Kế toán, kiểm toán - Accounting for income taxes

PREVIEW OF CHAPTERIntermediate AccountingIFRS 2nd EditionKieso, Weygandt, and Warfield 19Describe various temporary and permanent differences.Explain the effect of various tax rates and tax rate changes on deferred income taxes.Apply accounting procedures for a loss carryback and a loss carryforward.Describe the presentation of income taxes in financial statements.Indicate the basic principles of the asset-liability method.After studying this chapter, you should be able to:Accounting for Income Taxes19LEARNING OBJECTIVESIdentify differences between pretax financial income and taxable income.Describe a temporary difference that results in future taxable amounts.Describe a temporary difference that results in future deductible amounts.Explain the non-recognition of a deferred tax asset.Describe the presentation of income tax expense in the income statement.Corporations must file income tax returns following the guidelines developed by the appropriate tax authority.Because IFRS and tax regulations differ in a number of ways, frequently the amounts reported for the following will differ: Income tax expense (IFRS)Income taxes payable (Tax Authority)LO 1ACCOUNTING FOR INCOME TAXESTax CodeFinancial StatementsPretax Financial IncomeIFRSIncome 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 2015, $150,000 in 2016, and $140,000 in 2017. What is the effect on the accounts of reporting different amounts of revenue for IFRS versus tax?LO 1ACCOUNTING FOR INCOME TAXESRevenuesExpensesPretax financial incomeIncome tax expense (40%)$130,00060,000$70,000$28,000$130,000201660,000$70,000$28,000$130,000201760,000$70,000$28,000$390,000Total180,000$210,000$84,000IFRS ReportingRevenuesExpensesTaxable incomeIncome taxes payable (40%)$100,000201560,000$40,000$16,000$150,000201660,000$90,000$36,000$140,000201760,000$80,000$32,000$390,000Total180,000$210,000$84,000Tax Reporting2015ILLUSTRATION 19-3Book vs. Tax DifferencesLO 1ILLUSTRATION 19-2Financial ReportingIncomeIncome tax expense (IFRS)Income tax payable (TA)DifferenceIncome tax expense (40%)$28,00016,000$12,000$28,000$28,000201636,000$(8,000)$28,000$28,000201732,000$(4,000)$28,000$84,000Total84,000$0$84,000Comparison2015Are the differences accounted for in the financial statements?YearReporting Requirement201520162017Deferred tax liability account increased to $12,000Deferred tax liability account reduced by $8,000Deferred tax liability account reduced by $4,000YesBook vs. Tax DifferencesLO 1ILLUSTRATION 19-4Comparison of IncomeTax Expense to IncomeTaxes PayableStatement of Financial PositionAssets:Liabilities:Equity:Income tax expense 28,000Income StatementRevenues:Expenses:Net income (loss)20152015Deferred taxes 12,000Where does the “deferred tax liability” get reported in the financial statements?Income taxes payable 16,000Financial Reporting for 2015LO 1Describe various temporary and permanent differences.Explain the effect of various tax rates and tax rate changes on deferred income taxes.Apply accounting procedures for a loss carryback and a loss carryforward.Describe the presentation of income taxes in financial statements.Indicate the basic principles of the asset-liability method.After studying this chapter, you should be able to:Accounting for Income Taxes19LEARNING OBJECTIVESIdentify differences between pretax financial income and taxable income.Describe a temporary difference that results in future taxable amounts.Describe a temporary difference that results in future deductible amounts.Explain the non-recognition of a deferred tax asset.Describe the presentation of income tax expense in the income statement.A 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 19-22 provides Examples of Temporary DifferencesLO 2Future 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, 2015, IFRS-basis statement of financial position. However, the receivables have a zero tax basis.LO 2Future Taxable AmountsILLUSTRATION 19-5Temporary Difference,Accounts ReceivableChelsea 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: Reversal of Temporary Difference, Chelsea Inc.LO 2Future Taxable AmountsILLUSTRATION 19-6A 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 LiabilityLO 2Future Taxable AmountsIncome tax expense (IFRS)Income tax payable (IRS)DifferenceIncome tax expense (40%)$28,00016,000$12,000$28,000$28,000201636,000$(8,000)$28,000$28,000201732,000$(4,000)$28,000$84,000Total84,000$0$84,0002015ILLUSTRATION 19-4Comparison