Income Taxes

Question 1

Accounting profit

Answer 1

• pretax income
• earnings before tax
• EBT

Question 2

Taxable income

Answer 2

• related to tax law and tax reporting

- portion of income subject to income taxes

Question 3

Income tax payable

Answer 3

• based on tax law and tax reporting
• amount paied to tax authorities
• appears on BS
• minimized by showing higher expenses and lower taxable income

Question 4

Tax base of an asset

ie Asset tax base

Answer 4

• based on tax law and tax reporting

- the amount deductible for tax purposes in future periods as economic benefits are realized

Question 5

Why are accounting profit and taxable income different?

Answer 5

• Accounting profit is based on the accrual method of accounting
• taxable income is based on cash-basis accounting

Question 6

Financial reporting vs. Tax reporting terms

Answer 6

Financial reporting

• accounting profit (EBT)
• income tax expense
• “Carrying amount”

Tax reporting

• taxable income
• income tax payable
• tax base

Question 7

DTL occurs when:

Answer 7

• income tax expense (Financial accounting) > income tax payable (Tax Law)

aka:
- carrying amount > tax base

ie.
straight-line depreciation for accounting profit is used and accelerated depreciation for taxable profit is used

Question 8

What DTLs are liabilities and when they happen:

Answer 8

• its a liability bc less tax is paid now, thus an obligation to pay more in the future
• happens when: revenue is recognized on IS before cash is received, ie accrued/unbilled revenue
• happens when: expenses are tax deductible before recognized on IS, ie SL v Accl dep.

Question 9

DTLs are recorded on the ____

Answer 9

balance sheet

Question 10

DTA occurs when:

Answer 10

• income tax expense (Financial Accounting) < income tax payable (Tax Law)

aka:

• carrying amount < tax base (if recorded as an asset on the BS)
  - ex. research cost expensed for accounting profit, but amortized for taxes
• carrying amount > tax base (if recorded as a liability on the BSO
  - ex. cash received from customers before revenue recognition (unearned revenue), the cash from customers is taxed

Question 11

Why DTAs are assets and when they happen:

Answer 11

• when taxable income is higher than accounting profit
• tax is paid in advance, considered an asset, viewed as a prepaid expense

happens when

• payment is received in advance of service, ie before recognized on IS
• expense is recognized on the IS before being tax deductible

Question 12

DTAs are recorded on the ____

Answer 12

balance sheet

Question 13

DTLs and DTA are classified as ____ under IFRS and ___ under GAAP

Answer 13

• IFRS: non-current

- GAAP: classified based on the classification of the respective asset or liability

Question 14

Accounting Profit is based on ______

Answer 14

accounting principles/standards

Question 15

Tax Payable is based on _______

Answer 15

tax rules/laws

Question 16

Differences between Accounting Profit and Tax Payable come from:

Answer 16

Accounting profit:

• straight-line depreciation
• revenue recognition rules
• matching principle for expenses

Tax Laws: (tax payable)
- accelerated depreciation
- revenue based on cash received
expenses based on cash paid

Question 17

Income Tax Expense (provision) is shown on the ___

ie: the provision for income tax

Answer 17

income statement

Question 18

Income Tax Payable is shown on the ____

Answer 18

balance sheet

Question 19

Income Tax Paid

Answer 19

taxes that are actually paid

Question 20

DTL formula:

Answer 20

DTL = (Carrying amount - Tax base) * Tax rate

CA is based on financial reporting and tax base on tax reporting

Question 21

If the carrying amount is greater than the tax base, there will be a _____ unless reported as a liability on BS.

