FAR SEC 10

Question 1

What is the definition of accounts payable (trade payables)? (2 elements)

Answer 1

1) Accounts payable (trade payables) are liabilities. They are obligations to sellers incurred when an entity purchases inventory, supplies, or services on credit.
2) Accounts payable are usually noninterest-bearing unless they are not settled when due or payable.
-They also are usually not secured by collateral.

Question 2

What are current liabilities? (3 elements)

Answer 2

1) A current liability is an obligation that will be either paid using current assets or replaced by another current liability. Thus, a liability is classified as current if it is expected to be paid within the entity’s operating cycle or 1 year, whichever is longer.
2) Current liabilities (accounts payable) should be recorded at net settlement value. Thus, they are measured at the undiscounted amounts of cash expected to be paid to liquidate an obligation.
i) Obligations that are callable by the creditor within 1 year because of a violation of a debt agreement also are classified as current liabilities.
3) Checks written before the end of the period but not mailed to creditors should not be accounted for as cash payments for the period. The amounts remain current liabilities until control of the checks has been surrendered.

Question 3

For accounts payable, what is the gross method? (2 elements)

Answer 3

Cash discounts are offered to induce early payment. Purchases and related accounts payable may be recorded using the gross method or the net method.
1) The gross method ignores cash discounts. It accounts for payables at their face amount.
2) Purchase discounts taken are credited to a contra purchases account and closed to cost of goods sold.

Question 4

For accounts payable, what is the net method? (3 elements)

Answer 4

Cash discounts are offered to induce early payment. Purchases and related accounts payable may be recorded using the gross method or the net method.
1) The net method records payables net of the cash (sales) discount for early payment.
2) When the discount is taken (the payment is within the discount period), no additional adjustment is required.
3) Purchase discounts lost is recognized (debited) when payment is not made within the discount period.

Question 5

For accounts payable, what are shipping terms? (3 elements)

Answer 5

1) The timing of recognition of accounts payable may depend on the shipping terms.
2) When goods are shipped FOB shipping point, the buyer records inventory and a payable at the time of shipment.
3) When goods are shipped FOB destination, the buyer records inventory and a payable when the goods are tendered at the destination.

Question 6

For accrued expenses, how are accrual entries done? (3 elements)

Answer 6

1) Ordinarily, accrued expenses meet recognition criteria in the current period but have not been paid as of year end. They are accounted for using basic accrual entries.
2) Accruals may be used to facilitate accounting for expenses incurred but not paid at the end of an accounting period.
3) For example, the year-end accrual entry for wages payable is
Wages expense $XXX
Wages payable $XXX

Question 7

For accrued expenses, how are reversing entries done? (3 elements)

Answer 7

1) The reversing entry at the beginning of the next period is
Wages payable $XXX
Wages expense $XXX
2) No allocation between the liability and wages expense is needed when wages are paid in the subsequent period. The full amount of expenses paid in the next period can be debited to expense.
3) The entry is simply
Wages expense $XXX
Cash $XXX

Question 8

For accrued expenses, what is the accounting treatment if no reversing entries are done? (2 elements)

Answer 8

1) If reversing entries are not made, payments during the year are recorded by debiting expense for the full amount.
-The entry is
Wages expense $XXX
Cash $XXX
2) At year end, the liability is adjusted to the balance owed at that date.
-For example, if the liability for accrued wages has decreased, the adjusting entry is
Wages payable $XXX
Wages expense $XXX

Question 9

For accrued expenses, what are the effects of nonaccrual? (3 elements)

Answer 9

1) If an entity fails to accrue expenses at year end, income is overstated in that period and understated in the next period (when they are paid and presumably expensed).
2) Moreover, expenses incurred but unpaid and not recorded result in understated accrued liabilities and possibly understated assets (for example, if the amounts should be inventoried).
3) In addition, working capital (current assets – current liabilities) will be overstated, but cash flows will not be affected.

