Kế toán tài chính - Accounting for income taxes

PREVIEW OF CHAPTER 19Intermediate Accounting16th EditionKieso ● Weygandt ● Warfield Understand the fundamentals of accounting for income taxes. Identify additional issues in accounting for income taxes.LEARNING OBJECTIVESExplain the accounting for loss carrybacks and loss carryforwards.Describe the presentation of deferred income taxes in financial statements.After studying this chapter, you should be able to:Accounting for Income Taxes19LO 1Corporations must file income tax returns following the guidelines developed by the Internal Revenue Service (IRS).Because GAAP and tax regulations differ in a number of ways, the amounts reported for the following will differ: income tax expense (GAAP).income tax payable (Internal Revenue Code).ACCOUNTING FOR INCOME TAXESLO 1Tax CodeFinancial StatementsPretax Financial IncomeGAAPIncome Tax ExpenseTaxable IncomeIncome Taxes PayableTax Returnvs.LO 1ACCOUNTING FOR INCOME TAXESIllustration: Chelsea, Inc. reported revenues of $130,000 and expenses of $60,000 in each of its first three years of operations. For tax purposes, Chelsea reported the same expenses to the IRS in each of the years. Chelsea reported taxable revenues of $100,000 in 2017, $150,000 in 2018, and $140,000 in 2019. What is the effect on the accounts of reporting different amounts of revenue for GAAP versus tax?LO 1ACCOUNTING FOR INCOME TAXESRevenuesExpensesPretax financial incomeIncome tax expense (40%)$130,00060,000$70,000$28,000$130,000201860,000$70,000$28,000$130,000201960,000$70,000$28,000$390,000Total180,000$210,000$84,000GAAP ReportingRevenuesExpensesTaxable incomeIncome tax payable (40%)$100,000201760,000$40,000$16,000$150,000201860,000$90,000$36,000$140,000201960,000$80,000$32,000$390,000Total180,000$210,000$84,000Tax Reporting2017ILLUSTRATION 19-2ILLUSTRATION 19-3Book vs. Tax DifferencesLO 1Income tax expense (GAAP)Income tax payable (IRS)DifferenceIncome tax expense (40%)$28,00016,000$12,000$28,000$28,000201836,000$(8,000)$28,000$28,000201932,000$(4,000)$28,000$84,000Total84,000$0$84,000Comparison2017ILLUSTRATION 19-4Are the differences accounted for in the financial statements?YearReporting Requirement201720182019Deferred tax liability account increased to $12,000Deferred tax liability account reduced by $8,000Deferred tax liability account reduced by $4,000YesBook vs. Tax DifferencesLO 1Balance SheetAssets:Liabilities:Equity:Income tax expense 28,000Income StatementRevenues:Expenses:Net income (loss)20172017Deferred taxes 12,000Where does the “deferred tax liability” get reported in the financial statements?Income taxes payable 16,000Financial Reporting for 2017LO 1A temporary difference is the difference between the tax basis of an asset or liability and its reported (carrying or book) amount in the financial statements that will result in taxable amounts or deductible amounts in future years. Future Taxable AmountsFuture Deductible AmountsDeferred Tax Liability represents the increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year.Deferred Tax Asset represents the increase in taxes refundable (or saved) in future years as a result of deductible temporary differences existing at the end of the current year.Illustration 19-29 provides Examples of Temporary DifferencesLO 1Future Taxable and Deductible AmountsIllustration: In Chelsea’s situation, the only difference between the book basis and tax basis of the assets and liabilities relates to accounts receivable that arose from revenue recognized for book purposes. Chelsea reports accounts receivable at $30,000 in the December 31, 2017, GAAP-basis balance sheet. However, the receivables have a zero tax basis.Illustration 19-5Temporary Difference, Sales RevenueLO 1Future Taxable AmountsChelsea assumes that it will collect the accounts receivable and report the $30,000 collection as taxable revenues in future tax returns. Chelsea does this by recording a deferred tax liability.ILLUSTRATION 19-6Illustration: Reversal of Temporary Difference, Chelsea Inc.LO 1Future Taxable AmountsA deferred tax liability represents the increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year.Deferred Tax LiabilityIncome tax expense (GAAP)Income tax payable (IRS)Difference$28,00016,000$12,000$28,000201836,000$(8,000)$28,000201932,000$(4,000)$84,000Total84,000$02017ILLUSTRATION 19-4LO 1Future Taxable AmountsIllustration: Because it is the first year of operations for