Answer 21

deferred tax liability, if reported as an asset on BS (SL v Accl dep)

If liability on BS, DTA (unearned revenue)

Question 22

If the carrying amount is less than the tax base, there will be a _____

Answer 22

deferred tax asset

Question 23

Income tax expense (ITE) formula:

Answer 23

ITE = ITP + delta DTL - delta DTA

ITE = income tax payable + change in net DTL

net DTL = DTL - DTA

Question 24

Will most firms have a DTL or a DTA

Answer 24

a DTL bc they recognize revenue

Question 25

Tax base of a liability is:

Answer 25

the carrying amount of the liability - any amounts that will be deductible for tax purposes in the future

if a company receives $50 in advance of delivery of service, a liability called unearned revenue is created on the accounting side, so the carrying amount of the liability is $50.

On the tax side, $50 is shown as revenue and taxes are paid. So tax base is $0 and carrying amount is $50

Question 26

When income tax rates change, deferred tax assets and liabilities are calculated _____

Answer 26

calculated based on the new tax rate

Question 27

The formulas for calculating DTL change (delta) based on changes in tax rate. ie tax rate changes from .4 to .3

Answer 27

DTL (old rate) = (carrying amount - tax base) * tax rate

DTL (new rate) = (carrying amount - tax base) * tax rate

Delta is old rate - new rate

Question 28

What happens to the net DTL after a tax rate decrease?

Answer 28

reduces both DLT and DTA

A lower tax rate will cause the income tax expense to decrease and the net income and equity to increase

Question 29

Income tax expense is on the ____

Answer 29

income statement

Question 30

An increase in the tax rate does what to DTA and DTLs?

Answer 30

increases both DTA and DTL

Question 31

Reported effective tax rate formula

Answer 31

effective tax rate =
income tax expense / pretax income
AKA:
= provision for income tax / EBT

= income tax / taxable income

Question 32

What are temporary differences between taxable and accounting profit?

Answer 32

Temporary differences come from a difference between the tax base (reporting) and the carrying amount (fin statements)

Question 33

Balance sheet item: Asset
Carrying amt vs tax base: carrying amount > tax base

is this a DTA or DTL and give an example

Answer 33

CA > tax base = DTL

example: straight-line depreciation for acct profit v accl depreciation for taxable profit

Question 34

Balance sheet item: Asset
Carrying amt vs tax base: carrying amount < tax base

is this a DTA or DTL and give an example

Answer 34

CA < tax base = DTA

example: research cost expensed for accounting profit v research cost amortized for tax reporting

Question 35

Balance sheet item: Liability
Carrying amt vs tax base: carrying amount > tax base

is this a DTA or DTL and give an example

Answer 35

DTA

example: cash received from customers before revenue recognition (ie unearned revenue). Cash received is taxed now

Question 36

Tax loss carry forward is:

Answer 36

is when a firm experiences losses in the current period that may be used to reduce future taxable income
- tax loss carry forward reduces the taxes paid in the future.

Question 37

A tax credit is

Answer 37

the amount a taxpayer can deduct from the taxes owed

- govts grant tax credits

Question 38

IFRS and GAAP recognition of tax losses and tax creduts

Answer 38

IFRS: recognition of unused tax losses and tax credits only to the extent that it is probable that in the future there will be taxable income against which unused tax losses and credits can be applied

GAAP: a DTA is recognized in full but reduced by a valuation allowance if it is unlikely that the benefit will be realized

Question 39

Measurement and treatments of DTLs:

Answer 39

• classifed as a debt if the liability is expected to reverse in the future when taxes are paid
• if DTL will not be reversed, reduce DTL, and that amount reduction is treated as equity. There is no cash outflow expected in the future
• if there is uncertainty about the timing and amount of tax payments, treat DTL as neither liability or equity

Question 40

Measurement of DTA and Valuation Allowance

If the DTA will not be realized because of insufficient future taxable income then ____

Answer 40

the DTA must be reduced

Question 41

Measurement of DTA and Valuation Allowance

Under GAAP, DTA is reduced by creating a _______ which is a contra account.

Answer 41

DTA is reduced by creating a Valuation Allowance

Question 42

What happens to net income when the valuation allowance rises?

Answer 42

net income goes down if the valuation allowance rises