Question 10

With respect to accrued liability for employees’ vacations, what is the accounting for compensated absences? (5 elements)

Answer 10

1) The accounting for compensated absences applies to employees’ rights to receive compensation for future absences, such as vacations. It requires an accrual of a liability when four criteria are met:
2) The payment of compensation is probable.
3) The amount can be reasonably estimated.
4) The benefits either vest or accumulate.
i) Rights vest if they do not depend on employees’ future service. The employer has an obligation to pay even if an employee provides no future service.
ii) Rights accumulate if earned but, if unused, may be carried forward to subsequent periods.
5) The compensation relates to employees’ services that have already been rendered.

Question 11

What is the common way to measure the liability for compensated absences? (3 elements)

Answer 11

1)The common way to measure the liability for compensated absences at the end of the reporting period is to multiply current employees’ daily average wage rate by the number of vacation days earned and expected to be used in subsequent periods.
2) In future periods, the wage rate may change. Thus, the amount paid for compensated absences may differ from the liability recognized. The difference is accounted for as a change in estimate and recognized in the income statement.
3) The liability should be classified as
i) A current liability for the amount expected to be paid within 12 months after the end of the fiscal year and
ii) A noncurrent liability for the remaining amount.

Question 12

What are the federal taxes payable? (3 elements)

Answer 12

1) Federal unemployment tax and the employer’s share of FICA taxes are expenses incurred as employees earn wages. But they are only paid on a periodic basis to the federal government.
2) Accordingly, liabilities should be accrued by the employer for both expenses.
Payroll tax expense $XXX
Employer FICA taxes payable $XXX
Federal unemployment taxes payable $XXX
3) Income taxes withheld and the employees’ share of FICA taxes are accrued as withholding taxes (payroll deductions), not as employer payroll tax expense.

Question 13

What are the state taxes payable? (2 elements)

Answer 13

1) Most states impose sales taxes on certain types of merchandise. Ordinarily, the tax is paid by the buyer but is collected by the seller, and only later remitted to the state tax agency by the seller.
2) Most states require quarterly or monthly filing of sales tax returns and remittance of taxes collected.

Question 14

What are the local taxes payable?

Answer 14

Property taxes are usually expensed by monthly accrual over the fiscal period of the taxing authority.

Question 15

What is the definition of a deposit (contract liability)? (3 elements)

Answer 15

1) A deposit or other advance is a contract liability. It does not qualify for revenue recognition.
2) A contract liability is an obligation to transfer goods or services to a customer for which the consideration already has been received from the customer.
3) Alternative descriptions of a contract liability, such as deferred revenue, may be used in the statement of financial position.

Question 16

What is the accounting treatment of deposits (contract liabilities)? (4 elements)

Answer 16

1) Cash advances (such as sales of gift certificates) are recorded as follows:
Cash $XXX
Contract liability (deferred revenue) $XXX
2) The entity should derecognize the contract liability and recognize revenue when the promised goods or services are transferred to the customer.
Contract liability $XXX
Revenue $XXX
3) Cash received from customers for magazine subscriptions creates a liability for unearned subscription revenue.
4) If a customer option to acquire additional goods or services for free or at a discount provides a material right to the customer, the customer in effect pays the entity in advance for future goods or services. The following is the accounting for such an option:
i) The total transaction price is allocated to performance obligations based on their relative standalone selling prices (discussed in Study Unit 3, Subunit 3).
ii) At contract inception, the consideration allocated to the option is recognized as a contract liability (e.g., deferred revenue).
iii) Revenue is recognized when (a) those goods or services are transferred to the customer or (b) the option expires.

Question 17

What is the basic definition of a warranty? (3 elements)

Answer 17

1)A warranty is a written guarantee of the integrity of a product or service. The seller may also agree to repair or replace a product or provide additional service.
2) A warranty customarily is offered for a limited time, such as 2 years.
3) It may or may not be sold separately from the product or service.

Question 18

What is an assurance-type warranty? (2 elements)

Answer 18

1) A warranty that provides a customer assurance that a product will function as expected in accordance with agreed-upon specifications is an assurance-type warranty.
2) A standard one-year computer warranty against manufacturing defects is an example of an assurance-type warranty.

