F6- Income Taxes

Question 1

Define permanent differences and list some examples.

F6-16

Answer 1

Permanent differences are transactions that affect either taxable income or financial income, but not both, and only in the period in which they occur. They do not affect future financial or taxable income.

• Premium on key officer life insurance policy when entity is owner and beneficiary.
• Proceeds from key officer life insurance.
• Tax-exempt interest on state and municipal bonds.
• Nondeductible portion of meals and entertainment.
• Fines and expenses in violation of law.
• Dividends received deduction.

Question 2

Define temporary differences and list some examples.

F6-17

Answer 2

Temporary differences are differences between taxable income and financial income that result in taxable or deductible amounts in the future years and necessitate the recognition of deferred tax assets or liabilities.

• Depreciation (financial vs. MACRS).
• Gross profit on long-term construction contracts (percentage completion vs. completed contract).
• Estimated warranty costs.
• Litigation accruals.
• Gross profit on installment sales (accrual vs. cash).
• Bad debt expense using the allowance method vs. actual bad debt expense.

Question 3

Define deferred tax liability.

F6-18

Answer 3

• Anticipated future tax liabilities derived from situations in which future taxable income will be greater than future financial income due to temporary differences.
• A defered tax liability is measured by applying the applicable enacted tax rate and provisions of the enacted law to temporary differences in the periods in which they are expected to reverse.

Question 4

Define deferred tax asset.

F6-19

Answer 4

• Anticipated future taxable income will be less than future financial income due to temporary differences.
• A deferred tax asset is recognized for all deductible temporary differences, operating losses, and tax credit carryforwards by applying the applicable enacted tax rate and provisions of the enacted tax law to temporary differences in the period in which they are expected to reverse.
• Deferred tax assets are also subject to recording a valuation allowance to reduce the asset to its net realizable value if it is more likely than not that its full value will not be recognized.

Question 5

What is the valuation allowance?

F6-20

Answer 5

If it is more likely than not (>50%) that some portion or all of the deferred tax asset will not be realized, a valuation allowance needs to be created to recognize the reduction in the carrying amount of the deferred tax asset.

Note: IFRS prohibits the use of a valuation allowance. Under IFRS, a DTA is recognized only when it is probable (more likely than not) that sufficient taxable profit will be available against which the temporary difference can be utilized.

Question 6

Identify the tax rate used to measure deferred tax assets and liabilities under U.S. GAAP and IFRS.

F6-21

Answer 6

U.S. GAAP
The enacted tax rate expected to apply to taxable items (temporary differences) in the periods the taxable item is expected to be paid (liability) or realized (asset).

Do not allow the examiners to trick you into using the anticipated, proposed, or unsigned tax rate.

IFRS
IFRS permits the use of enacted or substantively enacted tax rates.

Question 7

How are deferred tax assets and liabilities classified on the balance sheet under U.S. GAAP?

F6-22A

Answer 7

U.S. GAAP
Classification between current and noncurrent is based on the classification of the related asset/liability. If there is no related asset or liability, then the timing of the reversal is used.

Current deferred tax assets and liabilities should be netted against each other. Noncurrent deferred tax assets and liabilities should be netted against each other as well.

Question 8

How are deferred tax assets and liabilities classified on the balance sheet under IFRS?

F6-22B

Answer 8

IFRS
Under IFRS, deferred tax assets and deferred tax liabilities are reported as noncurrent on the balance sheet.

Deferred tax assets and deferred tax liabilities may be netted if the entity has a legally enforceable right to offset current tax assets against current tax liabilities and the deferred tax assets and deferred tax liabilities relate to income taxes levied by the same tax authorities.