FAR CPA Lessons 172-183

Question 1

interperiod tax allocation

Answer 1

The process of recognizing income tax expense and associated deferred tax accounts.

The application of accrual accounting to the measurement of income tax effects on the financial statements.

Question 2

The main effects of applying the asset/liability approach for interperiod tax allocation

Answer 2

1. Income tax expense for the period reflects the amount that will ultimately be payable on the year’s transactions, even though the timing of payment and expense recognition will not coincide.
2. The income tax payable account, deferred tax asset account, and deferred tax liability account report the tax receivables and obligations from transactions that have already occurred as of the balance sheet date but that have not yet been received or paid.

Question 3

Taxable Items

Answer 3

Amounts that cause income tax to increase. This is an Internal Revenue Code term and typically refers to revenues that cause taxable income to increase.

Question 4

Deductible Items

Answer 4

Amounts that cause income tax to decrease. This is an Internal Revenue Code term and typically refers to expenses that cause taxable income to decrease.

Question 5

Pretax Accounting Income

Answer 5

Income before income tax for financial accounting purposes as determined by GAAP.

Question 6

Taxable Income

Answer 6

Income before income tax for tax purposes. Taxable income is the amount to which the tax rates are applied in determining the income tax liability for the year.

Question 7

Income Tax Expense

Answer 7

The account reported in the income statement that measures the income tax cost for the year’s transactions. Income tax expense equals the income tax liability plus or minus the net change in the deferred tax accounts for the period.

Question 8

Current Income Tax Provision

Answer 8

Also called current portion of income tax expense and current provision for income tax. This term is used in the income statement to refer to the amount of income taxes due for the year. This amount is the same as the income tax liability for the year.

Question 9

Deferred Income Tax Provision

Answer 9

The amount of income tax expense for the year that is not currently due. This amount equals the net sum of the changes in the deferred tax accounts.

Question 10

Example of a permanent Difference

Answer 10

These types of differences do not enter into the process of interperiod tax allocation. They have no deferred tax consequences.

Examples:

• Tax-Free Interest Income
• Life insurance expense
• Proceeds on Life Insurance
• Dividends Received Deduction
• Fines & Penalties
• Depletion

Question 11

Example of Temporary Differences

Answer 11

Depreciation can be different in any given year for income reporting and tax purposes, but total depreciation is the same over the life of the asset under the two reporting systems.

Question 12

Net Operating Loss

Answer 12

Negative taxable income (strictly a tax term). A net operating loss can be carried forward indefinitely to reduce up to 80% of taxable income in a year and therefore an NOL reduces the tax liability in future tax years.

Question 13

Deferred Tax Asset

Answer 13

The recognized tax effect of future deductible temporary differences. These differences, caused by transactions that have occurred as of the balance sheet date, will cause future taxable income to decrease relative to pretax accounting income.

Question 14

Deferred Tax Liability

Answer 14

Deferred Tax Liability—The recognized tax effect of future taxable temporary differences. These differences, caused by transactions that have occurred as of the balance sheet date, will cause future taxable income to increase relative to pretax accounting income.

Question 15

Three Types of Differences—Between GAAP and Income Tax Law

Answer 15

1. Permanent differences
2. Temporary differences
3. Net operating losses

Question 16

A primary objective of accounting for income taxes

Answer 16

To recognize the amount of deferred tax liabilities and deferred tax assets reported for future tax consequences.

Question 17

Nature of Permanent Differences

Answer 17

The permanent differences are those, due to the existing tax laws, that will not reverse themselves over an extended period of time.

Question 18

Explain Tax-Free Interest Income - Permanent Differences

Answer 18

An example of this difference is the interest income earned on an investment in state or municipal bonds. The interest income is included in pretax accounting income, but not in taxable income.

Question 19

Explain Life Insurance Expense - Permanent Differences

Answer 19

The insurance premiums on a life insurance policy for a key employee where the firm is the beneficiary are not deductible from taxable income, but are an expense for financial reporting.

Question 20

Explain Proceeds on Life Insurance - Permanent Differences

Answer 20

In the event of the death of the key employee, the proceeds from the insurance policy are not taxable but are included as a gain for financial reporting purposes.

Question 21

Explain Dividends Received Deduction - Permanent Differences

Answer 21

The dividends received deduction is a deduction for tax purposes equal to 80% (amount subject to change) of qualified dividends received. It is an amount of dividends received that is not subject to tax. However, the entire amount of dividends received is included in pretax accounting income.

Question 22

Explain Fines and Penalties - Permanent Differences

Answer 22

Many fines, penalties, and expenses resulting from a violation of law are not deductible for tax purposes, but are recognized as an expense or loss for financial reporting purposes.