Chelsea, there is no deferred tax liability at the beginning of the year. Chelsea computes the income tax expense for 2017 as follows:LO 1Deferred Tax LiabilityILLUSTRATION 19-9 Computation of Income Tax Expense, 2017Chelsea makes the following entry at the end of 2017 to record income taxes.Income Tax Expense 28,000 Income Taxes Payable 16,000 Deferred Tax Liability 12,000LO 1Deferred Tax LiabilityIncome tax expense (GAAP)Income tax payable (IRS)Difference$28,00016,000$12,000$28,000201836,000$(8,000)$28,000201932,000$(4,000)$84,000Total84,000$02017ILLUSTRATION 19-4LO 1Deferred Tax LiabilityChelsea makes the following entry at the end of 2018 to record income taxes.Income Tax Expense 28,000Deferred Tax Liability 8,000 Income Taxes Payable 36,000Income tax expense (GAAP)Income tax payable (IRS)Difference$28,00016,000$12,000$28,000201836,000$(8,000)$28,000201932,000$(4,000)$84,000Total84,000$02017ILLUSTRATION 19-4LO 1Deferred Tax LiabilityChelsea makes the following entry at the end of 2019 to record income taxes.Income Tax Expense 28,000Deferred Tax Liability 4,000 Income Taxes Payable 32,000Income tax expense (GAAP)Income tax payable (IRS)Difference$28,00016,000$12,000$28,000201836,000$(8,000)$28,000201932,000$(4,000)$84,000Total84,000$02017ILLUSTRATION 19-4The entry to record income taxes at the end of 2019 reduces the Deferred Tax Liability by $4,000. The Deferred Tax Liability account appears as follows at the end of 2019.ILLUSTRATION 19-12 Deferred Tax Liability Account after ReversalsLO 1Deferred Tax LiabilityLO 1Financial Statement EffectsILLUSTRATION 19-13Balance Sheet Presentation, Deferred Tax LiabilitiesILLUSTRATION 19-14Income Statement Presentation, Income Tax ExpenseLO 1Financial Statement EffectsILLUSTRATION 19-14Income Statement Presentation, Income Tax ExpenseILLUSTRATION 19-15Components of Income Tax ExpenseIllustration: Starfleet Corporation has one temporary difference at the end of 2017 that will reverse and cause taxable amounts of $55,000 in 2018, $60,000 in 2019, and $75,000 in 2020. Starfleet’s pretax financial income for 2017 is $400,000, and the tax rate is 30% for all years. There are no deferred taxes at the beginning of 2017.InstructionsCompute taxable income and income taxes payable for 2017.Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2017.LO 1Deferred Tax Liabilitya.a.LO 1Deferred Tax LiabilitySome analysts dismiss deferred tax liabilities when assessing the financial strength of a company. But the FASB indicates that the deferred tax liability meets the definition of a liability established in Statement of Financial Accounting Concepts No. 6, “Elements of Financial Statements” because: It results from a past transaction. In the Chelsea example, the company performed services for customers and recognized revenue in 2017 for financial reporting purposes but deferred it for tax purposes. It is a present obligation. Taxable income in future periods will exceed pretax financial income as a result of this temporary difference. Thus, a present obligation exists. It represents a future sacrifice. Taxable income and taxes due in future periods will result from past events. The payment of these taxes when they come due is the future sacrifice. A set of studies indicates that deferred taxes do provide incremental information about future tax payments and that the market views deferred tax assets and liabilities similarly to other assets and liabilities.Sources: B. Ayers, “Deferred Tax Accounting Under SFAS No. 109: An Empirical Investigation of Its Incremental Value-Relevance Relative to APB No. 11,” The Accounting Review (April 1998); and R. Laux, “The Association Between Deferred Tax Assets and Liabilities and Future Tax Payments,” The Accounting Review (February 2013).WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? “REAL LIABILITIES”LO 1Illustration: During 2017, Cunningham Inc. estimated its warranty costs related to the sale of microwave ovens to be $500,000, paid evenly over the next two years. For book purposes, in 2017 Cunningham reported warranty expense and a related estimated liability for warranties of $500,000 in its financial statements. For tax purposes, the warranty tax deduction is not allowed until paid. Future Deductible AmountsLO 1ILLUSTRATION 19-16 Temporary Difference, Warranty LiabilityWhen Cunningham pays the warranty liability, it reports an expense (deductible amount) for tax purposes. Cunningham reports