Question 19

What is a service-type warranty? (3 elements)

Answer 19

1) A warranty that provides a customer with a service in addition to the assurance that the product complies with agreed-upon specifications is a service-type warranty.
2) A warranty against customer-inflicted damages, such as dropping the computer on the floor or into water, is an example of a service-type warranty.
3) A service-type warranty is accounted for as a separate performance obligation in the contract.

Question 20

How is a warranty classified as either assurance-type or service-type? (4 elements)

Answer 20

1) A warranty that can be purchased separately by the customer is a service-type warranty.
-If a customer does not have the option to purchase a warranty separately, the warranty is an assurance-type warranty.
2) A warranty required by law is an assurance-type warranty.
3) The length of the warranty coverage period may indicate the type of warranty. A service-type warranty is more likely to have a longer coverage period. A longer warranty is more likely to provide service in addition to the assurance that the product complies with agreed-upon specifications.
4) If an assurance-type warranty and a service-type warranty provided in the contract cannot be separated, the warranties are accounted for as a single performance obligation in a contract (that is, as a service-type warranty).

Question 21

What is the accounting treatment for an assurance type warranty? (4 elements)

Answer 21

1) An assurance-type warranty is not a separate performance obligation in a contract. Thus, no transaction price is allocated to the warranty.
2)An assurance-type warranty creates a loss contingency.
Accrual accounting should be used if
i) Incurrence of warranty expense is probable,
ii) The amount can be reasonably estimated, and
iii) The amount is material.
3) A liability for warranty costs is recognized when the related revenue is recognized, i.e., on the day the product is sold.
i) Even if the warranty covers a period longer than the period in which the product is sold, the entire liability (expense) for the expected warranty costs must be recognized on the day the product is sold. The warranty liability (expense) must not be prorated over the annual periods covered by the warranty.
(Beginning warranty liability) + (Warranty expense recognized in the current period) - (Warranty payments in the current period) = Ending warranty liability
II) Actual payments for warranty costs reduce the amount of warranty liability recognized and do not affect warranty expense.
-If the warranty payments for the period are greater than the amount of warranty liability recognized, the excess is recognized as warranty expense.
4) The following are accrual-basis entries for warranty expense estimated as a percentage of sales when the warranty is not separable:
i) To record a sale of product
Cash or accounts receivable $XXX
Sales revenue $XXX
ii) To record related warranty expense recognized on the day of sale
Warranty expense $XXX
Estimated warranty liability $XXX
iii) To record actual warranty expenditures paid in the current period
Estimated warranty liability $XXX
Cash $XXX

Question 22

What is the accounting treatment for a service-type warranty? (4 elements)

Answer 22

1) A service-type warranty is a separate performance obligation in a contract. Thus, a portion of the total transaction price is allocated to the service-type warranty.
-The total transaction price is allocated to the service-type warranty and the related product sold based on their estimated standalone selling prices.
2) At contract inception, the consideration received for the service-type warranty is accounted for as an advance payment and a contract liability is recognized. The following entry is recorded on a sale of a product with a service-type warranty:
Cash $XXX (total transaction price)
Revenue $XXX (transaction price allocated to the product)
Contract liability $XXX (transaction price allocated to the service-type warranty)
3) Revenue from a service-type warranty is recognized over time (i.e., over the coverage period). The pattern of revenue recognized from a service-type warranty depends on the way the warranty performance obligation is satisfied.
i) If warranty service is provided continuously over the warranty period, revenue is recognized on the straight-line basis over the coverage period.
ii) If warranty service costs are not incurred on a straight-line basis, revenue recognition over the contract’s term should be proportionate to the estimated service costs.
iii) The following entry is recorded when revenue from a service-type warranty is recognized:
Contract liability $XXX
Revenue $XXX
iv) The following entry is recorded when an entity pays for the costs related to the claims under the warranty:
Warranty expense $XXX
Cash $XXX

Question 23

Is an assurance-type warranty a separate performance obligation in a contract?