Question 23

Explain Depletion - Permanent Differences

Answer 23

GAAP depletion (cost depletion) is based on the cost of a natural resource used up. Tax depletion is based on revenues of resource sold. The difference in any year is a permanent difference.

Question 24

General Rule for Accounting for Permanent Differences

Answer 24

For Permanent differences, an amount is recognized in one system of reporting but not in the other. The difference never reverses as it does with temporary differences. But the income tax law is what ultimately determines whether an item is considered for tax purposes. Hence the rule for permanent differences: The effect of a permanent difference on income tax expense is the same as its effect on the income tax liability for the period.

Question 25

Examples of temporary differences

Answer 25

1. Revenues or gains that are taxable after they are recognized in financial income (the equity method to recognize income from investments in equity securities)
2. Expenses or losses that are deductible after they are recognized in financial income (warranty expense)
   3 Revenues or gains that are taxable before they are recognized in financial income (rent revenue or subscription revenue)
3. Expenses or losses that are deductible before they are recognized in financial income (Depreciation)

Question 26

Two categories for temporary differences

Answer 26

1. Taxable Temporary Differences

2. Deductible Temporary Differences

Question 27

Explain Taxable Temporary Differences

Answer 27

Involves differences that initially cause a postponement in the payment of taxes.

• In the year of origination, the item causes taxable income to decline relative to pretax accounting income.
• When the item reverses, the item causes future taxable income to exceed pretax accounting income.
• Future taxable differences give rise to deferred tax liabilities.

Question 28

Explain Deductible Temporary Differences

Answer 28

Involves differences that initially cause a prepayment of taxes.

• In the year of origination, the item causes taxable income to increase relative to pretax accounting income.
• When the item reverses, the item causes future taxable income to be less than pretax accounting income.
• Future deductible differences give rise to deferred tax assets.

Question 29

income tax expense is classified into two parts

Answer 29

1. Current Provision of Income Tax

2. Plus Deferred Provision of Income Tax

Question 30

Explain deferred tax asset valuation allowance

Answer 30

Deferred tax assets can only be recognized if there is more than a 50% chance of being about to fully recognize it. If there is not - then a deferred tax valuation account (Contra account) i used to reduce the asset to the amount that has at least a 50% chance of being realized

Question 31

A valuation account is suggested if any of the following are present:

Answer 31

1. A history of unused net operating losses;
2. A history of operating losses;
3. Losses expected in future years; or
4. Very unfavorable contingencies.

Question 32

Evidence that a valuation account is not needed for deferred tax assets

Answer 32

1. Existing contracts or sales backlog will produce more than enough taxable income
2. An excess of appreciated asset value over the tax basis of the entity’s net assets will produce more than enough taxable income
3. A strong earnings history suggests that taxable income in the future will be enough

Question 33

Sources used to evaluation r Realizing the Deferred Tax Asset

Answer 33

One or more of the following can be used to asses if there is sufficient amount to achieve the 50% threshold

1. Expectation of future taxable income;
2. Future taxable differences; or
3. Tax planning strategies.

Question 34

Net Operating Loss (NOL)

Answer 34

negative taxable income for a year - occurs when taxable deductions exceed taxable revenues.

Question 35

NOL Carryforward

Answer 35

The tax law allows an NOL to be carried forward indefinitely to reduce taxes in those years. A company may offset 80% of its taxable income each year as it applies the NOL carryforward.

Question 36

Tax Credits

Answer 36

Tax credits reduce income tax by the amount of the credit and are thus more valuable dollar for dollar. Thus, it may be advantageous to use prior year taxable income for these credits.

Question 37

Accounting for NOL

Answer 37

A carryforward generates a deferred tax asset. Both a carryforward of an NOL and a future deductible difference reduce future taxable income relative to pretax accounting income. The tax benefit of a carryforward is recognized in income in the period of the loss.

The carryforward is recorded with a debit to Deferred Tax Asset and credit to Income Tax Benefit

Question 38

IFRS deferred tax netting

Answer 38

The IFRS provides that the netting of deferred tax assets and liabilities may only occur if the accounts relate to the same taxing authority and the entity has a legal right to offset the taxes. Therefore, the deferred tax asset and the deferred tax liability may be offset if related to the same taxing authority

Question 39

Retrospective

Answer 39

Application of a principle to prior periods as if that principle had always been used.

Question 40

Accounting for accounting changes or errors retrospectively

Answer 40

Record the effect of the change on prior years as an adjustment to the beginning balance in retained earnings for the year of change rather than in income; prior year financial statements reported comparatively with the current year statements are adjusted to reflect the new method.

Question 41

Prospective

Answer 41

Prior period statements are not affected in anyway nor are there disclosures with respect to prior statements.

Question 42

Restatement

Answer 42

Restatement is the term reserved specifically for error changes. Restatement requires correcting the comparative financial information presented along with correcting the opening retained earnings balance. The entity must disclose the nature of the error and the effect on current and prior periods.