this future tax benefit in the December 31, 2017, balance sheet as a deferred tax asset.ILLUSTRATION 19-17Illustration: Reversal of Temporary Difference.Future Deductible AmountsLO 1A deferred tax asset represents the increase in taxes refundable (or saved) in future years as a result of deductible temporary differences existing at the end of the current year.Deferred Tax AssetFuture Deductible AmountsLO 1Illustration: Hunt Company has revenues of $900,000 for both 2017 and 2018. It also has operating expenses of $400,000 for each of these years. In addition, Hunt accrues a loss and related liability of $50,000 for financial reporting purposes because of pending litigation. Hunt cannot deduct this amount for tax purposes until it pays the liability, expected in 2018. As a result, a deductible amount will occur in 2018 when Hunt settles the liability, causing taxable income to be lower than pretax financial information. Illustration 19-18 shows the GAAP and tax reporting over the two years.Deferred Tax AssetLO 1LO 1ILLUSTRATION 19-18 GAAP and Tax Reporting, Hunt CompanyIllustration: Hunt can compute the deferred tax asset by preparing a schedule that indicates the future deductible amounts due to deductible temporary differences.Deferred Tax AssetLO 1ILLUSTRATION 19-20Schedule of Future Deductible AmountsAssume that 2017 is Hunt’s first year of operations, and income tax payable is $200,000, compute income tax expense.ILLUSTRATION 19-21Deferred Tax AssetPrepare the entry at the end of 2017 to record income taxes.Income Tax Expense 180,000Deferred Tax Asset 20,000 Income Taxes Payable 200,000LO 1Computation of Income Tax Expense for 2018.ILLUSTRATION 19-22Deferred Tax AssetPrepare the entry at the end of 2018 to record income taxes.Income Tax Expense 200,000 Deferred Tax Asset 20,000 Income Taxes Payable 180,000LO 1Financial Statement EffectsILLUSTRATION 19-23Balance Sheet Presentation, Deferred Tax AssetILLUSTRATION 19-24Income Statement Presentation, Deferred Tax AssetThe entry to record income taxes at the end of 2018 reduces the Deferred Tax Asset by $20,000. LO 1Financial Statement EffectsILLUSTRATION 19-25Deferred Tax Asset Account after ReversalsIllustration: Columbia Corporation has one temporary difference at the end of 2017 that will reverse and cause deductible amounts of $50,000 in 2018, $65,000 in 2019, and $40,000 in 2020. Columbia’s pretax financial income for 2017 is $200,000 and the tax rate is 34% for all years. There are no deferred taxes at the beginning of 2017. Columbia expects to be profitable in the future. InstructionsCompute taxable income and income taxes payable for 2017.Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2017.Deferred Tax AssetLO 1a.a.Deferred Tax AssetLO 1A key issue in accounting for income taxes is whether a company should recognize a deferred tax asset in the financial records. Based on the conceptual definition of an asset, a deferred tax asset meets the three main conditions for an item to be recognized as an asset: 1. It results from a past transaction. In the Hunt example, the accrual of the loss contingency is the past event that gives rise to a future deductible temporary difference.2. It gives rise to a probable benefit in the future. Taxable income exceeds pretax financial income in the current year (2017). However, in the next year the exact opposite occurs. That is, taxable income is lower than pretax financial income. Because this deductible temporary difference reduces taxes payable in the future, a probable future benefit exists at the end of the current period. 3. The entity controls access to the benefits. Hunt can obtain the benefit of existing deductible temporary differences by reducing itsWHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? “REAL ASSETS”LO 1(continued)taxes payable in the future. Hunt has the exclusive right to that benefit and can control others’ access to it. Market analysts’ reactions to the write-off of deferred tax assets also supports their treatment as assets. When Twitter reported that it was writing off its net U.S deferred assets, analysts believed that Twitter was signaling that it would not realize the future benefits of these tax deductions. Thus, Twitter should write down these assets like other assets.Sources: J. Weil and S. Liesman, “Stock Gurus Disregard Most Big Write-Offs but They Often Hold Vital Clues to Outlook,” Wall Street Journal Online (December 31, 