of Income Tax Expense to Income Taxes PayableIllustration: 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 2015 as follows:LO 2Deferred Tax LiabilityILLUSTRATION 19-9Computation of IncomeTax Expense, 2015Chelsea makes the following entry at the end of 2015 to record income taxes.Income Tax Expense 28,000 Income Taxes Payable 16,000 Deferred Tax Liability 12,000LO 2Deferred Tax LiabilityIncome tax expense (IFRS)Income tax payable (IRS)DifferenceIncome tax expense (40%)$28,00016,000$12,000$28,000$28,000201636,000$(8,000)$28,000$28,000201732,000$(4,000)$28,000$84,000Total84,000$0$84,0002015ILLUSTRATION 19-4Comparison of Income Tax Expense to Income Taxes PayableChelsea makes the following entry at the end of 2016 to record income taxes.Income Tax Expense 28,000Deferred Tax Liability 8,000 Income Taxes Payable 36,000LO 2Deferred Tax LiabilityIncome tax expense (IFRS)Income tax payable (IRS)DifferenceIncome tax expense (40%)$28,00016,000$12,000$28,000$28,000201636,000$(8,000)$28,000$28,000201732,000$(4,000)$28,000$84,000Total84,000$0$84,0002015ILLUSTRATION 19-4Comparison of Income Tax Expense to Income Taxes PayableThe entry to record income taxes at the end of 2017 reduces the Deferred Tax Liability by $4,000. The Deferred Tax Liability account appears as follows at the end of 2017 .LO 2Deferred Tax LiabilityILLUSTRATION 19-11Deferred Tax LiabilityAccount after ReversalsIllustration: Starfleet Corporation has one temporary difference at the end of 2014 that will reverse and cause taxable amounts of $55,000 in 2015, $60,000 in 2016, and $75,000 in 2017. Starfleet’s pretax financial income for 2014 is $400,000, and the tax rate is 30% for all years. There are no deferred taxes at the beginning of 2014.InstructionsCompute taxable income and income taxes payable for 2014.Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2014.LO 2Deferred Tax Liabilitya.a.LO 2Deferred Tax LiabilityLO 2Describe various temporary and permanent differences.Explain the effect of various tax rates and tax rate changes on deferred income taxes.Apply accounting procedures for a loss carryback and a loss carryforward.Describe the presentation of income taxes in financial statements.Indicate the basic principles of the asset-liability method.After studying this chapter, you should be able to:Accounting for Income Taxes19LEARNING OBJECTIVESIdentify differences between pretax financial income and taxable income.Describe a temporary difference that results in future taxable amounts.Describe a temporary difference that results in future deductible amounts.Explain the non-recognition of a deferred tax asset.Describe the presentation of income tax expense in the income statement.Illustration: During 2015, 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 2015 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 3ILLUSTRATION 19-12Temporary 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, 2015, statement of financial position as a deferred tax asset.Illustration: Reversal of Temporary Difference.Future Deductible AmountsLO 3ILLUSTRATION 19-13A 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 3Illustration: Hunt Co. accrues a loss and a related liability of $50,000 in 2015 for financial reporting purposes because of pending litigation. Hunt cannot deduct this amount for tax purposes until the period it pays the liability, expected in 2016. Deferred Tax AssetLO 3ILLUSTRATION 19-14Computation of DeferredTax Asset, End of 2015LO 3Assume that 2015 is Hunt’s first year of operations, and income tax payable is $100,000, compute income tax expense.Deferred Tax AssetPrepare the entry at the end of 2015 to record income taxes.Income Tax Expense 80,000Deferred Tax Asset 20,000 Income Taxes Payable 100,000ILLUSTRATION 19-16Computation of IncomeTax Expense, 2015Computation of Income Tax Expense for 2016.Deferred Tax AssetPrepare the entry at the end of 2016 to record income taxes.Income Tax Expense 160,000 Deferred Tax Asset 20,000 Income Taxes Payable 140,000LO 3ILLUSTRATION 19-17Computation of IncomeTax Expense, 2016The entry to record income taxes at the end of 2016 reduces the Deferred Tax Asset by $20,000. Deferred Tax AssetLO 3ILLUSTRATION 19-18Deferred Tax AssetAccount after ReversalsIllustration: Columbia Corporation has one temporary difference at the end of 2014 that will reverse and cause deductible amounts of $50,000 in 2015, $65,000 in 2016, and $40,000 in 2017. Columbia’s pretax financial income for 2014 is $200,000 and the tax rate is 34% for all years. There are no deferred taxes at the beginning of 2014. Columbia expects to be profitable in the future. InstructionsCompute taxable income and income taxes payable for 2014.Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2014.Deferred Tax AssetLO 3a.a.Deferred Tax AssetLO 3LO 3Describe various temporary and permanent differences.Explain the effect of various tax rates and tax rate changes on deferred income taxes.Apply accounting procedures for a loss carryback and a loss carryforward.Describe the presentation of income taxes in financial statements.Indicate the basic principles of the asset-liability method.After studying this chapter, you should be able to:Accounting for Income Taxes19LEARNING OBJECTIVESIdentify differences between pretax financial income and taxable income.Describe a temporary difference that results in future taxable amounts.Describe a temporary difference that results in future deductible amounts.Explain the non-recognition of a deferred tax asset.Describe the presentation of income tax expense in the income statement.Deferred Tax Asset (Non-Recognition)A company should reduce a deferred tax asset if it is probable that it will not realize some portion or all of the deferred tax asset. “Probable” means a level of likelihood of at least slightly more than 50 percent.LO 4ACCOUNTING FOR INCOME TAXESIllustration: Callaway Corp. has a deferred tax asset account with a balance of €150,000 at the end of 2014 due to a single cumulative temporary difference of €375,000. At the end of 2015, this same temporary difference has increased to a cumulative amount of €500,000. Taxable income for 2015 is €850,000. The tax rate is 40% for all years.Instructions:Assuming that it is probable that €30,000 of the deferred tax asset will not be realized, prepare the journal entry at the end of 2015 to recognize this probability.LO 4Deferred Tax Asset (Non-Recognition)LO 4Deferred Tax Asset (Non-Recognition)Describe various temporary and permanent differences.Explain the effect of various tax rates and tax rate changes on deferred income taxes.Apply accounting procedures for a loss carryback and a loss carryforward.Describe the presentation of income taxes in financial statements.Indicate the basic principles of the asset-liability method.After studying this chapter, you should be able to:Accounting for Income Taxes19LEARNING OBJECTIVESIdentify differences between pretax financial income and taxable income.Describe a temporary difference that results in future taxable amounts.Describe a temporary difference that results in future deductible amounts.Explain the non-recognition of a deferred tax asset.Describe the presentation of income tax expense in the income statement.Income Taxes Payable Or RefundableChange In Deferred Income TaxesTotal Income 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 attributable to continuing operations.Formula to Compute Income Tax ExpenseLO 5Income Statement PresentationACCOUNTING FOR INCOME TAXESILLUSTRATION 19-20Formula to ComputeIncome Tax ExpenseIncome Statement PresentationGiven the previous information related to Chelsea Inc., Chelsea reports its income statement as follows.ILLUSTRATION 19-21LO 5Describe various temporary and permanent differences.Explain the effect of various tax rates and tax rate changes on deferred income taxes.Apply accounting procedures for a loss carryback and a loss carryforward.Describe the presentation of income taxes in financial statements.Indicate the basic principles of the asset-liability method.After studying this chapter, you should be able to:Accounting for Income Taxes19LEARNING OBJECTIVESIdentify differences between pretax financial income and taxable income.Describe a temporary difference that results in future taxable amounts.Describe a temporary difference that results in future deductible amounts.Explain the non-recognition of a deferred tax asset.Describe the presentation of income tax expense in the income statement.Taxable temporary differences - Deferred tax liabilityDeductible temporary differences - Deferred tax AssetTemporary DifferencesLO 6Specific DifferencesACCOUNTING FOR INCOME TAXESLO 6Temporary 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 the cost-recovery method (zero-profit method) 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 non-monetary 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 19-22Examples of TemporaryDifferencesLO 6Temporary 