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McGraw-Hill /Irwin © 2009 The McGraw-Hill Companies, Inc.
ACCOUNTING FOR ACCOUNTING FOR INCOME TAXESINCOME TAXES
Chapter 16
Slide 2
16-2
The Internal Revenue Code is
the set of rules for preparing tax
returns.
The Internal Revenue Code is
the set of rules for preparing tax
returns.
Financial statement income tax expense.
Financial statement income tax expense.
IRS income taxes payable.
IRS income taxes payable.
GAAP is the set of rules for preparing
financial statements.
GAAP is the set of rules for preparing
financial statements.
Usually. . . Results in . . . Results in . . .
The objective of accounting for income taxes is to recognize a deferred tax liability or deferred tax assetfor the tax consequences of amounts that will become
taxable or deductible in future years as a result of transactions or events that already have occurred.
The objective of accounting for income taxes is to recognize a deferred tax liability or deferred tax assetfor the tax consequences of amounts that will become
taxable or deductible in future years as a result of transactions or events that already have occurred.
Deferred Tax Assets and Deferred Tax Deferred Tax Assets and Deferred Tax LiabilitiesLiabilities
Slide 3 Slide 3
16-3
Temporary DifferencesTemporary Differences
These are called temporary
differences.
Often, the difference between pre-tax accounting income and taxable income results from items entering the income
computations at different times.
Often, the difference between pre-tax accounting income and taxable income results from items entering the income
computations at different times.
Slide 4 Slide 4
16-4
Temporary differences will reverse out in one or more future periods.
Temporary differences will reverse out in one or more future periods.
Temporary DifferencesTemporary Differences
Accounting Income>Taxable Income
Future Taxable Amounts
Deferred Tax Liability
Accounting Income<Taxable Income
Future Deductible Amounts
Deferred Tax Asset
Slide 5
16-5
Deferred tax liabilities result in taxable
amounts in the future.
Deferred tax liabilities result in taxable
amounts in the future.
Deferred tax assets result in deductible
amounts in the future.
Deferred tax assets result in deductible
amounts in the future.
Revenues (or gains) Expenses (or losses)
Items reported on
the tax return
Installment sales of property (installment method for taxes)
Estimated expenses and losses (tax deductible when paid)
AFTER the income
statement
Unrealized gain from recording investments at fair value (taxable when asset is sold)
Unrealized loss from recording investments at fair value or inventory at LCM (tax deductible when asset is sold)
Items reported on
the tax return
Rent or subscriptions collected in advance
Accelerated depreciation on tax return (straight-line on income statement)
BEFORE the income
statement
Other revenue collected in advance
Prepaid expenses (tax deductible when paid)
Slide 6
16-6
Deferred Tax LiabilitiesDeferred Tax Liabilities
In 2009, Baxter reports $300,000 of pretax income. Included in this amount is $100,000 resulting from revenue earned from an
installment sale for which no cash was collected. The revenue will be taxed as the cash is collected in 2010 and 2011. Baxter expects to collect $70,000 in 2010 and the remaining $30,000 in 2011. In 2010
and 2011, Baxter reports $200,000 of pretax income. The company is subject to a 32% tax rate.
There are no other temporary differences.
In 2009, Baxter reports $300,000 of pretax income. Included in this amount is $100,000 resulting from revenue earned from an
installment sale for which no cash was collected. The revenue will be taxed as the cash is collected in 2010 and 2011. Baxter expects to collect $70,000 in 2010 and the remaining $30,000 in 2011. In 2010
and 2011, Baxter reports $200,000 of pretax income. The company is subject to a 32% tax rate.
There are no other temporary differences.
Originates2009 2010 2011 Total
Accounting income 300,000$ 200,000$ 200,000$ 700,000$ Installment sale income on the income statement (100,000) (100,000) Installment sale income on the tax return 70,000 30,000 100,000 Taxable income 200,000$ 270,000$ 230,000$ 700,000$
ReversesTemporary Difference
Slide 7
16-7
Deferred Tax LiabilitiesDeferred Tax Liabilities
Description Debit CreditIncome tax expense 96,000
Income tax payable 64,000 Deferred tax liability 32,000
General Journal
Originates2009 2010 2011 Total
Accounting income 300,000$ 200,000$ 200,000$ 700,000$ Installment sale income on the income statement (100,000) (100,000) Installment sale income on the tax return 70,000 30,000 100,000 Taxable income 200,000$ 270,000$ 230,000$ 700,000$
ReversesTemporary Difference
2009 Income tax payable = $200,000 × 32% = $64,0002009 Income tax payable = $200,000 × 32% = $64,000
2009 Deferred tax liability change = ($100,000 × 32%) - $02009 Deferred tax liability change = ($100,000 × 32%) - $0 = $32,000 = $32,000
2009 Income tax payable = $200,000 × 32% = $64,0002009 Income tax payable = $200,000 × 32% = $64,000
2009 Deferred tax liability change = ($100,000 × 32%) - $02009 Deferred tax liability change = ($100,000 × 32%) - $0 = $32,000 = $32,000
Slide 8
16-8
Deferred Tax LiabilitiesDeferred Tax Liabilities
2010 2011 Total
Future taxable amounts 70,000$ 30,000$ 100,000$
Enacted tax rate 32%
Deferred tax liability 32,000$
32,000 2009Deferred Tax Liability
The Deferred Tax Liability
represents the future taxes Baxter
will pay in 2010 and 2011.