2001); and V. Fleisher, “Why Twitter May Have to Pay Income Taxes One Day,” The New York Times (November 6, 2013).WHAT’S YOUR PRINCIPLEWHAT DO THE NUMBERS MEAN? “REAL ASSETS”LO 1Deferred Tax Asset—Valuation AllowanceA company should reduce a deferred tax asset by a valuation allowance if it is more likely than not that it will not realize some portion or all of the deferred tax asset. “More likely than not” means a level of likelihood of at least slightly more than 50 percent.LO 1ACCOUNTING FOR INCOME TAXESIllustration: Callaway Corp. has a deferred tax asset balance of $150,000 at the end of 2017 due to a single cumulative temporary difference of $375,000. At the end of 2018 this same temporary difference has increased to a cumulative amount of $500,000. Taxable income for 2018 is $850,000. The tax rate is 40% for all years. No valuation account is in existence at the end of 2017.InstructionsAssuming that it is more likely than not that $30,000 of the deferred tax asset will not be realized, prepare the journal entries required for 2018.LO 1Deferred Tax Asset—Valuation AllowanceLO 1Deferred Tax Asset—Valuation AllowanceBalance Sheet PresentationLO 1Deferred Tax Asset—Valuation AllowanceUnderstand the fundamentals of accounting for income taxes. Identify additional issues in accounting for income taxes.LEARNING OBJECTIVESExplain the accounting for loss carrybacks and loss carryforwards.Describe the presentation of deferred income taxes in financial statements.After studying this chapter, you should be able to:Accounting for Income Taxes19LO 2Income Taxes Payable Or RefundableChange In Deferred Income TaxesIncome Tax Expense or Benefit+-=In the income statement or in the notes to the financial statements, a company should disclose the significant components of income tax expense (current and deferred).Formula to Compute Income Tax ExpenseILLUSTRATION 19-27LO 2Income Statement PresentationADDITIONAL CONSIDERATIONSIncome Statement PresentationGiven the previous information related to Chelsea Inc., Chelsea reports its income statement as follows.LO 2ILLUSTRATION 19-28Income Statement Presentation of Income Tax ExpenseTaxable temporary differences - Deferred tax liabilityDeductible temporary differences - Deferred tax AssetTemporary DifferencesLO 2Specific DifferencesACCOUNTING FOR INCOME TAXESLO 2Temporary DifferencesRevenues or gains are taxable after they are recognized in financial income.An asset (e.g., accounts receivable or investment) may be recognized for revenues or gains that will result in taxable amounts in future years when the asset is recovered. Examples:Sales accounted for on the accrual basis for financial reporting purposes and on the installment (cash) basis for tax purposes.Contracts accounted for under the percentage-of-completion method for financial reporting purposes and a portion of related gross profit deferred for tax purposes.Investments accounted for under the equity method for financial reporting purposes and under the cost method for tax purposes.Gain on involuntary conversion of nonmonetary asset which is recognized for financial reporting purposes but deferred for tax purposes.Unrealized holding gains for financial reporting purposes (including use of the fair value option), but deferred for tax purposes.Illustration 19-29Examples of TemporaryDifferencesLO 2Temporary DifferencesExpenses or losses are deductible after they are recognized in financial income.A liability (or contra asset) may be recognized for expenses or losses that will result in deductible amounts in future years when the liability is settled. Examples:Product warranty liabilities.Estimated liabilities related to discontinued operations or restructurings.Litigation accruals.Bad debt expense recognized using the allowance method for financial reporting purposes; direct write-off method used for tax purposes.Stock-based compensation expense.Unrealized holding losses for financial reporting purposes (including use of the fair value option), but deferred for tax purposes.Illustration 19-29Examples of TemporaryDifferencesLO 2Temporary DifferencesRevenues or gains are taxable before they are recognized in financial income.A liability may be recognized for an advance payment for goods or services to be provided in future years. For tax purposes, the advance payment is included in taxable income upon the receipt of cash. Future sacrifices to provide goods or services (or future refunds