Question 43

Change in Accounting Principle

Answer 43

A change from one generally accepted accounting principle to another when there are at least two acceptable principles, or when the current principle used is no longer generally accepted. A change in the method of applying a principle is also considered a change in accounting principle.

Inventory method, Accounting for construction contract method etc.

Question 44

Steps for retrospective approach

Answer 44

1. The effect is adjusted to the carrying amounts of affected assets and liabilities as of the beginning of the earliest period presented, offset to the opening balance of retained earnings for that period
2. The financial statements for prior periods presented comparatively are recast to reflect the period-specific effects of applying the new principle. Each account affected by the change is adjusted as if the new method had been used in those periods.
3. A journal entry to the beginning balance of retained earnings in the year of the change is adjusted to reflect the use of the new principle through that date.

Question 45

Justification for Principle Change

Answer 45

The allowable new principle must improve financial reporting given the environment of the firm. Common justifications include changing business conditions, and better matching of revenues and expenses.

Question 46

Direct effects

Answer 46

recognized changes in assets or liabilities necessary to effect the change. Related effects on deferred tax accounts, or an impairment adjustment resulting from applying LC-M valuation to the new inventory balance are also examples of direct effects.

Question 47

Indirect effects

Answer 47

changes in current or future cash flows resulting from making a change in accounting principle applied retrospectively. Such changes are recognized in the period of change. Prior period financial statements are not adjusted although a description of the effects, amounts and per share amounts are disclosed in the footnotes.

Question 48

How to report a change in depreciation method

Answer 48

changes in accounting principle to be given retrospective application, and the cumulative effects of the change reflected in the carrying value of assets and period-specific effects on the financial statements for each period presented.

Question 49

How to report a change from cash basis to accrual based accounting

Answer 49

As a prior period adjustment resulting from the correction of an error

Question 50

The retrospective approach should not be applied if any of the follow applies

Answer 50

1. After making a reasonable effort to apply the principle to prior periods, the entity is unable to do so.
2. Assumptions about management’s intent in prior periods are required and such assumptions cannot be independently substantiated.
3. Retrospective application requires estimates of amounts based on information that was unavailable in the prior periods or on circumstances that did not exist in the prior periods.

Question 51

Changes in reporting entities is limited mainly to:

Answer 51

1. Presenting consolidated or combined financial statements in place of financial statements of individual entities
2. Changing the set of subsidiaries that make up a consolidated group
3. Changing the entities included in combined financial statements

Question 52

Change in Accounting Estimate

Answer 52

Is derived from new information and is a change that causes the carrying amount of an asset or liability to change, or that changes the subsequent accounting for an asset or liability. Estimate changes are the most frequent type of accounting change.

Bad debts, warranties, depreciation, pension accounting, lower of cost or market, asset impairment

Question 53

How to account for a change in principle when it cannot be distinguished from a change in estimate

Answer 53

As a change in estimate prospectively

Question 54

Prospective changes for estimate changes affecting only the current period

Answer 54

the new estimate is used and the usual accounting procedure applies.

Question 55

Prospective changes for changes in method of depreciation, amortization, or depletion

Answer 55

the book value at the beginning of the current period is used as the basis for expense recognition over the asset’s remaining useful life, along with new estimates of salvage value and useful life if necessary. The new method is applied as of the beginning of the period of change.

Question 56

Disclosures for Estimate Changes

Answer 56

For the current period, the following are required:

1. Effect of the change on income from continuing operations, net income, and related per-share amounts for the period of change for estimate changes affecting current and future periods
2. For estimate changes affecting only the period of change, the above disclosures are required only if material.

Question 57

Error in Prior-Period Financial Statements

Answer 57

change from an inappropriate accounting principle to one that is generally accepted is considered an error correction.

Changes in estimates that reflect negligence or those that were made in bad faith are also considered error corrections.

Question 58

The procedure for error corrections

Answer 58

1. The effect of the error correction on periods before those presented is reflected in the affected real accounts as of the beginning of the earliest period presented
2. The financial statements for prior periods presented comparatively are recast to reflect the effect of the error correction.
3. Through a journal entry, the beginning balance of retained earnings in the year of the correction is adjusted to reflect the correct accounting through that date (prior period adjustment)

Question 59

Disclosures for Error Corrections

Answer 59

1. A statement that previous financial statements were restated, and the nature of the error
2. Effect of the correction on each financial statement line item and related per share amounts for each prior period presented
3. The total cumulative effect of the change on retained earnings as of the beginning of the first period presented
4. Pre- and post-tax effects of the correction on net income for each prior period presented

Question 60

primary objective of accounting for income taxes

Answer 60

To recognize the amount of deferred tax liabilities and deferred tax assets reported for future tax consequences.