Description Debit CreditIncome tax expense 96,000
Income tax payable 64,000 Deferred tax liability 32,000
General Journal
Slide 9
16-9
Originates2009 2010 2011 Total
Accounting income 300,000$ 200,000$ 200,000$ 700,000$ Installment sale income on the income statement (100,000) (100,000) Installment sale income on the tax return 70,000 30,000 100,000 Taxable income 200,000$ 270,000$ 230,000$ 700,000$
ReversesTemporary Difference
Deferred Tax LiabilitiesDeferred Tax Liabilities
Description Debit CreditIncome tax expense 64,000 Deferred tax liability 22,400 Income tax payable 86,400
General JournalDescription Debit Credit
Income tax expense 64,000 Deferred tax liability 22,400 Income tax payable 86,400
General Journal
Recall this information for
Baxter.
2010 Income tax payable = $270,000 × 32% = $86,4002010 Income tax payable = $270,000 × 32% = $86,400
2010 Deferred tax liability change = ($30,000 × 32%) - $32,0002010 Deferred tax liability change = ($30,000 × 32%) - $32,000 = $22,400 = $22,400
2010 Income tax payable = $270,000 × 32% = $86,4002010 Income tax payable = $270,000 × 32% = $86,400
2010 Deferred tax liability change = ($30,000 × 32%) - $32,0002010 Deferred tax liability change = ($30,000 × 32%) - $32,000 = $22,400 = $22,400
Slide 10
16-10
Deferred Tax LiabilitiesDeferred Tax Liabilities
2011 Total
Future taxable amounts 30,000$ 30,000$
Enacted tax rate 32%
Deferred tax liability 9,600$
Future Taxable Amount
Schedule
2010 22,400 32,000 20099,600 Balance
Deferred Tax Liability
The Deferred Tax Liability represents the future taxes Baxter will pay in 2011.
Slide 11
16-11
Description Debit CreditIncome tax expense 64,000 Deferred tax liability 9,600 Income tax payable 73,600
General JournalDescription Debit Credit
Income tax expense 64,000 Deferred tax liability 9,600 Income tax payable 73,600
General Journal
Deferred Tax LiabilitiesDeferred Tax LiabilitiesOriginates
2009 2010 2011 TotalAccounting income 300,000$ 200,000$ 200,000$ 700,000$ Installment sale income on the income statement (100,000) (100,000) Installment sale income on the tax return 70,000 30,000 100,000 Taxable income 200,000$ 270,000$ 230,000$ 700,000$
ReversesTemporary DifferenceRecall this
information for Baxter.
2011 Income tax payable = $230,000 × 32% = $73,6002011 Income tax payable = $230,000 × 32% = $73,600
2011 Deferred tax liability change = ($0 × 32%) - $9,600 2011 Deferred tax liability change = ($0 × 32%) - $9,600 = $9,600 = $9,600
2011 Income tax payable = $230,000 × 32% = $73,6002011 Income tax payable = $230,000 × 32% = $73,600
2011 Deferred tax liability change = ($0 × 32%) - $9,600 2011 Deferred tax liability change = ($0 × 32%) - $9,600 = $9,600 = $9,600
Slide 12
16-12
2010 22,400 32,000 20099,600 Balance
2011 9,600 0 Balance
Deferred Tax Liability
Deferred Tax LiabilitiesDeferred Tax Liabilities
2012 Total
Future taxable amounts -$ -$
Enacted tax rate 32%
Deferred tax liability -$
Future Taxable Amount
Schedule
The Deferred Tax Liability represents the future taxes Baxter will pay.
Slide 13
16-13
Health Magazine received $150,000 of subscriptions in advance during 2009.
Subscription revenue will be earned equally in 2010, 2011 and 2012 for financial accounting purposes.
The entire $150,000 will be taxed in 2009.
There is additional income of $500,000 in each year. The company is subject to a 30% tax rate in each year.