to those who cancel their orders) that settle the liability will result in deductible amounts in future years. Examples:Subscriptions received in advance.Advance rental receipts.Sales and leasebacks for financial reporting purposes (income deferral) but reported as sales for tax purposes.Prepaid contracts and royalties received in advance.Illustration 19-29Examples of TemporaryDifferencesLO 2Temporary DifferencesExpenses or losses are deductible before they are recognized in financial income.The cost of an asset may have been deducted for tax purposes faster than it was expensed for financial reporting purposes. Amounts received upon future recovery of the amount of the asset for financial reporting (through use or sale) will exceed the remaining tax basis of the asset and thereby result in taxable amounts in future years. Examples:Depreciable property, depletable resources, and intangibles.Deductible pension funding exceeding expense.Prepaid expenses that are deducted on the tax return in the period paid.Illustration 19-29Examples of TemporaryDifferencesLO 2Originating and Reversing Aspects of Temporary Differences.Originating temporary difference is the initial difference between the book basis and the tax basis of an asset or liability. Reversing difference occurs when eliminating a temporary difference that originated in prior periods and then removing the related tax effect from the deferred tax account.Specific DifferencesPermanent differences result from items that (1) enter into pretax financial income but never into taxable income or (2) enter into taxable income but never into pretax financial income.Permanent differences affect only the period in which they occur. They do not give rise to future taxable or deductible amounts. There are no deferred tax consequences to be recognized.LO 2Specific DifferencesLO 2Permanent DifferencesItems are recognized for financial reporting purposes but not for tax purposes.Examples:Interest received on state and municipal obligations.Expenses incurred in obtaining tax-exempt income.Proceeds from life insurance carried by the company on key officers or employees.Premiums paid for life insurance carried by the company on key officers or employees (company is beneficiary).Fines and expenses resulting from a violation of law.ILLUSTRATION 19-31Examples of PermanentDifferencesItems are recognized for tax purposes but not for financial reporting purposes.Examples:“Percentage depletion” of natural resources in excess of their cost.The deduction for dividends received from U.S. corporations, generally 70% or 80%. Do the following generate: Future Deductible Amount = Deferred Tax AssetFuture Taxable Amount = Deferred Tax LiabilityPermanent DifferenceThe MACRS depreciation system is used for tax purposes, and the straight-line depreciation method is used for financial reporting purposes.A landlord collects some rents in advance. Rents received are taxable in the period when they are received.Expenses are incurred in obtaining tax-exempt income.Future Taxable AmountLO 2Specific DifferencesLiabilityFuture Deductible AmountAssetPermanent DifferenceIllustrationDo the following generate: Future Deductible Amount = Deferred Tax AssetFuture Taxable Amount = Deferred Tax LiabilityPermanent DifferenceCosts of guarantees and warranties are estimated and accrued for financial reporting purposes.Installment sales of investments are accounted for by the accrual method for financial reporting purposes and the installment-sales method for tax purposes. Proceeds are received from a life insurance company because of the death of a key officer (the company carries a policy on key officers).Future Deductible AmountLO 2Specific DifferencesAssetFuture Taxable AmountLiabilityPermanent DifferenceIllustrationIllustration: Havaci Company reports pretax financial income of $80,000 for 2017. The following items cause taxable income to be different than pretax financial income.Depreciation on the tax return is greater than depreciation on the income statement by $16,000.Rent collected on the tax return is greater than rent earned on the income statement by $27,000.Fines for pollution appear as an expense of $11,000 on the income statement.Havaci’s tax rate is 30% for all years, and the company expects to report taxable income in all future years. There are no deferred taxes at the beginning of 2017.LO 2Specific DifferencesLO 2Specific DifferencesA company must