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.Share-based compensation expense.Unrealized holding losses for financial reporting purposes (including use of the fair value option), but deferred for tax purposes.ILLUSTRATION 19-22Examples of TemporaryDifferencesLO 6Temporary 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 19-22Examples of TemporaryDifferencesLO 6Temporary 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.Development costs that are deducted on the tax return in the period paid.ILLUSTRATION 19-22Examples of TemporaryDifferencesLO 6Originating 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 6Specific DifferencesLO 6Permanent DifferencesItems are recognized for financial reporting purposes but not for tax purposes.Examples:Interest received on certain types of government obligations.Expenses incurred in obtaining tax-exempt income.Fines and expenses resulting from a violation of law.Charitable donations recognized as expense but sometimes not deductible for tax purposes.ILLUSTRATION 19-24Examples 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 other corporations, sometimes considered tax-exempt.Do the following generate: Future Deductible Amount = Deferred Tax AssetFuture Taxable Amount = Deferred Tax LiabilityPermanent DifferenceAn accelerated 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 6Specific 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 method for tax purposes. Interest is received on an investment in tax-exempt governmental obligations.Future Deductible AmountLO 6Specific DifferencesAssetFuture Taxable AmountLiabilityPermanent DifferenceIllustrationE19-4: Havaci Company reports pretax financial income of €80,000 for 2015. 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 2015.LO 6Specific DifferencesLO 6Specific DifferencesDescribe various temporary and permanent differences.Explain the effect of various tax rates and tax rate changes on deferred income taxes.Apply accounting procedures for a loss carryback and a loss carryforward.Describe the presentation of income taxes in financial statements.Indicate the basic principles of the asset-liability method.After studying this chapter, you should be able to:Accounting for Income Taxes19LEARNING OBJECTIVESIdentify differences between pretax financial income and taxable income.Describe a temporary difference that results in future taxable amounts.Describe a temporary difference that results in future deductible amounts.Explain the non-recognition of a deferred tax asset.Describe the presentation of income tax expense in the income statement.A 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.Future Tax RatesLO 7Tax 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 7Tax Rate ConsiderationsDescribe various temporary and permanent differences.Explain the effect of various tax rates and tax rate changes on deferred income taxes.Apply accounting procedures for a loss carryback and a loss carryforward.Describe the presentation of income taxes in financial statements.Indicate the basic principles of the asset-liability method.After studying this chapter, you should be able to:Accounting for Income Taxes19LEARNING OBJECTIVESIdentify differences between pretax financial income and taxable income.Describe a temporary difference that results in future taxable amounts.Describe a temporary difference that results in future deductible amounts.Explain the non-recognition of a deferred tax asset.Describe the presentation of income tax expense in the income statement.Net operating loss (NOL) = tax-deductible expenses exceed taxable revenues.Tax laws permit taxpayers to use the losses of one year to offset the profits of other years (loss carryback and loss carryforward). ACCOUNTING FOR NET OPERATING LOSSESLO 8Loss CarrybackBack 2 years and forward 20 yearsLosses must be applied to earliest year firstLO 8NET OPERATING LOSSESILLUSTRATION 19-29Loss Carryback ProcedureLoss CarryforwardMay elect to forgo loss carryback andCarryforward losses 20 yearsLO 8NET OPERATING LOSSESILLUSTRATION 19-30Loss Carryforward ProcedureIllustration: Groh Inc. has no temporary or permanent differences. Groh experiences the following.LO 8Loss Carryback Example$110,000LO 8Loss Carryback ExampleLO 8Loss Carryback ExampleJournal Entry for 2015:Income Tax Refund Receivable 110,000 Benefit Due to Loss Carryback (Income Tax Expense) 110,000Illustration: Groh Inc. reports the account credited on the income statement for 2014 as shown.LO 8Loss Carryback ExampleILLUSTRATION 