Deferred Tax AssetsDeferred Tax Assets
Originates2009 2010 2011 2012 Total
Accounting income 500,000$ 550,000$ 550,000$ 550,000$ 2,150,000$ Subscription revenue on the income statement (50,000) (50,000) (50,000) (150,000) Subscription revenue on the tax return 150,000 150,000 Taxable income 650,000$ 500,000$ 500,000$ 500,000$ 2,150,000$
ReversesTemporary Difference
Slide 14
16-14
Calculation of Deferred Tax Asset 2010 2011 2012 TotalFuture deductible amount (50,000)$ (50,000)$ (50,000)$ (150,000)$ Enacted tax rate 30%Deferred tax asset (45,000)$
Deferred Tax AssetsDeferred Tax Assets
Now, let’s record the income tax entry for 2009.
This is the computation for the Deferred Tax Asset.
Originates2009 2010 2011 2012 Total
Accounting income 500,000$ 550,000$ 550,000$ 550,000$ 2,150,000$ Subscription revenue on the income statement (50,000) (50,000) (50,000) (150,000) Subscription revenue on the tax return 150,000 150,000 Taxable income 650,000$ 500,000$ 500,000$ 500,000$ 2,150,000$
ReversesTemporary Difference
Slide 15
16-15
Deferred Tax AssetsDeferred Tax Assets
Description Debit CreditIncome tax expense 150,000 Deferred tax asset 45,000 Income tax payable 195,000
General JournalDescription Debit Credit
Income tax expense 150,000 Deferred tax asset 45,000 Income tax payable 195,000
General Journal
Originates2009 2010 2011 2012 Total
Accounting income 500,000$ 550,000$ 550,000$ 550,000$ 2,150,000$ Subscription revenue on the income statement (50,000) (50,000) (50,000) (150,000) Subscription revenue on the tax return 150,000 150,000 Taxable income 650,000$ 500,000$ 500,000$ 500,000$ 2,150,000$
ReversesTemporary Difference
2009 Income tax payable = $650,000 × 30% = $195,0002009 Income tax payable = $650,000 × 30% = $195,000
2009 Deferred tax asset change = [($150,000 × 30%] - $02009 Deferred tax asset change = [($150,000 × 30%] - $0 = $45,000 = $45,000
2009 Income tax payable = $650,000 × 30% = $195,0002009 Income tax payable = $650,000 × 30% = $195,000
2009 Deferred tax asset change = [($150,000 × 30%] - $02009 Deferred tax asset change = [($150,000 × 30%] - $0 = $45,000 = $45,000
Slide 16
16-16
2009 45,000 Balance 45,000
Deferred Tax Asset
Deferred Tax AssetsDeferred Tax Assets
After posting the entry, the Deferred Tax Asset account will have the desired ending balance of $45,000.
Description Debit CreditIncome tax expense 150,000 Deferred tax asset 45,000 Income tax payable 195,000
General JournalDescription Debit Credit
Income tax expense 150,000 Deferred tax asset 45,000 Income tax payable 195,000
General Journal
Calculation of Deferred Tax Asset 2010 2011 2012 TotalFuture deductible amount (50,000)$ (50,000)$ (50,000)$ (150,000)$ Enacted tax rate 30%Deferred tax asset (45,000)$
Slide 17
16-17
Deferred Tax AssetsDeferred Tax Assets
Description Debit CreditIncome tax expense 165,000 Deferred tax asset 15,000 Income tax payable 150,000
General JournalDescription Debit Credit
Income tax expense 165,000 Deferred tax asset 15,000 Income tax payable 150,000
General Journal
Originates2009 2010 2011 2012 Total
Accounting income 500,000$ 550,000$ 550,000$ 550,000$ 2,150,000$ Subscription revenue on the income statement (50,000) (50,000) (50,000) (150,000) Subscription revenue on the tax return 150,000 150,000 Taxable income 650,000$ 500,000$ 500,000$ 500,000$ 2,150,000$
ReversesTemporary Difference
2010 Income tax payable = $500,000 × 30% = $150,0002010 Income tax payable = $500,000 × 30% = $150,000
2010 Deferred tax asset change = [($100,000) × 30%] - $45,0002010 Deferred tax asset change = [($100,000) × 30%] - $45,000 = ($15,000) = ($15,000)
2010 Income tax payable = $500,000 × 30% = $150,0002010 Income tax payable = $500,000 × 30% = $150,000
2010 Deferred tax asset change = [($100,000) × 30%] - $45,0002010 Deferred tax asset change = [($100,000) × 30%] - $45,000 = ($15,000) = ($15,000)
Slide 18
16-18
Deferred Tax AssetsDeferred Tax AssetsIn 2010, the balance in the Deferred Tax Asset should
decrease to $30,000.
