1. ACCOUNTING FOR INCOME TAXES
CHAPTER 16
INCOME TAXES

2. Learning Objectives The concept of deferred taxes
Permanent differences:
Temporary differences.
Apply the concept & compute:
Changes in Enacted Tax rates
Use of Valuation Allowance
The Provisions of Tax loss carry-backs/forwards
Financial statement presentation and disclosure

3. FUNDAMENTAL REPORTING Financial & Tax Reporting
FINANCIAL REPORTING
- Useful Information
INCOME TAX SYSTEM:
Equitable collection of revenue

4. Fundamentals of Accounting for Income Taxes
4/20/2017
Fundamentals of Accounting for Income Taxes
FINANCIAL REPORTING
TAX REPORTING
IRS
vs.
SEC
Investors and Creditors
Pretax Financial Income
Taxable Income 
GAAP
Tax Code 
Income Tax Expense
Income Tax Payable

5. INCOME COMPUTATION: Two sets of rules
Pretax Financial (Accounting) Income:
– according to GAAP (FASB 109)
is income before income taxes for financial reporting purposes
Taxable Income:
- according to IRS rules
is the amount of income on which the income tax is based
Therefore the above two income differ

6. DIFFERENT TAXABLE
Depreciation GAAP: (based on estimated amount) IRS: The Modified Accelerated Cost Recovery System (MACRS)
June 2004

7. Temporary Differences TIMMING DIFFERENCES
A temporary difference
corporation’s pretax financial income & taxable income that “originates” in one or more years and
“reverses” in later years.

8. HOW IS ADVANCED SUBSCRIPTION
RECORDING ACCORDING TO:
GAAP?
IRS?
For recording expense we need GAAP reporting
For Income tax payment we need IRS rule

9. STOP & THINK!
Is it possible for a company to have both deferred tax assets and deferred tax liability at the same time? If so, How? Give Example! Let’s Illustrate

10. Examples: Types of Temporary Differences
Temporary differences can result from either revenues (and gains) or expenses (and losses) which are reported on the income statement and the tax return at different times.
The temporary differences in the purple boxes create deferred tax liabilities because they result in taxable amounts in the future. Items reported in the current income statement, but on later tax return that result in deferred tax liabilities include installment sales of property when the installment method is used for taxes and unrealized gain from recording investments at fair value which is taxable when asset is sold.
Items reported on the tax return before the income statement that result in deferred tax liabilities include accelerated depreciation on the tax return when straight-line is used on the income statement and prepaid expenses that are tax deductible when paid.
The temporary differences in the blue boxes create deferred tax assets because they result in deductible amounts in the future. Items reported in the current income statement, but on later tax return that result in deferred tax assets include estimated expenses and losses that are not tax deductible until paid and unrealized loss from recording investments at fair value or inventory at Lower-of-Cost-or-Market which is tax deductible when the asset is sold.
Items reported on the tax return before the income statement that result in deferred tax assets include rent or subscriptions collected in advance and other revenue collected in advance.
Deferred tax assets result in deductible amounts in the future.
Deferred tax liabilities result in taxable amounts in the future.

11. Permanent Differences
Some items of revenue and expense that a corporation reports for financial accounting purposes are never reported for income tax purposes. These permanent differences never reverse in a later accounting period.

12. Book-Tax Differences – Permanent
Examples of permanent book-tax differences
Tax-exempt state and local bond interest income
Nondeductible expenses incurred to generate state and local bond interest income
Life insurance proceeds (death benefits)
50% of meals and entertainment
Political contributions
Fines and penalties
Bribes, kickbacks and illegal payments
Dividends-received deduction: Certain deductions
Professor Vedd

13. CONT… PART II CHANGES IN TAX RATES

14. ACCOUNTING FOR INCOME TAXES
CHAPTER 16 PART II
INCOME TAXES
DEFERED TAX: WITH CHANGES IN ENACTED TAX RATES
Professor Vedd

15. Tax Rate Considerations
Deferred tax assets and liabilities should be determined using the future tax rates, if known.
The deferred tax asset or liability must be adjusted if a change in a tax law or rate occurs.
Deferred tax assets and liabilities should be determined using the future tax rates, if known.
The deferred tax asset or liability must be adjusted if a change in a tax law or rate occurs.

16. 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
Changes in tax rates are treated just like any other change in estimate, prospectively
See example following slide

17. Net Operating Losses (NOL)
Tax laws often allow a company to use tax NOLs to offset taxable income in earlier or subsequent periods.
When used to offset earlier taxable income:
Called: operating loss carryback.
Result: tax refund.
When used to offset future taxable income:
Called: operating loss carryforward.
Result: reduced tax payable.
Tax laws often allow a company to use tax net operating losses to offset taxable income in earlier or subsequent periods. When a net operating loss is used to offset earlier taxable income it is called an operating loss carryback and results in a tax refund. When a net operating loss is used to offset future taxable income it is called an operating loss carryforward and results reduced tax payable.

18. Accounting for Net Operating Losses
Loss Carryback
Back 2 years and forward 20 years
Losses must be applied to earliest year first
Loss Carryforward
May elect to forgo loss carryback and
Carryforward losses 20 years
A company would most likely choose the carry-forward option for a net operating loss if the company expected higher tax rates in the future compared to the past

19. Balance Sheet Classification
Disclose the following:
Total of all deferred tax liabilities.
Total of all deferred tax assets.
Total valuation allowance recognized.
Net change in valuation account.
Approximate tax effect of each type of temporary difference (and carryforward).
Deferred tax assets/liabilities are classified as current or noncurrent based on the classification of the related asset or liability.
Part I
Deferred tax assets/liabilities are classified as current or noncurrent based on the classification of the related asset or liability.
Part II
Disclose the following:
Total of all deferred tax liabilities.
Total of all deferred tax assets.
Total valuation allowance recognized.
Net change in valuation account and
Approximate tax effect of each type of temporary difference (and carryforward).

20. INTERPERIOD/INTRAPERIOD INCOME TAX ALLOCATION
INTERPERIOD: is to recognize an asset or liability for the tax consequences of temporary differences that exist at the balance sheet date.
INTRAPERIOD:
The total income tax expense for a reporting period is allocated among the financial statement items that gave rise to the income tax expense. The following items should be reported net of their respective income tax effects:
• Income (or loss) from continuing operations
• Discontinued operations
• Extraordinary items
• Changes in accounting principle
• Prior period adjustments (to the beginning retained earnings balance)