19-31Recognition of Benefit of the Loss Carryback in the Loss YearLO 8In addition to recording the 110,000 Benefit Due to Loss Carryback, Groh Inc. records the tax effect of the $200,000 loss carryforward as a deferred tax asset of $80,000 assuming that the enacted future tax rate is 40 percent. The entry is made as follows:Loss Carryforward ExampleLO 8Entry to recognize the benefit of the loss carryforward:Carryforward (Recognition)Deferred Tax Asset 80,000 Benefit Due to Loss Carryforward 80,000The two accounts credited are contra income tax expense items, which Groh presents on the 2014 income statement shown.LO 8ILLUSTRATION 19-32Recognition of the Benefit of the Loss Carryback and Carryforward in the Loss YearCarryforward (Recognition)For 2015, assume that Groh returns to profitable operations and has taxable income of $250,000 (prior to adjustment for the NOL carryforward), subject to a 40 percent tax rate.LO 8Carryforward (Recognition)Groh records income taxes in 2015 as follows:LO 8Income Tax Expense 100,000 Deferred Tax Asset 80,000 Income Taxes Payable 20,000Carryforward (Recognition)The 2015 income statement does not report the tax effects of either the loss carryback or the loss carryforward because Groh had reported both previously.LO 8ILLUSTRATION 19-34Presentation of the Benefit of Loss Carryforward Realized in 2015, Recognized in 2014Carryforward (Recognition)Assume that Groh will not realize the entire NOL carryforward in future years. In this situation, Groh does not recognize a deferred tax asset for the loss carryforward because it is probable that it will not realize the carryforward. Groh makes the following journal entry in 2014.LO 8Carryforward (Non-Recognition)Income Tax Refund Receivable 110,000 Benefit Due to Loss Carryback (Income Tax Expense) 110,000Groh’s 2014 income statement presentation is as follows:LO 8ILLUSTRATION 19-35Recognition of Benefit of Loss Carryback OnlyCarryforward (Non-Recognition)In 2015, assuming that Groh has taxable income of $250,000 (before considering the carryforward), subject to a tax rate of 40 percent, it realizes the deferred tax asset. Groh records the following entries.LO 8Deferred Tax Asset 80,000 Benefit Due to Loss Carryforward 80,000Income Tax Expense 100,000 Deferred Tax Asset 80,000 Income Taxes Payable 20,000Carryforward (Non-Recognition)Assuming that Groh derives the income for 2015 from continuing operations, it prepares the income statement as shown.LO 8ILLUSTRATION 19-36Recognition of Benefit of Loss Carryforward When RealizedCarryforward (Non-Recognition)Whether the company will realize a deferred tax asset depends on whether sufficient taxable income exists or will exist within the carryforward period available under tax law.LO 8ILLUSTRATION 19-37Possible Sources of Taxable IncomeNon-Recognition RevisitedDescribe various temporary and permanent differences.Explain the effect of various tax rates and tax rate changes on deferred income taxes.Apply accounting procedures for a loss carryback and a loss carryforward.Describe the presentation of income taxes in financial statements.Indicate the basic principles of the asset-liability method.After studying this chapter, you should be able to:Accounting for Income Taxes19LEARNING OBJECTIVESIdentify differences between pretax financial income and taxable income.Describe a temporary difference that results in future taxable amounts.Describe a temporary difference that results in future deductible amounts.Explain the non-recognition of a deferred tax asset.Describe the presentation of income tax expense in the income statement.Statement of Financial PositionFINANCIAL STATEMENT PRESENTATIONDeferred tax assets and deferred tax liabilities are also separately recognized and measured but may be offset in the statement of financial position. The net deferred tax asset or net deferred tax liability is reported in the non-current section of the statement of financial position.LO 9Statement of Financial PositionLO 9ILLUSTRATION 19-38Classification of Temporary DifferencesIncome StatementCompanies allocate income tax expense (or benefit) to continuing operations, discontinued operations, other comprehensive income, and prior period adjustments. FINANCIAL STATEMENT PRESENTATIONLO 9Components of income tax expense (benefit) may include:Current tax expense (benefit).Any adjustments recognized in the period for current tax of prior periods.Amount of deferred tax expense (benefit) relating to the