consider presently enacted changes in the tax rate that become effective for a particular future year(s) when determining the tax rate to apply to existing temporary differences.In determining the appropriate enacted tax rate for a given year, companies must use the average tax rate.Future Tax RatesLO 2Tax Rate ConsiderationsACCOUNTING FOR INCOME TAXESWhen a change in the tax rate is enacted, companies should record its effect on the existing deferred income tax accounts immediately. A company reports the effect as an adjustment to income tax expense in the period of the change.Revision of Future Tax RatesLO 2Tax Rate ConsiderationsACCOUNTING FOR INCOME TAXESUnderstand the fundamentals of accounting for income taxes. Identify additional issues in accounting for income taxes.LEARNING OBJECTIVESExplain the accounting for loss carrybacks and loss carryforwards.Describe the presentation of deferred income taxes in financial statements.After studying this chapter, you should be able to:Accounting for Income Taxes19LO 3Net operating loss (NOL) = tax-deductible expenses exceed taxable revenues.The federal tax laws permit taxpayers to use the losses of one year to offset the profits of other years (loss carryback and loss carryforward). NET OPERATING LOSSESLO 3Loss CarrybackBack 2 years and forward 20 yearsLosses must be applied to earliest year firstLO 3NET OPERATING LOSSESILLUSTRATION 19-36Loss Carryback ProcedureLoss CarryforwardMay elect to forgo loss carryback andCarryforward losses 20 yearsLO 3NET OPERATING LOSSESILLUSTRATION 19-37Loss Carryforward ProcedureIllustration: Conlin Corporation had the following tax information.In 2018 Conlin suffered a net operating loss of $480,000, which it elected to carry back. The 2018 enacted tax rate is 29%. Prepare Conlin’s entry to record the effect of the loss carryback.LO 3NET OPERATING LOSSES$144,000LO 3NET OPERATING LOSSESJournal Entry for 2018Income Tax Refund Receivable 144,000 Benefit Due to Loss Carryback 144,000LO 3NET OPERATING LOSSESIllustration: Rode Inc. incurred a net operating loss of $500,000 in 2017. Combined income for 2015 and 2016 was $350,000. The tax rate for all years is 40%. Rode elects the carryback option. Prepare the journal entries to record the benefits of the loss carryback and the loss carryforward.LO 3NET OPERATING LOSSESLO 3NET OPERATING LOSSESLO 3Journal Entries for 2017Income Tax Refund Receivable 140,000 Benefit Due to Loss Carryback 140,000NET OPERATING LOSSESLO 3Journal Entries for 2017Deferred Tax Asset 60,000 Benefit Due to Loss Carryforward 60,000NET OPERATING LOSSESLO 3Illustration: Rode Inc. incurred a net operating loss of $500,000 in 2017. Combined income for 2015 and 2016 was $350,000. The tax rate for all years is 40%. Rode elects the carryback option. Assume that it is more likely than not that the entire net operating loss carryforward will not be realized in future years. Prepare all the journal entries necessary at the end of 2017.NET OPERATING LOSSESJournal Entries for 2017LO 3Income Tax Refund Receivable 140,000 Benefit Due to Loss Carryback 140,000Deferred Tax Asset 60,000 Benefit Due to Loss Carryforward 60,000Benefit Due to Loss Carryforward 60,000 Allowance for Deferred Tax Asset 60,000NET OPERATING LOSSESWhether the company will realize a deferred tax asset depends on whether sufficient taxable income exists or will exist within the carryforward period.LO 3Valuation Allowance RevisitedIllustration 19-44Possible Sources ofTaxable IncomeNET OPERATING LOSSESLO 3Valuation Allowance RevisitedIllustration 19-45Evidence to Consider in Evaluating the Need for a Valuation AccountUnderstand the fundamentals of accounting for income taxes. Identify additional issues in accounting for income taxes.LEARNING OBJECTIVESExplain the accounting for loss carrybacks and loss carryforwards.Describe the presentation of deferred income taxes in financial statements.After studying this chapter, you should be able to:Accounting for Income Taxes19LO 4Balance SheetFINANCIAL STATEMENT PRESENTATIONIncome taxes payable and income tax refund receivable are reported as a current liability and current asset, respectively, on the balance sheet. Companies should classify deferred tax accounts as a net noncurrent amount on the balance sheet. LO 4Balance SheetLO 4To illustrate, assume that Scott Company has four deferred tax items at December 31, 2017, as shown in the following table.Income StatementCompanies