Answer 23

No. An assurance-type warranty is not a separate performance obligation in a contract. Thus, no transaction price is allocated to the warranty.

Question 24

What are the three criteria for using accrual accounting for an assurance-type warranty?

Answer 24

An assurance-type warranty creates a loss contingency. Accrual accounting should be used if
1) Incurrence of warranty expense is probable,
2) The amount can be reasonably estimated, and
3) The amount is material.

Question 25

When is a liability for warranty costs recognized? (3 elements)

Answer 25

1) A liability for warranty costs is recognized when the related revenue is recognized, i.e., on the day the product is sold.
2) Even if the warranty covers a period longer than the period in which the product is sold, the entire liability (expense) for the expected warranty costs must be recognized on the day the product is sold. The warranty liability (expense) must not be prorated over the annual periods covered by the warranty.
(Beginning warranty liability) + (Warranty expense recognized in the current period) - (Warranty payments in the current period) = Ending warranty liability
3) Actual payments for warranty costs reduce the amount of warranty liability recognized and do not affect warranty expense.
-If the warranty payments for the period are greater than the amount of warranty liability recognized, the excess is recognized as warranty expense.

Question 26

What are the accrual-basis entries for warranty expense when the warranty is not separable? (3 elements)

Answer 26

The following are accrual-basis entries for warranty expense estimated as a percentage of sales when the warranty is not separable:
i) To record a sale of product
Cash or accounts receivable $XXX
Sales revenue $XXX
ii) To record related warranty expense recognized on the day of sale
Warranty expense $XXX
Estimated warranty liability $XXX
iii) To record actual warranty expenditures paid in the current period
Estimated warranty liability $XXX
Cash $XXX

Question 27

Is a service-type warranty a separate performance obligation in contract? (2 elements)

Answer 27

Yes.
1) A service-type warranty is a separate performance obligation in a contract. Thus, a portion of the total transaction price is allocated to the service-type warranty.
2) The total transaction price is allocated to the service-type warranty and the related product sold based on their estimated standalone selling prices.

Question 28

What is the journal entry for consideration received for a service-type warranty?

Answer 28

At contract inception, the consideration received for the service-type warranty is accounted for as an advance payment and a contract liability is recognized. The following entry is recorded on a sale of a product with a service-type warranty:
Cash $XXX (total transaction price)
Revenue $XXX (transaction price allocated to the product)
Contract liability $XXX (transaction price allocated to the service-type warranty)

Question 29

How is revenue from a service-type warranty recognized? (5 elements)

Answer 29

1) Revenue from a service-type warranty is recognized over time (i.e., over the coverage period). The pattern of revenue recognized from a service-type warranty depends on the way the warranty performance obligation is satisfied.
2) If warranty service is provided continuously over the warranty period, revenue is recognized on the straight-line basis over the coverage period.
3) If warranty service costs are not incurred on a straight-line basis, revenue recognition over the contract’s term should be proportionate to the estimated service costs.
4) The following entry is recorded when revenue from a service-type warranty is recognized:
Contract liability $XXX
Revenue $XXX
5) The following entry is recorded when an entity pays for the costs related to the claims under the warranty:
Warranty expense $XXX
Cash $XXX

Question 30

What is the nature of the divergence of the tax code from GAAP?

Answer 30

Until 1954, business income reported to the IRS and income reported on financial statements were essentially the same. In that year, accelerated depreciation for tax purposes was permitted for the first time. Since then, more and more provisions of the tax code have diverged from GAAP. The procedures necessary to calculate the amount owed for taxes and current-year tax expense are the subject of the next five subunits.

Question 31

What are the objectives of accounting for income taxes? (2 elements)

Answer 31

1) The objectives of accounting for income taxes are to recognize
i) The amount of taxes currently payable or refundable
ii) Deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the financial statements or tax returns
2) To achieve these objectives, an entity uses the asset-and-liability approach to account for (1) income taxes currently payable or deductible and (2) deferred taxes.

