1. Accounting for Income Taxes
Intermediate Accounting II
Chapter 16

2. Financial Reporting vs Tax Reporting
Revenues and expenses reported for financial accounting purposes are, for the most part, the same as those reported for income tax purposes. However, in some instances, tax laws and financial accounting standards differ.
A consequence of differences between GAAP and tax rules is that tax payments frequently occur in years different from when the revenues and expenses that cause the differences are recognized for financial accounting purposes.

3. Temporary Differences
If GAAP and tax rules differ, tax payments might occur in years different from when the revenues and expenses that cause the taxes are generated producing a difference between pretax accounting income and taxable income.
The difference is a temporary difference if it originates in one period and reverses in one or more later periods.
Temporary, or timing, differences create deferred tax assets or liabilities.
Income tax expense includes both the current and deferred tax consequences of the activities of the reporting period.

4. Types of Temporary Differences
Revenues (or gains)
Expenses (or losses)
Reported in the Income Statement Now, but on the Tax Return Later
Installment sales of property (installment method for taxes)
Unrealized gain from recording investments at fair value (taxable when asset is sold)
Estimated expenses and losses (tax-deductible when paid)
Unrealized loss from recording investments at fair value or inventory at LCM (tax-deductible when asset is sold)
Reported on the Tax Return Now, but in the Income Statement Later
Rent collected in advance
Subscriptions collected in advance 
Other revenue collected in advance
Accelerated depreciation on the tax return in excess of straight-line depreciation in the income statement
Prepaid expenses (tax-deductible when paid) 
Liability
Asset

5. Deferrered Tax Assets
If taxable income will be decreased relative to accounting income in the year(s) when the difference reverses, the temporary difference will cause a deferred tax asset.
Expenses or losses reported on the tax return after the income statement.
Revenues or gains reported on the tax return before the income statement.
A future deductible amount results.

6. Brief Exercise 16–3
Since taxable income is greater than pretax accounting income, a future deductible amount will occur when the temporary difference reverses. This means a deferred tax asset should be recorded.
Account
Debit
Credit
Income Tax Expense
4,000,000
Deferred Tax Asset
800,000
Income Tax Payable
4,800,000
Calculations
Income Tax Payable: Taxable Income X Tax Rate $12,000,000 X 40% = $4,800,000
Temporary Difference: Pretax Accounting Income – Taxable Income $12,000,000 - $10,000,000 = $2,000,000
Deferred Tax Asset: Temporary Difference X Tax Rate $2,000,000 X 40% = $800,000
Income Tax Expense: To Balance

7. Deferrered Tax Liabilitites
If taxable income will be increased relative to accounting income in the year(s) when the difference reverses, the temporary difference will cause a deferred tax liability.
Revenues or gains reported on the tax return after the income statement.
Expenses or losses reported on the tax return before the income statement.
A future taxable amount results.

8. Brief Exercise 16–1
Since taxable income is less than pretax accounting income, a future taxable amount will occur when the temporary difference reverses. This means a deferred tax liability should be recorded.
Account
Debit
Credit
Income Tax Expense
4,000,000
Deferred Tax Liability
1,200,000
Income Tax Payable
2,800,000
Calculations
Income Tax Payable: Taxable Income X Tax Rate $7,000,000 X 40% = $2,800,000
Temporary Difference: Pretax Accounting Income – Taxable Income $10,000,000 - $7,000,000 = $3,000,000
Deferred Tax Liability: Temporary Difference X Tax Rate $3,000,000 X 40% = $1,200,000
Income Tax Expense: To Balance

9. Income Tax Expense
Income Tax Expense is a “plug” determined by changes in the tax payable, deferred tax assets, and deferred tax liability accounts.
Calculate the income tax that is currently payable
Calculate what the ending balance in the deferred tax liability (or asset) should be.
Determine the change (debit or credit) in the deferred tax liability (or asset) necessary to reach that ending balance.
Combine that change with tax payable to determine income tax expense.

10. Brief Exercise 16–4
Brief Exercise 16–5

11. Valuation Allowance
A valuation allowance is needed if it is more likely than not that some portion or all of a deferred tax asset will not be realized.
The adjustment is recorded in the year in which the determination is made.
Debit Income Tax Expense
Credit Valuation Allowance – Deferred Tax Asset
The valuation is reported on the balance sheet as a reduction to the Deferred Tax Asset account.

12. Brief Exercise 16–6, page 944 Income Tax Expense 2
Account
Debit
Credit
Income Tax Expense 2
Deferred tax asset ($30 x 40%) 12
Income tax payable ($35 x 40%) 14
Income tax expense 3
Valuation allowance-deferred tax asset (1/4 x $12)

13. Permanent Differences
Transactions and events that under existing tax law will never affect taxable income or taxes payable are permanent differences.
See page 922 for examples of situations causing permanent book/tax differences.
Permanent differences are disregarded when determining both the tax payable currently and the deferred tax effect.