are required to report income before income taxes and income tax expense on the income statement. PepsiCo reported the following amounts related to tax expense.LO 4FINANCIAL STATEMENT PRESENTATIONIllustration 19-47Tax Expense Disclosures The FASB believes that the asset-liability method (sometimes referred to as the liability approach) is the most consistent method for accounting for income taxes.LO 4The Asset-Liability MethodILLUSTRATION 19-52Basic Principles of theAsset-Liability MethodLO 4ILLUSTRATION 19-53Procedures for Computingand Reporting DeferredIncome TaxesFiscal Year-2016Allman Company, which began operations at the beginning of 2016, produces various products on a contract basis. Each contract generates a gross profit of $80,000. Some of Allman’s contracts provide for the customer to pay on an installment basis. Under these contracts, Allman collects one-fifth of the contract revenue in each of the following four years. For financial reporting purposes, the company recognizes gross profit in the year of completion (accrual basis); for tax purposes, Allman recognizes gross profit in the year cash is collected (installment basis). LO 5 Understand and apply the concepts and procedures of interperiod tax allocation.COMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONAPPENDIX 19AFiscal Year-2016Presented below is information related to Allman’s operations for 2016.In 2016, the company completed seven contracts that allow for the customer to pay on an installment basis. Allman recognized the related gross profit of $560,000 for financial reporting purposes. It reported only $112,000 of gross profit on installment sales on the 2016 tax return. The company expects future collections on the related installment receivables to result in taxable amounts of $112,000 in each of the next four years.At the beginning of 2016, Allman Company purchased depreciable assets with a cost of $540,000. For financial reporting purposes, Allman depreciates these assets using the straight-line method over a six-year service life. For tax purposes, the assets fall in the five-year recovery class, and Allman uses the MACRS system. LO 5COMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONAPPENDIX 19AFiscal Year-2016LO 5The company warrants its product for two years from the date of completion of a contract. During 2016, the product warranty liability accrued for financial reporting purposes was $200,000, and the amount paid for the satisfaction of warranty liability was $44,000. Allman expects to settle the remaining $156,000 by expenditures of $56,000 in 2017 and $100,000 in 2018.COMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONAPPENDIX 19AFiscal Year-2016LO 5In 2016 nontaxable municipal bond interest revenue was $28,000.During 2016 nondeductible fines and penalties of $26,000 were paid.Pretax financial income for 2016 amounts to $412,000.Tax rates enacted before the end of 2016 were:2016 50%2017 and later years 40%The accounting period is the calendar year.The company is expected to have taxable income in all future years.COMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONAPPENDIX 19ATaxable Income and Income Taxes Payable-2016LO 5The first step is to determine Allman Company’s income tax payable for 2016 by calculating its taxable income.ILLUSTRATION 19A-1COMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONAPPENDIX 19AILLUSTRATION 19A-2Computing Deferred Income Taxes – End of 2016LO 5ILLUSTRATION 19A-3ILLUSTRATION 19A-4COMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONAPPENDIX 19ADeferred Tax Expense (Benefit) and the Journal Entry to Record Income Taxes - 2016LO 5ILLUSTRATION 19A-5Computation of Deferred Tax Expense (Benefit), 2016Computation of Net Deferred Tax Expense, 2016ILLUSTRATION 19A-6COMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONAPPENDIX 19ADeferred Tax Expense (Benefit) and the Journal Entry to Record Income Taxes - 2016LO 5ILLUSTRATION 19A-7Computation of Total Income Tax Expense, 2016Journal Entry for Income Tax Expense, 2016Income Tax Expense 174,000Deferred Tax Asset 62,400 Income Taxes Payable 50,000 Deferred Tax Liability 186,400COMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONAPPENDIX 19ACompanies should classify deferred tax assets and liabilities as current and noncurrent on the balance sheet based on the classifications of related assets and liabilities.Financial Statement Presentation - 2016LO 5ILLUSTRATION 