Question 32

What is interperiod tax allocation? (3 elements)

Answer 32

1) Amounts in the entity’s income tax return for a year include the tax consequences of most items recognized in the financial statements for the same year. But significant exceptions may exist.
2) Revenues and expenses reported in financial statements prepared in accordance with GAAP are based on the accrual method of accounting. However, revenues and expenses reported in an income tax return are based on the income tax basis of accounting.
i) The accrual basis of accounting reports the effects of transactions and other events and circumstances on the entity’s resources and claims when they occur, not necessarily when the cash flows occur.
ii) Under the income tax basis of accounting, certain revenues and expenses are recognized when cash is received or paid, respectively. Recognition does not depend on when (a) goods are delivered or received or (b) services are rendered.
-Accordingly, tax consequences of some items may be recognized in tax returns for a year different from that in which their financial-statement effects are recognized (temporary differences).
-Moreover, some items may have tax consequences or financial-statement effects but never both (permanent differences).
3) When tax consequences and financial-statement effects differ, income taxes currently payable or refundable also may differ from income tax expense or benefit.
-The accounting for these differences is interperiod tax allocation.

Question 33

For intraperiod tax allocation, income tax expense (benefit) is allocated to: (4 elements)

Answer 33

Intraperiod tax allocation is required. Income tax expense (benefit) is allocated to
1) Continuing operations,
2) Discontinued operations,
3) Other comprehensive income, and
4) Items debited or credited directly to equity.

Question 34

What is an income tax expense or benefit?

Answer 34

Income tax expense or benefit is the sum of (1) current tax expense or benefit and (2) deferred tax expense or benefit.

Question 35

What is current tax expense or benefit?

Answer 35

Current tax expense or benefit is the amount of taxes paid or payable (or refundable) for the year as determined by applying the enacted tax law to the taxable income or excess of deductions over revenues for that year.

Question 36

What is taxable income?

Answer 36

Taxable income is the income calculated under the tax code. Taxable income equals pretax accounting income adjusted for permanent and temporary differences.

Question 37

What is deferred tax expense or benefit?

Answer 37

Deferred tax expense or benefit is the net change during the year in an entity’s deferred tax amounts.

Question 38

What is a deferred tax liability?

Answer 38

A deferred tax liability records the deferred tax consequences of taxable temporary differences. It is measured using the enacted tax rate and enacted tax law.

Question 39

What is a deferred tax asset?

Answer 39

A deferred tax asset records the deferred tax consequences of deductible temporary differences and carryforwards. It is measured using the enacted tax rate and enacted tax law.

Question 40

What is a valuation allowance?

Answer 40

A valuation allowance is the portion of a deferred tax asset for which it is more likely than not that a tax benefit will not be realized.

Question 41

What is a temporary difference? (3 elements)

Answer 41

1) A temporary difference (TD) results when the GAAP basis and the tax basis of an asset or liability differ.
2) Differences in the two bases arise when items of income and expense are recognized in different periods under GAAP and under the tax code.
3) The effect is that a taxable or deductible amount will occur in future years when the asset is recovered or the liability is settled.
-But some TDs may not be related to an asset or liability for financial reporting.

Question 42

What is a permanent difference?

Answer 42

A permanent difference is an event that is recognized either in pretax financial income or in taxable income but never in both. It does not result in a deferred tax amount.

Question 43

What are the basic principles of income tax accounting? (4 elements)

Answer 43

1) A current tax liability or asset is recognized for the estimated taxes payable or refundable on current-year tax returns.
2) A deferred tax liability or asset is recognized for the estimated future tax effects of temporary differences and carryforwards.
3) Measurement of tax liabilities and assets is based on enacted tax law. The effects of future changes in that law are not anticipated.
4) A deferred tax asset is reduced by a valuation allowance.

Question 44

For the asset-and-liability approach for income tax accounting, what is the method? (4 elements)

Answer 44

1) Income reported under GAAP (accrual basis) differs from income reported for tax purposes (income tax basis).
-The asset-and-liability approach accounts for the resulting temporary (but not permanent) differences.
2) This approach recognizes the deferred tax consequences for balance sheet measurements and related income statement amounts.
i) As a result of temporary differences, the tax bases of assets and liabilities differ from their carrying amounts reported on the financial statements. A deferred tax amount equals the tax rate times the difference between (a) the tax basis and (b) the carrying amount.

