1. Chapter 20: Accounting for Income Taxes
Intermediate Accounting, 10th Edition
Kieso, Weygandt, and Warfield
Chapter 20: Accounting for Income Taxes
Prepared by
Krishnan Ranganathan, Angelo State University,
San Angelo, Texas

2. Deferred Taxes: Basics
Deferred taxes arise when income tax expense differs from income tax liability
The tax expense is determined under GAAP
The income tax liability is determined under the Internal Revenue Code
Some of these differences are temporary and reverse over time
Others are permanent and do not reverse
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

3. Temporary and Permanent Differences
Temporary Differences Example: tax and book depreciation deductions may be different
These are differences in revenue and expense amounts reported on tax returns and for financial purposes
Over a given period, they reverse
Permanent Differences Example: Interest on municipal obligations is not taxed but is income for accounting purposes
Items, included on the financials but either excluded or not deducted on tax return
These differences do not reverse
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

4. Temporary Differences: Examples
Revenues and Gains, recognized in financial income, are later taxed for income tax purposes
Expenses and losses, recognized in financial income, are later deducted for income tax purposes
Revenues and gains are taxed for income tax purposes before they are recognized in financial income
Expenses and losses are deducted for income tax purposes before they are recognized in financial income
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

5. Summary of Temporary Differences
Transaction
When recorded
in books
on tax return
Deferred
tax effect
Rev or Gain
Earlier
Later
Liability
Rev or Gain
Later
Earlier
Asset
Exp or Loss
Earlier
Later
Asset
Exp or Loss
Later
Earlier
Liability
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

6. Permanent Differences: Examples
Items, recognized for financial accounting purposes, but not for income tax purposes:
interest income received on tax exempt securities
fines and expenses resulting from violations of law
Items, recognized for tax purposes, but not for financial accounting purposes:
the dividends received deduction under the Code
percentage depletion of natural resources in excess of their cost
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

7. Summary of Permanent Differences
Sources of PERMANENT DIFFERENCES
Some items
are recorded
in Books
but NEVER
on tax return
Other items
are NEVER
recorded in books
but recorded
on tax return
No deferred tax effects
for permanent differences
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

8. Deferred Tax Asset & Deferred Tax Liability: Sources
Deferred taxes may be a:
Deferred tax liability, or
Deferred tax asset
Deferred tax liability arises due to net taxable amounts in the future.
Deferred tax asset arises due to net deductible amounts in the future.
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

9. Recording Deferred Tax Liability: Example
Book tax expense = $20,000
Tax liability = $18,000
Journal Entry: Income Tax Expense , Def.Tax Liability 2, Tax Payable 18,000
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

10. Recording Deferred Tax Asset: Example
Book tax expense = $5,000
Tax payable = $6,000
Journal Entry: Income tax expense 5,000 Def. Tax Asset 1, Tax payable ,000
Deferred tax asset is recognized for all deductible differences
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

11. Temporary Differences: Originating & Reversing
Year Tax Expense Tax Liability Difference Nature
(per GAAP) (per IRC) DTA / DTL
1 $17,600 $16,000 $1,600 D.Tax Liab
2 $17,600 $16,800 $ D.Tax Liab
3 $17,600 $18,400 $ D.Tax Asset
4 $17,600 $19,200 $1,600 D.Tax Asset
Net Deferred Tax Effect $ -0-
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

12. Recording a Valuation Allowance for Doubtful Deferred Tax Assets
If Deferred tax asset appears doubtful,
A Valuation Allowance account is needed.
Journal entry: Income Tax Expense $$ Allowance to Reduce Deferred Tax Asset to Expected Realizable Value $$
The entry records a potential future tax benefit that is not expected to be realized in the future.
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

13. Deferred Taxes: Applying Tax Rates
Basic Rule: Apply the yearly tax rate to calculate deferred tax effects.
If future tax rates change: use the enacted tax rate expected to apply in the future year
If new rates are not yet enacted into law for future years, the current rate should be used
The appropriate enacted rate for a year is the average tax rate [based on graduated tax brackets].
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

