 quarters (e.g. 36 months).

Question 43

What are the key facts for accounting for uncertain tax positions?

Answer 43

-ASC 740 required a 2-step process for determining whether a tax benefit can be recognized in the financial statements
-A company first determines whether it is more likely than not that its tax position on a particular account will be sustained on IRS examination based on its technical merits
-A company then computes the amount it expects to be able to recognize
-The measurement process requires the company to make a cumulative probability assessment of all likely outcomes of the audit and ligation process
-The company recognizes the amount that has a greater than 50% probability of being sustained on examination and subsequent litigation
-The amount not recognized is recorded as a liability on the balance sheet

Question 44

What is the objective of ASC 740-10 (FIN 48)?

Answer 44

To provide a uniform approach to recording and disclosing tax benefits resulting from tax positions that are considered to be uncertain

Question 45

A tax provision is a _______ (asset, liability)

Answer 45

Liability

Question 46

What does a favorable temporary difference turn into?

Answer 46

A deferred tax liability (DTL)

Question 47

Provision = ____________, tax expense = ____________

Answer 47

A provision is what’s on the books, whereas a tax expense is what is on your return aka what you are actually paying the IRS

Question 48

What does an unfavorable temporary difference turn into?

Answer 48

A deferred tax asset (DTA) (aka you’ve paid more in tax this year and eventually that will flip and you will pay less so you’ve accumulated an asset that is going to be used in the future)

Question 49

Future taxes payable is recorded on the balance sheet as ___________

Answer 49

Deferred tax liability = FAVORABLE

Question 50

Future taxes refundable is recorded on the balance sheet as ___________

Answer 50

Deferred tax asset = UNFAVORABLE

Question 51

True or false: permanent dfferences are differences that appear on both the income statement and tax return

Answer 51

FALSE
The appear on one or the other, but not on both

Question 52

Structural tax rate

Answer 52

the tax rate computed by dividing a company’s ­income tax provision adjusted for nonrecurring permanent differences by its pretax income from continuing operations.

Question 53

Cash tax rate

Answer 53

the tax rate computed by dividing a company’s taxes paid during the year by its pretax income from continuing operations.

Question 54

The expected future tax recovery from a taxable deductible difference is recognized as a…

Answer 54

deferred tax asset

Question 55

The income tax provision is reported on the

Answer 55

income statement

The provision is the income tax expense reported on the income statement.