(Tax basis – Carrying amount) × Tax rate = Deferred tax asset (liability)

ii) A positive difference results in recognition of a deferred tax asset, and a negative difference results in recognition of a deferred tax liability.
iii) In the equation above, tax bases and carrying amounts of assets will be included as positive amounts (illustrated in Example 10-10 below). However, tax bases and carrying amounts of liabilities will be included as negative amounts (illustrated in Example 10-12 below).
3) Taxable temporary differences result in future taxable amounts and deferred tax liabilities (DTL).

[Income under GAAP > Taxable Income] => [Future Taxable Amounts] => DTL

4) Deductible temporary differences result in future deductible amounts and deferred tax assets (DTA).

[Income under GAAP < Taxable Income] => [Future Deductible Amounts] => DTA

Question 45

What is shown on the diagrams for taxable temporary differences and deductible temporary differences?

Answer 45

Question 46

What is the formula for calculating the amount of the deferred tax asset (liability)?

Answer 46

(Tax basis – Carrying amount) × Tax rate = Deferred tax asset (liability)

Question 47

What are the two attributes of deferred tax liabilities (DTLs) and future taxable amounts?

Answer 47

1) DTLs arise when revenues or gains are recognized under GAAP before they are included in taxable income. Examples include the following:
i) Income recognized under the equity method for financial statement purposes and at the time of distribution in taxable income
ii) Sales revenue accrued for financial reporting and recognized on the installment basis for tax purposes
iii) Gains on involuntary conversion

DTL = Future taxable amount × Enacted tax rate

2) DTLs also result when expenses or losses are deductible for tax purposes before they are recognized under GAAP. An example is accelerated tax depreciation of property.

Question 48

What is the formula for calculating the amount of the DTL?

Answer 48

DTL = Future taxable amount × Enacted tax rate

Question 49

What are the two attributes of deferred tax assets (DTAs) and future deductible amounts?

Answer 49

1) DTAs result when revenues or gains are included in taxable income before they are recognized under GAAP.
i) Examples are unearned revenues such as rent and subscriptions received in advance.

DTA = Future deductible amount × Enacted tax rate

2) DTAs also result when expenses or losses are recognized under GAAP before they are deductible for tax purposes.
Examples include the following:
i) Credit loss expense recognized under the allowance method
ii) Warranty costs
iii) Startup and organizational costs

Question 50

What is the formula for calculating the amount of the deferred tax asset (DTA)?

Answer 50

DTA = Future deductible amount × Enacted tax rate

Question 51

What are the attributes of permanent differences - no deferred tax consequences? (4 elements)?

Answer 51

1) Permanent differences are never reversed. Therefore, they have no deferred tax consequences.
2) One category of permanent differences consists of income items included in net income but not taxable income. Examples include the following:
i) State and municipal bond interest
ii) Proceeds from life insurance on key employees
3) Another category of permanent differences consists of items subtracted in calculating net income but not taxable income. Examples include the following:
i) Premiums paid for life insurance on key employees
ii) Fines resulting from a violation of law
4) A third category of permanent differences consists of items subtracted in calculating taxable income but not net income. Examples include the following:
i) Percentage depletion of natural resources
ii) The dividends-received deduction

Question 52

For tax accounting, what is the valuation allowance? (2 elements)

Answer 52

1) A valuation allowance reduces a deferred tax asset. It is recognized if it is more likely than not (probability > 50%) that some portion of the deferred tax asset will not be realized. The allowance should reduce the deferred tax asset to the amount that is more likely than not to be realized.

Income tax expense $XXX
Deferred tax asset – valuation allowance $XXX

2) A new judgment about realizability may require a change in the beginning balance. This revision ordinarily is an item of income from continuing operations.

Question 53

For income tax accounting, what are the applicable tax rates?