14. Procedures for Computing and Reporting Deferred Taxes
Identify types and amounts of
existing temporary differences and carryforwards
Measure deferred tax asset
using enacted tax rate.
Measure deferred tax liability
using enacted tax rate.
On the balance sheet, classify
deferred taxes as current or
noncurrent based on asset or
liability to which they relate.
Establish Valuation
Allowance for doubtful asset
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

15. Revision of Future Tax Rates
When a change in tax rate is enacted, its effect should be recorded immediately
The effect is reported as an adjustment to tax expense in the period of change
See example following slide
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

16. Revision of Future Tax Rates: Example
End of 1999, corporate tax rate is changed from 40% to 35%
The new rate is effective January 1, 2001
The deferred tax account ( ) is as follows:
Excess tax depreciation: $3 million
Deferred tax liability: $1.2 million.
Related taxable amounts are expected to occur equally over 2000, 2001, and 2002.
Provide the journal entry to reflect the change.
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

17. Revision of Future Tax Rates: Example
The deferred tax liability end of 2002 is as follows:
Future tax inc $1,000,000 1,000,000 1,000,000
Tax rate 40% 35% 35%
Deferred tax liability $400, , ,000
Entry: Deferred Tax Liability $100, Income Tax Expense $100,000
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

18. Financial Statement Presentation
Balance Sheet Presentation:
The deferred tax classification relates to its underlying asset or liability
Classify the deferred tax amounts as current or noncurrent
Sum the various deferred tax assets and liabilities classified as current
Sum the various deferred tax assets and liabilities classified as noncurrent
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

19. Financial Statement Presentation
Balance Sheet Presentation:
Sum the various deferred tax assets and liabilities classified as current:
If net result is an asset, report as current asset
If net result is a liability, report as current liability
Sum the various deferred tax assets and liabilities classified as noncurrent
If net result is an asset, report as long-term asset
If net result is a liability, report as long-term liability
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

20. Income Statement Presentation
Income tax expense, as allocated to:
Continuing operations
Discontinued operations
Extraordinary items
Cumulative effect of an accounting change, and
Prior period adjustments
Other significant components, such as:
current tax expense, deferred tax expense/benefit
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

21. Net Operating Losses [NOLs]: Basic Terminology
Net operating loss is a tax terminology
A net operating loss occurs when tax deductions for a year exceed taxable revenues
Net loss or operating loss is a financial accounting term
NOL can be derived from net loss: but these two amounts must be kept separately
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

22. NOLs: Rules of Application
NOL for each tax year is computed
The NOL of one year can be applied to offset taxable income of other years, possibly resulting tax refunds
NOLs can be:
carried back 2 years and carried forward 20 years (carryback option), or
carried forward 20 years (carryforward only)
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

23. NOL Carryback: Example
Gross Income: $ 200,000
Less:
Business deductions: ($ 300,000)
Dividend Received
deduction ($ 70,000)
NOL [tax loss] $ 170,000
Year 2002
Net Loss:
loss 100,000
Tax income: 40,000
NOL c/back: 170,000
Tax loss: ,000
Year 2001
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

24. Net Operating Loss: Carryback rules.
If NOLs are carried back 2 years and carried forward 20 years:
NOL is applied to the earlier of the 2 year period, then to the immediately preceding year etc
Remaining NOLs are applied to the following 20 year period
Any tax refunds are reported in the year of the original net operating loss
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

25. NOL Carryback Rules: continued
Tax years
next
NOL
2002
Apply first
Loss carryforward
20 years forward
Expect
tax refund
here
Record all
tax effects here
Expect
tax
shield
here
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

26. NOL Carryforward Rules
Tax years
NOL
2002
Forgo 2
year rule
Loss carryforward
20 years forward
Record all
tax effects here
Expect
tax
shield
here
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Intermediate Accounting, 10th Edition, Ch. 20 (Kieso et al.)

27. COPYRIGHT
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