Test 3

Question 1

What method do companies use for financial reporting (GAAP) of income taxes?

Answer 1

full accrual method (“pretax financial income”)

*income tax expense

Question 2

What method is used for Tax Reporting of income taxes?

Answer 2

modified cash basis (“taxable income”)

*income tax payable

Question 3

What is the difference between Temporary and Permanent Differences?

Answer 3

Temporary = reverse themselves in subsequent accounting periods
-Taxable -> DTL (result in taxable amounts in. future years)
-Deductible -> DTA (results in deductible amounts in future years)

Permanent = do not reverse -> income tax is included in current year income tax (no DTA/DTL)

Question 4

CONC: What are examples of Permanent Differences?

Answer 4

-interest on state and municipal obligations
-premiums made/proceeds received from life insurance by Co. for key officers
-fines from law violation
-% depletion of natural resources

Question 5

What is a Deferred Tax Liability (DTL)?

Answer 5

Fin. Statement Income > Taxable Income

Revenue is deferred for tax purposes, but not fin. reporting purposes
-A/R; % of Completion Contracts; investments accounted under equity method

Expense is deferred for fin. reporting purposes, but not tax purposes
-MACRS; depreciation; prepaid expenses

Question 6

What is a Deferred Tax Asset (DTA)?

Answer 6

Fin. Statement Income < Taxable Income

Revenue is deferred for fin. reporting purposes, but not tax purposes
-Subscriptions received in advance; advance rental receipts; prepaid contacts and royalties received in advance

Expense is deferred for tax purposes, but not fin. reporting purposes
-Product warranty liabilities; litigation accruals; bad debt expense using allowance method

Question 7

What is Deferred Tax Asset Valuation Allowance and what type of account is it?

Answer 7

“More than likely than not” that the company will NOT realize some portion of all of the DTA

+XA (contra assets account to DTA)

*DOES NOT APPLY TO DTL!

Question 8

What is the journal entry for DTA Valuation Allowance?

Answer 8

Dr. Income Tax Expense - Allowance
Cr. DTA Valuation Allowance

Question 9

On the Balance Sheet, what are Deferred Taxes classified as?

Answer 9

as either net noncurrent DTA or DTL

(change with new tax law rules)

Question 10

What are the TWO components for Income Tax Expense on the Income Statement?

Answer 10

CURRENT tax expense = current taxes payable for the period (IRS)

DEFERRED tax expense = changes in DTL/DTA balances from the beginning to the end of the year

Question 11

COMP: What is the formula for:

Income Tax Payable
Income Tax Expense
DTL
DTA

Answer 11

Income Tax Payable = Taxable Income (IRS) x Tax Rate

Income Tax Expense = Pretax Fin. Income (+/- Perm. Diff.) x Tax Rate

DTL = item x tax rate

DTA = item x tax rate

Question 12

As of Jan. 1, 2021:

What is the new rule regarding Net Operating Loss (NOL), specifically loss carry forward?

Answer 12

NO CARRYBACK ALLOWED!

Indefinite years, with an 80% limitation (i.e., can only offset 80% of taxable income in years following a loss…so government still makes money)

Question 13

What is the journal entry for NOL with amounts related to loss carryforward?

Answer 13

Dr. DTA
Cr. Income Tax Benefit

Question 14

CONC: What should a pension account for (3 answers)?

Answer 14

-Measuring the amount of pension obligation
-Disclosing the status and effects of the plan in the financial statements
-Allocating the cost of the plan to the proper periods

Question 15

In a Defined-Contribution Plan such as a 401(k) plan, from whom is the risk borne, who contributes, and who is the beneficiary?

Answer 15

Risk borne by employee

Employee contribution, with employer agreeing to contribute a certain amount each period based on a formula

Employee is beneficiary

Question 16

In a Defined-Benefit Plan, from whom is the risk borne, who contributes, and who is the beneficiary?

Answer 16

Risk borne by employer

Employer contribution varies (determined by actuaries)

Employer is beneficiary

Question 17

What is the important piece of a Defined-Benefit Plan?

Answer 17

must ensure that enough funds will be available at retirement to meet benefits promised!!

Question 18

CONC: What are the THREE different measures of Pension Obligation?

Answer 18

1. Vested Benefit: benefits for vested employees at current salaries
2. Accumulated Benefit: benefits for non-vested employees at current salaries
3. Projected Benefit (PBO): benefits for vested and non-vested employees at future salaries

Question 19

What are the components of Pension Expense?

Answer 19

Service Cost
+Interest on PBO (beg. yr. PBO x settlement rate)
-Return on plan assets (plan assets x expected rate)
+Amortization of prior service costs
+/- Gain/Loss

Question 20

When is a pension underfunded?

Answer 20

PBO > FV of Plan Assets (liability)

Question 21

When is a pension overfunded?

Answer 21

PBO < FV of Plan Assets (asset)

Question 22

What is Prior Service Cost and how is it recorded?

Answer 22

employee service provided in prior years before the plan began

-amortized over a specified period

Records PSC as an adjustment to “Other Comprehensive Income” (OCI), which is a part of SE