Answer 53

A deferred tax amount is measured using the enacted tax rate(s) expected to apply when the liability or asset is expected to be settled or realized. In the U.S., the applicable tax rate is the regular rate.

Question 54

For income tax accounting, what are the enacted changes in law or rates?

Answer 54

Such changes require an adjustment of a deferred tax amount in the period of the enactment. The effect is included in the amount of income tax expense or benefit allocated to continuing operations.

Question 55

How is taxable income calculated?

Answer 55

Taxable income (or excess of deductions over revenue) equals pretax accounting income (or loss) adjusted for permanent and temporary differences.

Question 56

What is shown on the table for how to calculate taxable income?

Answer 56

Question 57

How is tax expense or benefit calculated? (2 elements)

Answer 57

Income tax expense or benefit reported on the income statement is the sum of the current component and the deferred component.
1) Current tax expense or benefit is the amount of taxes paid or payable (or refundable) for the year based on the enacted tax law.
Current tax expense or benefit:

Taxable income (or excess of deductions over revenue) × Tax rate

2) Deferred tax expense or benefit is the net change during the year in an entity’s deferred tax amounts.
Deferred tax expense or benefit:

Changes in DTL balances ± Changes in DTA balances

Question 58

What is the formula for calculating current tax expense or benefit?

Answer 58

Taxable income (or excess of deductions over revenue) × Tax rate

Question 59

What is the formula for calculating deferred tax expense or benefit?

Answer 59

Changes in DTL balances ± Changes in DTA balances

Question 60

How is the journal entry for current income tax expense recorded?

Answer 60

Current income tax expense is recorded as follows:

Income tax expense – current $XXX
Income tax payable $XXX

Question 61

How is the journal entry for deferred income tax expense or benefit that is recognized for net change during the year in the deferred tax amounts (DTL and DTA) recorded?

Answer 61

Deferred income tax expense or benefit is recognized for the net change during the year in the deferred tax amounts (DTL and DTA) and recorded as follows:

If the DTL balance increased during the year:
Income tax expense – deferred $XXX
Deferred tax liability $XXX

If the DTA balance increased during the year:
Deferred tax asset $XXX
Income tax expense – deferred $XXX

If the DTL balance decreased during the year:
Deferred tax liability $XXX
Income tax expense – deferred $XXX

If the DTA balance decreased during the year:
Income tax expense – deferred $XXX
Deferred tax asset $XXX

Question 62

How is the total amount of income tax expense or benefit reported on the income statement?

Answer 62

In the income statement, one line item is generally reported for the total amount of income tax expense or benefit (Current + Deferred) recognized for the period.
-The amounts of current income tax expense (or benefit) and deferred income tax expense (or benefit) are disclosed in the notes.

Question 63

What are the options of the entity for a net operating loss (NOL) with respect to income tax accounting? (2 elements)

Answer 63

Depending on the year in which the net operating loss (NOL) arose, entities have several options for obtaining the tax benefit of the loss. For example,
1) Carry forward the loss indefinitely or
2) Carry the loss back 5 years and forward an unlimited number of years.

Question 64

What is the tax accounting for initial recognition of net operating loss (NOL) carryforward? (3 elements)

Answer 64

1) Carryforwards are deductions or credits that may be carried forward to reduce taxable income or taxes payable in a future year.
2) A carryforward results in a future deductible amount, requiring recognition of a deferred tax asset.
3) The journal entry is

Deferred tax asset $XXX
Income tax benefit from loss carryforward $XXX

Question 65

What is the tax accounting for the realization of net operating loss (NOL) carryforward? (2 elements)

Answer 65

1) The amount of the NOL carryforward is realized in future periods by reducing the taxable income for these periods.
2) Upon realization, the deferred tax asset reduces the amount of income tax payable in future periods and does not affect the total amount of income tax expense recognized.

Question 66

What is the tax accounting for carryback of net operating losses (NOLs)? (2 elements)

Answer 66

1) If NOLs are carried back, the entity files an amended tax return that carries the loss back, offsetting some or all of that year’s tax expense. The journal entry is
Income tax refund receivable (tax offset by carryback) $XXX
Income tax benefit from loss carryback $XXX

2) Any current-year loss that remains after the 5-year carryback will be carried forward, resulting in recognition of a deferred tax asset.

