Ch 19 Flashcards
Tax accounting term: Taxable income
How do companies determine taxable income?
Indicates amount used to compute income taxes payable
Companies determine taxable income according to the
Internal Revenue Code (tax code)
Financial reporting term: pretax income,
How is it determined by companiesu.
Income before taxes AKA income for financial/book purposes
Companies Determine pretax income using GAAP
Deferred tax liability
Taxes are currently lower but will be higher in future
Deferred tax consequences attributable to taxable temporary
Differences
Deferred tax asset
In cases where taxes will be lower in future
Future tax benefit reported in balance sheet, results from
Temporary differences existing at end of current year
Temporary basis, what do they result in?
Difference between tax basis of an asset or liability and
It’s reported book amount in the financial statements
Result in taxable or deductible amounts in future years
Taxable amounts
Increase taxable income in future years
Deductible amounts
Decrease taxable income in future years
Current tax expense
Amount of income taxes payable for period
Deferred tax expense
Increase in deferred tax liability balance from beginning to
End of accounting period
2 key income tax accounting objectives
1 recognize amount of taxes payable or refundable for
current year
2 recognize deferred tax liabilities or assets for future tax
Consequences of events already recognized in financial
Statements or tax returns
Deferred tax benefit
Credits to income tax expense
Results from increase in deferred tax asset from beginning
To end of accounting period
When is the warranty tax deduction allowed
Once it’s paid
3 conditions for deferred tax asset to be recognized as an asset
1 results from past transactions
2 gives rise to probable benefit in future
3 entity controls access to benefits
Entity controls access to benefits
Company has exclusive right to deductible tax benefit in
Future
Deferred tax asset: Reduction of valuation allowance
More likely than not it will not realize portion or all of
deferred Tax asset
More likely than not
Slightly more than 50%
Valuation allowance
2) how often is it evaluated
Established to recognize reduction in carrying amount of
Deferred tax asset
2) at end of each accounting period
Formula to compute income tax expense or benefit
Total income tax expense or benefit =
(income taxes payable or refundable + or -
(change in deferred income taxes)
Taxable temporary differences
Temporary differences that will result in taxable amounts
In future years when related assets are recovered
Deductible temporary differences
Temporary differences that will result in deductible amounts
In future years when related book liabilities are settled
Revenues or gains are taxable after they are recognized in financial income, 5 examples
1 sales on accrual basis
2 contracts under percentage completion
3 investments accounted for under equity method
4 gain from involuntary conversion of nonmonetary asset
5 unrealized holding gains
Expenses or losses are deductible after recognized in financial income, 6 examples
1 product warranty liabilities
2 estimated liabilities of discontinued operations
3 litigation accruals
4 bad debt expense (allowance method), direct write off
5 stock based compensation expense
6 unrealized holding losses
Revenues or gains taxable before recognized in financial income, 4 examples
1 subscriptions received in advance
2 advance rental receipts
3 sales + leasebacks (income deferral)
4 prepaid contracts + royalties received in advance
Expenses or losses are deductible before they are recognized in financial income, 3 examples
1 Depreciable property, deportable resources, intangibles
2 deduction of pension funding exceeding expenses
3 prepaid expenses deducted on tax return in period paid
Originating temporary difference
Initial difference btw/ book basis and tax basis of asset or
Liability
Reversing difference
Occurs when eliminating temporary difference that
originated In prior periods
And removing related tax effect from deferred tax account
Permanent differences: 2 possible results from items that…
1 enter into pretax financial income but never into taxable
Income
2 enter into taxable income but never into pretax financial
Income
4 examples of items recognized for financial reporting purposes but not tax purposes
1 interest received on state and municipal obligations
2 expenses incurred in obtaining tax exempt income
3 proceeds or premiums paid from life insurance carried by company on Key officers or employees
4 fines or expenses resulting from violation of law
2 examples of items recognized for tax purposes, but not financial reporting purposes
1 % depletion of natural resources in excess of cost
2 deduction for dividends received from US corporations
Generally 70% or 80%
How does a company compute: effective tax rate?
Effective tax rate =
total income tax exp. for period)/(pretax financial income
When does the company use the enacted tax rate, expected to apply?
If tax rates are expected to change in the future
In determining the appropriate enacted tax rate for a given year companies must use…
The average tax rate, which is a graduated tax rate
Ex. 15% on first 50k, 20% on next 25 k, etc.
What happens to company’s financial statements when a change in tax rate is enacted?
Companies record effects on deferred accounts immediately
Company reports the effect as adjustment to income tax
Expense in period of change
Net operating loss (NOL)
Occurs for tax purposes in year when tax-deductible
Expenses exceed taxable revenues
Under certain circumstances, federal tax laws permit
Taxpayers to use losses of 1 year to offset profits of other
Years
Carry back and carry forward of net operating losses: what happens in year of loss?
Company pays no income taxes for year where net operating
Loss is incurred
Loss carry back
Company may carry net operating loss back 2 years and
Receive refunds for income taxes paid in those years
Company must apply loss to earlier year first and then to
2nd year
After using loss carryback: Carry forward
Company may carry forward any loss remaining after 2 year
Carry back up to 20 years to offset future income
Lose carry forward option
Company may forego loss carry back option and use it
Against future taxable income
A loss carry back is classified as?
A tax effect (tax benefit)
Taxable income sources 4
1 future reversals of temporary differences
2 future taxable income exclusive of reversing temporary
Differences and carry forwards
3 taxable income in prior carry back years
4 tax planning strategies
Taxable income sources: tax planning strategies 3
1 accelerate taxable amounts to utilize expiring carry forwards
2 change character of ordinary income to capital gain/loss
3 switch from tax exempt to taxable investments
Negative evidence considered in evaluating need for valuation account, 4 items
1 history of operating loss or tax credit carry forwards
expiring unused
2 losses expected in future years
3 unsettled circumstances may result in adverse effect on
Operations
4 carry back, carry forward period is too brief limiting
realization of tax benefits
Positive evidence to consider in evaluating the need for a valuation account
1 existing contracts or firm sales backlog that will produce
More than enough taxable income
2 excess of appreciated asset value over tax basis of entities
Net assets
3 strong earnings history, with very few losses
Under IFRS, a company may not recognize a deferred asset unless…
Realization is probable
2 things companies should disclose relating to deferred taxes
1 net change during the year in total valuation allowance
2 types of temporary differences, carry forwards, carry backs,
That give rises to significant portions of deferred tax liabilities
And assets
Alternative minimum tax (AMT)
IRS provision designed to curb excessive tax avoidance
Assessing quality of earnings
Investors are interested in assessing reconciliation of
Pretax financial income to taxable income
To see if no recurring benefits (tax deductions) increased
Earnings temporarily
Making better predictions of future cashflows
Examination of deferred portion of income tax expense
Provides information as to whether taxes payable will
Be higher or lower in future
Predicting future cashflows for operating loss carry forwards
Companies should disclose amounts and expiration dates
Of any operating loss carry forwards for tax purposes
Uncertain tax positions
Tax positions for which tax authorities may deduction in
Whole or in part
Asset liability method AKA Liability approach
Most consistent method for accounting for income taxes
2 objectives of asset-liability method
1 recognize amount of taxes payable or refundable for
Current year
2 recognize deferred tax assets and liabilities for future tax
Consequences of events recognized in financial statements
Or tax returns