origination and reversal of temporary differences.Amount of deferred tax expense (benefit) relating to changes in tax rates or the imposition of new taxes.Amount of the benefit arising from a previously unrecognized tax loss, tax credit, or temporary difference of a prior period that is used to reduce current and deferred tax expense.LO 9Income StatementLO 9Tax ReconciliationCompanies either provide:A numerical reconciliation between tax expense (benefit) and the product of accounting profit multiplied by the applicable tax rate(s), disclosing also the basis on which the applicable tax rate(s) is (are) computed; orA numerical reconciliation between the average effective tax rate and the applicable tax rate, disclosing also the basis on which the applicable tax rate is computed.FINANCIAL STATEMENT PRESENTATIONLO 9Describe various temporary and permanent differences.Explain the effect of various tax rates and tax rate changes on deferred income taxes.Apply accounting procedures for a loss carryback and a loss carryforward.Describe the presentation of income taxes in financial statements.Indicate the basic principles of the asset-liability method.After studying this chapter, you should be able to:Accounting for Income Taxes19LEARNING OBJECTIVESIdentify differences between pretax financial income and taxable income.Describe a temporary difference that results in future taxable amounts.Describe a temporary difference that results in future deductible amounts.Explain the non-recognition of a deferred tax asset.Describe the presentation of income tax expense in the income statement.REVIEW OF THE ASSET-LIABILITY METHODCompanies apply the following basic principles: ILLUSTRATION 19-43Basic Principles of theAsset-Liability MethodLO 10ASSET-LIABILITY METHODILLUSTRATION 19-44Procedures for Computingand Reporting DeferredIncome TaxesINCOME TAXESSimilar to IFRS, U.S. GAAP uses the asset and liability approach for recording deferred taxes. The differences between IFRS and U.S. GAAP involve a few exceptions to the asset-liability approach; some minor differences in the recognition, measurement, and disclosure criteria; and differences in implementation guidance.GLOBAL ACCOUNTING INSIGHTSRelevant FactsFollowing are the key similarities and differences between U.S. GAAP and IFRS related to accounting for taxes.SimilaritiesAs indicated above, U.S. GAAP and IFRS both use the asset and liability approach for recording deferred taxes.DifferencesUnder U.S. GAAP, deferred tax assets and liabilities are classified based on the classification of the asset or liability to which it relates (see discussion in About the Numbers below). The classification of deferred taxes under IFRS is always non-current.GLOBAL ACCOUNTING INSIGHTSRelevant FactsDifferencesU.S. GAAP uses an impairment approach to assess the need for a valuation allowance. 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. Under 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. Under U.S. GAAP, the enacted tax rate must be used in measuring deferred tax assets and liabilities. IFRS uses the enacted tax rate or substantially enacted tax rate (“substantially enacted” means virtually certain).GLOBAL ACCOUNTING INSIGHTSRelevant FactsDifferencesUnder U.S. GAAP, charges or credits for all tax items are recorded in income. That is not the case under IFRS, in which the charges or credits related to certain items are reported in equity. U.S. 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 U.S. GAAP.GLOBAL ACCOUNTING INSIGHTSOn the HorizonThe IASB and the FASB have been working to address some of the differences in the accounting for income taxes. One of the issues under discussion is 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 U.S. GAAP and IFRS. In addition, the IASB is considering adoption of the classification approach used in U.S. GAAP for deferred assets and liabilities. Also, U.S. GAAP will likely continue to use the enacted tax rate in computing deferred taxes, except in situations where the U.S. 