Question 67

What is shown on the table for how to calculate taxable income?

Answer 67

Question 68

What is the financial statement presentation of deferred tax amounts? (3 elements)

Answer 68

1) In the statement of financial position, deferred tax liabilities and assets are classified as noncurrent amounts.
2) Deferred tax liabilities and assets and any related valuation allowance are netted and presented as a single noncurrent amount.
3) However, deferred tax amounts attributable to different tax jurisdictions must not be netted.

Question 69

What are the required disclosures for deferred tax assets (DTAs)? (3 elements)

Answer 69

1) The following are some of the required disclosures:
i) Total deferred tax liabilities and total deferred tax assets
ii) Total DTA valuation allowance and the net annual change in it
iii) The significant components of income tax expense related to continuing operations
2) No disclosures about permanent differences are required.
3) The current income tax expense (or benefit) and deferred income tax expense (or benefit) recognized for the period must be disclosed in the financial statements or in the notes.

Question 70

What is the accounting treatment for uncertainty in income taxes? (3 elements)

Answer 70

1) A tax position is one taken or to be taken in a tax return. It is reflected in financial statement measurements of tax assets and liabilities, whether current or deferred.
For example, tax positions may include
i) Decisions not to file,
ii) Income exclusions,
iii) Transaction exemptions,
iv) Income characterizations, or
v) Shifts of income among jurisdictions.
2) The evaluation of a tax position is a two-stage procedure:
i) Recognition threshold. The financial statement effects are initially recognized if it is more likely than not (probability > 50%) that the position will be sustained upon examination based on its technical merits. It also may be recognized if effective settlement has occurred.
ii) Measurement. The entity recognizes the largest benefit that is more than 50% likely to be realized.
3) Applying this guidance may result in recognition of a tax benefit different from the amount in the current tax return. Thus, unrecognized tax benefits are differences between a tax position in a tax return and the benefits recognized under GAAP.
i) The result is a contingent liability (or reduction of a loss carryforward or refund). This result reflects the entity’s possible future tax obligation because of a tax position not recognized in the financial statements.
ii) The entity ordinarily recognizes one or both of the following:
-An increased liability for taxes payable or a reduced refund receivable
-A decreased deferred tax asset or increased deferred tax liability
iii) A tax position recognized under this guidance may affect the tax bases of assets or liabilities and change (or create) temporary differences.

Question 71

What is a tax position?

Answer 71

A tax position is one taken or to be taken in a tax return. It is reflected in financial statement measurements of tax assets and liabilities, whether current or deferred.
For example, tax positions may include
i) Decisions not to file,
ii) Income exclusions,
iii) Transaction exemptions,
iv) Income characterizations, or
v) Shifts of income among jurisdictions.

Question 72

What are the two steps for evaluation of a tax position?

Answer 72

The evaluation of a tax position is a two-stage procedure:
1) Recognition threshold. The financial statement effects are initially recognized if it is more likely than not (probability > 50%) that the position will be sustained upon examination based on its technical merits. It also may be recognized if effective settlement has occurred.
2) Measurement. The entity recognizes the largest benefit that is more than 50% likely to be realized.

Question 73

What is the accounting treatment of unrecognized tax benefits? (3 elements)

Answer 73

Applying this guidance may result in recognition of a tax benefit different from the amount in the current tax return. Thus, unrecognized tax benefits are differences between a tax position in a tax return and the benefits recognized under GAAP.
1) The result is a contingent liability (or reduction of a loss carryforward or refund). This result reflects the entity’s possible future tax obligation because of a tax position not recognized in the financial statements.
2) The entity ordinarily recognizes one or both of the following:
-An increased liability for taxes payable or a reduced refund receivable
-A decreased deferred tax asset or increased deferred tax liability
3) A tax position recognized under this guidance may affect the tax bases of assets or liabilities and change (or create) temporary differences.