14. Brief Exercise 16–9

15. Change in Tax Rates
A deferred tax liability or asset is calculated using currently enacted tax rates and laws unless additional information is available.
If a phased-in change in rates is scheduled to occur, the specific tax rates of each future year are multiplied by the amounts reversing in each of those years to determine the deferred tax liability or asset.
When an unexpected change in tax law or rate occurs, we adjust the deferred tax to reflect the change in the amount to be paid or recovered.
The effect of any adjustment in deferred tax is reported in the operating income in the year of the tax law or rate change.

16. Future Deductible Amounts
Brief Exercise 16–10, page 945
Current Year
Future Deductible Amounts
Total
2018
2019
2020
2021
Pretax Accounting Income
$291
Temp Diff: Warranty Exp 9
(3)
Taxable Income
$300
Tax Rate
40%
30%
Tax Payable
$120
Deferred Tax Asset
(1.2)
(.9)
Account
Debit
Credit
Income Tax Expense
117
Deferred Tax Asset* 3
Income Tax Payable
120
*A future deductible amount creates a deferred tax asset.

17. Exercise 16–16, page 949 2018 Income Tax Expense (to balance) 13.2
Part 1
Date
Account
Debit
Credit
2018
Income Tax Expense (to balance)
13.2
Deferred Tax Liability ($8 * 40%)
3.2
Income Tax Payable ([$33 – 8] * 40%)
10.0
Part 2
Date
Account
Debit
Credit
2019
Income Tax Expense (to balance)
20.0
Deferred Tax Liability* .8
Income Tax Payable ([$50 + 2] * 40%)
20.8
*Deferred Tax Liability
Desired Balance $2.4 (Future Taxable Amount $6 * 40%) Current Balance (3.2)
Adjustment $(0.8)

18. Future Taxable Amounts
Exercise 16–16, page 977 (continued)
Part 3
Date
Account
Debit
Credit
2019
Income Tax Expense
19.4
Deferred Tax Liability*
1.4
Income Tax Payable
20.8
Current Year
Future Taxable Amounts
Total
2019
2020
2021
2022
Pretax Accounting Income
$50
Temp Diff: Advance Rent Pmt 2
Taxable Income
$52
Tax Rate
40%
30%
Tax Payable
$20.8
Deferred Tax Liability .6
$1.8
*Deferred Tax Liability
Desired Balance $1.8 Current Balance (3.2)
Adjustment $(1.4)

19. Net Operating Loss
A net operating loss (NOL) occurs when tax-deductible expenses exceed taxable revenues.
A NOL can be used to reduce taxable income in other, profitable years by either:
A carryback of the NOL to the previous two years (must go to the earlier year first). When an unexpected change in tax law or rate occurs, we adjust the deferred tax to reflect the change in the amount to be paid or recovered.
A carryforward of the NOL to later years (up to 20)
The income tax benefit of both NOL carryback and NOL carryforward are recognized for accounting purposes in the year the NOL occurs.

20. Brief Exercise 16–13, page 973
Computation of Loss Carryback/Carryforward
Current Operating Loss
Prior Years
Future Year P2 P1 F1
Loss Carryback/forward
(25)
15 
10  0 
Tax Rate
40% 
Tax Refund 6  4 
Account
Debit
Credit
Income Tax Refund Receivable 10
Income Tax Benefit – Operating Loss

21. Example Exercise Computation of Loss Carryback/Carryforward
During 2018, American Laminating Corporation reported an operating loss of $125 million. The enacted tax rate is 40% for 2018.
Taxable Income Income Tax Rates Taxes Paid
2016 $20 million 35% $7 million
million 40% 22 million
Computation of Loss Carryback/Carryforward
Current Operating Loss
Prior Years
Future Year
2016
2017
Loss Carryback/forward
(125) 20 55 50
Tax Rate
35% 
40% 
Tax Refund 7 
22 
20 
Deferred Tax Asset
$49 

22. VALUATION ALLOWANCE
 Deferred tax assets are recognized for all deductible temporary differences. However, a deferred tax asset is then reduced by a valuation allowance if it is “more likely than not” that some portion or all of the deferred tax asset will not be realized.

23. Income tax expense 3 Valuation allowance – deferred tax asset 3
Assume management determines that it’s more likely than not that $3 million of an $8 million deferred tax asset will not ultimately be realized.
Income tax expense 3 Valuation allowance – deferred tax asset 3
The deferred tax asset is reported at its estimated net realizable value:
Deferred tax asset $8 Less: Valuation allowance – deferred tax asset (3) $5

24. Accounting for Income Taxes
Intermediate accounting ii - Chapter 16
End of presentation