Chapter 16 Power Point Notes

Question 1

Temporary

Answer 1

differences will reverse over time –aggregate effect on taxable and financial income over time is the same. No impact on effective tax rate.
Differences originate and then reverse

Question 2

Permanent

Answer 2

differences will not reverse will never be in both taxable and financial income. Impacts the effective tax rate.

Question 3

Examples of Temporary Differences

Answer 3

Depreciation
Tax return: Accelerated (MACRS)
Financial statements: Straight-line (or accelerated)
** Same total, different patterns

Revenue Recognition – installment sales, sale-leaseback

Warranties – GAAP deducted when accrued, not for taxes

Contingencies
e.g., record an expense for probable and estimable loss in lawsuit (deduction when paid)

Question 4

Permanent Differences Examples

Answer 4

Tax-exempt interest - municipal bonds

Fines - not deductible for taxes (BDO fine)

Dividends received - corporations can deduct 70% - 100% of dividends received from other corporations (according to ownership percentages)

Goodwill writeoffs (usually)–most goodwill is not tax-deductible

Only temporary differences have implications for deferred taxes

Question 5

How do we calculate tax expense for 2011

Answer 5

1. Determine taxes payable (taxable income * tax rate)
2. Identify book-tax differences
3. Calculate the deferred tax asset (book-tax difference * tax rate)
   a. Compare the calculation in (3) to the current balance in the deferred tax asset or liability and record the difference.
4. Combine tax payable and deferred taxes to get tax expense.

Question 6

Deferred Tax Asset

Answer 6

DTAs are recognized for the future tax benefit of deductible temporary differences
Arise when taxable income is initially higher than accounting income either tax revenue > book revenue or book expense > tax deduction
We are pre-paying taxes Asset (DTA)

Question 7

DTA Example

Answer 7

Subscription revenue, where a customer pre-paid for the subscription - Included in tax return when received and on the income statement when earned.

Question 8

Deferred Tax Liability

Answer 8

Tax payable < tax expense at that time
DTLs are recognized for the future tax consequences of taxable temporary differences
Arise when taxable income is initially lower than accounting income either tax deduction > book expense or book revenue > tax revenue

Question 9

DTL Example

Answer 9

Installment Sales reported on the IS when earned and on the tax return when received (Revenue earned before cash is received)

Question 10

Example:
Straight-line deprecation for financial statement reporting and MACRS for income taxes (at origination lower taxes payable than tax expense)
Building with carrying value of $400,000 and tax basis of $300,000 three years after purchase – $100,000 more deprecation in total has been taken on tax return.
Tax rate = 40%
What is the total amount of the deferred tax liability on the balance sheet?

Answer 10

= book-tax difference * tax rate = 100,000*0.40 = 40,000

Question 11

Example:
No other temporary differences and no permanent differences
Taxable income = $4 million
DTL balance as $32,000 last year
What is the journal entry to record taxes?

Answer 11

Tax Expense 1,608,000 (=1,600,000+8,000)
Taxes Payable 1,600,000 (.40*4 mil)
DTL 8,000 (40,000-32,000)

Question 12

Corporate Income Tax Rates

Answer 12

Vary based on the amount of taxable income:
0-$50,000  15%
> $50,000, varying amounts but
generally 34-35%.

Plus state taxes (generally between 0-10%).

Question 13

How often must corporations file income taxes?

Answer 13

Quarterly

Question 14

Timing differences that generally result in a deferred liability

Answer 14

Depreciation Expense
Accelerated depreciation is used for tax purpose
Variety of methods use for book accounting

Installment Sales
Recognize when cash payments are received for tax
Recognize as revenue when earned and realizable for book

Question 15

Timing differences that generally result in a deferred asset

Answer 15

Unearned Revenue
Recognize when cash payments are received for tax
Recognize as revenue when earned and realizable for book

LT Construction Contracts
Can only use PC for tax purposes
Use either PC or CC for book accounting

Warranties Expense and Other Contingencies
Recognize when actual expenditures occur for tax
Allowance method used for book accounting

Question 16

Net operating loss (NOL)

Answer 16

occurs when tax-deductible expenses exceed taxable revenues.

The federal tax laws permit taxpayers to use the losses of one year to offset the profits of other years (carryback and carryforward).
Back 2 years and forward 20 years
Losses must be applied to earliest year first, but can elect to forgo the loss carryback and just carryforward.

Question 17

A company should reduce a deferred tax asset by a valuation allowance if

Answer 17

it is more likely than not that it will not realize some portion or all of the deferred tax asset.
“More likely than not” means a level of likelihood of at least slightly more than 50 percent.

Question 18

Uncertain Tax Positions

Answer 18

Step 1: recognition threshold
Determine whether uncertain tax position meets the threshold test of “more likely than not” that it will be able to sustain the tax return position, based on its technical merits

Step 2: measurement of tax benefit
Measured as largest amount of benefit that is cumulatively greater than 50 percent likely of being realized

Question 19

JE for Uncertain Tax Positions

Answer 19

Dr. Tax Expense 4,150
Cr. Tax Payable 4,000
Cr. Tax Contingency Reserve 150