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 U.S. GAAP, which allocates the effects to income. GLOBAL ACCOUNTING INSIGHTSAPPENDIX 19ACOMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONFiscal Year-2014Akai Company, which began operations at the beginning of 2014, produces various products on a contract basis. Each contract generates an income of ¥80,000 (amounts in thousands). Some of Akai’s contracts provide for the customer to pay on an installment basis. Under these contracts, Akai collects one-fifth of the contract revenue in each of the following four years. For financial reporting purposes, the company recognizes income in the year of completion (accrual basis); for tax purposes, Akai recognizes income in the year cash is collected (installment basis).LO 11 Understand and apply the concepts and procedures of interperiod tax allocation.Fiscal Year-2014Presented below is information related to Akai’s operations for 2014.In 2014, the company completed seven contracts that allow for the customer to pay on an installment basis. Akai recognized the related income of ¥560,000 for financial reporting purposes. It reported only ¥112,000 of income on installment sales on the 2014 tax return. The company expects future collections on the related receivables to result in taxable amounts of ¥112,000 in each of the next four years.LO 11APPENDIX 19ACOMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONPresented below is information related to Akai’s operations for 2014.At the beginning of 2014, Akai purchased depreciable assets with a cost of ¥540,000. For financial reporting purposes, Akai depreciates these assets using the straight-line method over a six-year service life. The depreciation schedules for both financial reporting and tax purposes are shown as follows.LO 11APPENDIX 19ACOMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONPresented below is information related to Akai’s operations for 2014.The company warrants its product for two years from the date of completion of a contract. During 2014, 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. Akai expects to settle the remaining ¥156,000 by expenditures of ¥56,000 in 2015 and ¥100,000 in 2016.In 2014, non-taxable governmental bond interest revenue was ¥28,000.During 2014, non-deductible fines and penalties of ¥26,000 were paid.LO 11APPENDIX 19ACOMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONPresented below is information related to Akai’s operations for 2014.Pretax financial income for 2014 amounts to ¥412,000.Tax rates enacted before the end of 2014 were:2014 50%2015 and later years 40%The accounting period is the calendar year.The company is expected to have taxable income in all future years.LO 11APPENDIX 19ACOMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONTaxable Income and Income Taxes Payable-2014LO 11The first step is to determine Akai’s income tax payable for 2014 by calculating its taxable income.APPENDIX 19ACOMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONILLUSTRATION 19A-1Computation of TaxableIncome, 2014LO 11Akai computes income taxes payable on taxable income for ¥100,000 as follows.ILLUSTRATION 19A-1APPENDIX 19ACOMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONILLUSTRATION 19A-2Computation of Income Taxes Payable, End of 2014Computing Deferred Income Taxes – End of 2014LO 11ILLUSTRATION 19A-3ILLUSTRATION 19A-4APPENDIX 19ACOMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONDeferred Tax Expense (Benefit) and the Journal Entry to Record Income Taxes - 2014LO 11ILLUSTRATION 19A-5Computation of Deferred Tax Expense (Benefit), 2014Computation of Net Deferred Tax Expense, 2014ILLUSTRATION 19A-6APPENDIX 19ACOMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONDeferred Tax Expense (Benefit) and the Journal Entry to Record Income Taxes - 2014LO 11ILLUSTRATION 19A-7Computation of Total Income Tax Expense, 2014Journal Entry for Income Tax Expense, 2014Income Tax Expense 174,000Deferred Tax Asset 62,400 Income Taxes Payable 50,000 Deferred Tax Liability 186,400APPENDIX 19ACOMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONCompanies should classify deferred tax assets and liabilities as current and non-current on the statement of financial position. Deferred tax assets are therefore netted against deferred tax liabilities to compute a net deferred asset (liability).Financial Statement Presentation - 2014LO 11APPENDIX 19ACOMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONILLUSTRATION 19A-8Classification of Deferred Tax Accounts, End of 2014Statement of Financial Position Presentation for 2014.Financial Statement Presentation - 2014LO 11ILLUSTRATION 19A-9Income statement for 2014.ILLUSTRATION 19A-10APPENDIX 19ACOMPREHENSIVE EXAMPLE OF INTERPERIOD TAX ALLOCATIONCopyright © 2015 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. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. 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