19A-8Classification of Deferred Tax Accounts, End of 2016COMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONAPPENDIX 19ABalance Sheet Presentation of Deferred Taxes, 2016Financial Statement Presentation - 2016LO 5ILLUSTRATION 19A-9COMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONIncome statement for 2016 reports the following.ILLUSTRATION 19A-10APPENDIX 19ALO 6 Compare the accounting for income taxes under GAAP and IFRS.RELEVANT FACTS - SimilaritiesSimilar to GAAP, IFRS uses the asset and liability approach for recording deferred taxes.The classification of deferred taxes under both IFRS and GAAP is always non-current. RELEVANT FACTS - DifferencesUnder IFRS, an affirmative judgment approach is used, by which a deferred tax asset is recognized up to the amount that is probable to be realized. GAAP uses an impairment approach. In this approach, the deferred tax asset is recognized in full. It is then reduced by a valuation account if it is more likely than not that all or a portion of the deferred tax asset will not be realized.IFRS uses the enacted tax rate or substantially enacted tax rate. (“Substantially enacted” means virtually certain.) For GAAP, the enacted tax rate must be used.The tax effects related to certain items are reported in equity under IFRS. That is not the case under GAAP, which charges or credits the tax effects to income. LO 6RELEVANT FACTS - Differences GAAP requires companies to assess the likelihood of uncertain tax positions being sustainable upon audit. Potential liabilities must be accrued and disclosed if the position is “more likely than not” to be disallowed. Under IFRS, all potential liabilities must be recognized. With respect to measurement, IFRS uses an expected-value approach to measure the tax liability, which differs from GAAP.LO 6ON THE HORIZONThe IASB and the FASB have worked to address some of the differences in the accounting for income taxes. Some of the issues under discussion are the term “probable” under IFRS for recognition of a deferred tax asset, which might be interpreted to mean “more likely than not.” If the term is changed, the reporting for impairments of deferred tax assets will be essentially the same between GAAP and IFRS. In addition, the FASB recently adopted the IFRS classification approach for deferred tax assets and liabilities. Also, GAAP will likely continue to use the enacted tax rate in computing deferred taxes, except in situations where the taxing jurisdiction is not involved. In that case, companies should use IFRS, which is based on enacted rates or substantially enacted tax rates. Finally, the issue of allocation of deferred income taxes to equity for certain transactions under IFRS must be addressed in order to converge with GAAP, which allocates the effects to income. At the time of this printing, deliberations on the income tax project have been suspended indefinitely.LO 6Which of the following is false?Under GAAP, deferred taxes are reported based on the classification of the asset or liability to which it relates.Under IFRS, some potential liabilities are not recognized.Under GAAP, the enacted tax rate is used to measure deferred tax assets and liabilities.Under IFRS, all deferred tax assets and liabilities are classified as non-current.IFRS SELF-TEST QUESTIONLO 6Which of the following statements is correct with regard to IFRS and GAAP?Under GAAP, all potential liabilities related to uncertain tax positions must be recognized.The tax effects related to certain items are reported in equity under GAAP; under IFRS, the tax effects are charged or credited to income. IFRS uses an affirmative judgment approach for deferred tax assets, whereas GAAP uses an impairment approach for deferred tax assets.IFRS classifies deferred taxes based on the classification of the asset or liability to which it relates.IFRS SELF-TEST QUESTIONLO 6Under IFRS:“probable” is defined as a level of likelihood of at least slightly more than 60%.a company should reduce a deferred tax asset when it is likely that some or all of it will not be realized by using a valuation allowance.a company considers only positive evidence when determining whether to recognize a deferred tax asset.deferred tax assets must be evaluated at the end of each accounting period.IFRS SELF-TEST QUESTIONLO 6“Copyright © 2016 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. 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