Chapter 19 Flashcards
What SFAS applies to Deferred Taxes?
SFAS 109
When do deferred taxes arise?
when income tax expense differs from income tax liability and these differences unwind
What is tax expense determined under?
GAAP
What is income tax liability determined under?
Internal Revenue Code
What types of differences exist between GAAP and the Internal Revenue Code?
temporary and permanent
What are permanent differences?
items recognized for financial accounting purposes but not for income tax purposes
Why are deferred taxes created?
because of a fundamental difference between GAAP and IRS
What kind of income do companies want when dealing with taxes?
Want low income because higher income is seen as a liability
What are examples of permanent differences?
1) Interest income received on tax exempt securities, 2) Fines and expenses resulting from violations of law, 3) Premiums paid for life insurance on key officers, employees
How does interest income effect taxes?
included in GAAP, but permanently lowers taxes and income
How do fines and expenses effect taxes?
Expense that lowers net income but no tax break for this kind of activity therefore increases net income and taxes
How do life insurance premiums on executives and employees effect a company?
Helps absorb costs if something bad happens to executives
How do life insurance premiums effect taxes?
deducted under GAAP but not deducted under IRS, similar to fines and expenses, increases taxable income and therefore increases taxes
Do permanent differences create assets and liabilities?
No, these are created by the reversal of temporary differences
What are the two types of deferred taxes?
Assets and Liabilities
When does a deferred tax liability arise?
due to net taxable amounts in the future
When does a deferred tax asset arise?
due to a net deductible amount in the future
How does a deferred tax liability effect taxes in the future?
increase in taxes in the future
How does a deferred tax asset effect taxes in the future?
deduction in taxes in the future
What are examples of temporary differences?
1) warranty expense, 2) unearned revenue, 3) depreciation, 4) installment sales
How does warranty expense create a deferred tax?
lower GAAP net income so right now there are no tax issues, but in the future the company will have to pay claims which will lower net income and result in lower taxes making it a deferred tax asset
How does unearned revenue create a deferred tax?
taxes are owed right now since record all of income now, but in future taxes will not be owed making it a deferred tax asset
How does depreciation create a deferred tax?
depreciation occurs much quicker under taxes to encourage companies to spend and help the economy so the company gets a big deduction today, but in the future they will no longer have that deduction and taxes will be larger making it a deferred tax liability
What is the most common deferred tax issue?
depreciation
What depreciation method is used for taxes?
MACRS (most accelerated)
Sum of the years digits method of depreciation formula
Base(cost-salvage value) x (Years Remaining/Sum of years (ex. 4 years, 1+2+3+4)) x (number of months in depreciation period)
Double-declining balance method of depreciation formula
2/useful life x base (cost-accumulated depreciation)
How do installment sales create a deferred tax?
no cash is given upfront right now there is no tax, but in the future as cash is collected net income will increase which ultimately increases taxes creating a deferred tax liability
What steps are used to determine how to deal with a difference?
1) Is the difference temporary or permanent? 2) What does the difference do to GAAP? 3)Does the difference create higher or lower taxes in the future?
What is the basic rule of applying tax rates when determining a deferred tax?
apply the yearly tax rate to calculate deferred tax effects
What tax rate is used if the future tax rate changes?
use the enacted tax rate expected to apply in the future year
What tax rate should be used if new rates are not yet enacted into law for future years?
use the current rate
How is income tax expense presented on the income statement?
1) continuing operations, 2) discontinued operations, 3) extraordinary items, 4) prior period adjustments (errors)
What is intraperiod tax allocation?
Showing separate tax impact of specific items
When are NOLs computed?
for each tax year
How is a NOL used?
can be applied to offset taxable income of other years, possibly resulting in tax refunds
What is the carryback option?
when NOLs are carried back 2 years and carried forward 20 years
What is the carryforward only option?
when NOLs are carried forward 20 years
How are NOLs beneficial to a company?
can help companies survive a few bumps in the road, but only a bandaid for companies in severe trouble
What is the maximum refund a company can receive when using a NOL?
what previously paid in taxes for 2 years
When might a carryforward be beneficial?
if Congress is raising tax rates
How are NOLs applied when they are carried back 2 years and carried forward 20 years?
1) NOL is applied to earlier of the 2-year period, then to the immediately preceding year, 2) remaining NOLs are applied to the following 20-year period using future rates, 3) any tax refunds are reported in the year of the original net operating loss
Why is a carryback beneficial?
get refund immediately while have to wait several years for a deferred tax asset from carryforwards
Effective tax rate calculation
income tax expense/income before taxes
What is an NOL designed for?
to give a company relief from having a bad year
What tax rate is used when using a carryback?
apply the past rate
What tax rate is used when using a carryforward?
apply the future rate
When is a valuation account used?
1) huge deferred tax asset balances, 2) large carryforwards
What kind of account is the benefit on carryback?
income statement account
What type of account is income tax refund receivable?
current asset
What journal entry is made if in the next year there is not enough deferred tax asset to cover income taxes?
debit income tax expense for the year and credit deferred tax asset for the carryforward amount left and income tax payable for the remainder
What happens if there is a loss in the next year and you still have a carryfoward left?
carryforward the entire amount to the next year