2009 45,000 15,000 2010Balance 30,000
Deferred Tax Asset
Can you prepare the entries for 2011 and 2012?
Calculation of Deferred Tax Asset 2011 2012 TotalFuture deductible amount (50,000)$ (50,000)$ (100,000)$ Enacted tax rate 30%Deferred tax asset (30,000)$
Slide 19
16-19
Deferred Tax AssetsDeferred Tax AssetsThis would be the entry for 2011 and 2012.
2009 45,000 15,000 201015,000 201115,000 2012
Balance -
Deferred Tax Asset
At the end of 2012, the balance in the Deferred Tax Asset would be zero.
Description Debit CreditIncome tax expense 165,000 Deferred tax asset 15,000 Income tax payable 150,000
General JournalDescription Debit Credit
Income tax expense 165,000 Deferred tax asset 15,000 Income tax payable 150,000
General Journal
Slide 20
16-20
A valuation allowance account is required when it is more likely than not that some portion of the deferred tax asset will not be realized.
The deferred tax asset is then reported at its estimated net realizable value.
A valuation allowance account is required when it is more likely than not that some portion of the deferred tax asset will not be realized.
The deferred tax asset is then reported at its estimated net realizable value.
Valuation AllowanceValuation Allowance
Slide 21
16-21
Nontemporary DifferencesNontemporary Differences
Created when an income item is included in taxable income or
accounting income but will never be included in the computation of the
other.
Example: Interest on tax-free municipal bonds is included in accounting income but is never
included in taxable income.
Also called permanent differences.Also called permanent differences.
Slide 22
16-22
Tax Rate ConsiderationsTax 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.
InternalRevenue
Code
Slide 23
16-23
Multiple Temporary DifferencesMultiple Temporary Differences
It would be unusual for any but a very small company to have only a single temporary
difference in any given year.
Categorize all temporary differences according to whether they create …
Future taxable amounts
Future deductible amounts
Slide 24
16-24
Net Operating Losses (NOL)Net Operating Losses (NOL)
Tax laws often allow a company to use tax NOLs to offset taxable income in earlier or
subsequent periods.
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 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.
When used to offset future taxable income:
Called: operating loss carryforward.
Result: reduced tax payable.
Slide 25
16-25
Net Operating Losses (NOL)Net Operating Losses (NOL)
Current Year
-1-2
Carryback Period
+3+2+1 . . . +20+4 +5
Carryforward Period
The NOL may first be applied against taxable income from two previous years.
Unused NOL may be carried forward for 20 years.
The NOL may first be applied against taxable income from two previous years.
Unused NOL may be carried forward for 20 years.
Slide 26
16-26
Net Operating Losses (NOL) Net Operating Losses (NOL)
In 2009 Garson, Inc. incurred an $85,000 net operating loss. The company is subject to a
30% tax rate. In 2007, Garson reported taxable income of $20,000, and in 2008,
taxable income was $10,000. The company elects to carryback the NOL.
In 2009 Garson, Inc. incurred an $85,000 net operating loss. The company is subject to a
30% tax rate. In 2007, Garson reported taxable income of $20,000, and in 2008,
taxable income was $10,000. The company elects to carryback the NOL.
Tax year
Taxable Income
Tax rate Taxes Paid
2007 20,000$ 30% 6,000$
2008 10,000 30% 3,000
Let’s look at the tax benefits of the operating loss carryback and carryforward.
Slide 27
16-27
Net Operating Losses (NOL) Net Operating Losses (NOL)
Current Year2007 2008 2009
Operating loss (85,000)$
Loss carryback (20,000)$ (10,000)$ 30,000 Loss carryforward 55,000 (55,000)$ Subtotal (20,000)$ (10,000)$ -$ (55,000)$ Enacted tax rate 30% 30% 30% 30%Tax refund (6,000)$ (3,000)$ -$
Deferred tax asset (16,500)$
Prior YearsFuture
Deductible Amounts
Description Debit CreditReceivable--income tax refund 9,000 Deferred tax asset 16,500 Income tax benefit-- operating loss 25,500
Description Debit CreditReceivable--income tax refund 9,000 Deferred tax asset 16,500 Income tax benefit-- operating loss 25,500
Slide 28
16-28
Net Operating Losses (NOL) Net Operating Losses (NOL)
Operating loss before income taxes (85,000)$ Benefit of NOL carryback 9,000 Benefit of NOL carryforward 16,500 Net loss (59,500)$
Garson, Inc.Partial Income Statement
For the Year Ended December 31, 2009Operating loss before income taxes (85,000)$ Benefit of NOL carryback 9,000 Benefit of NOL carryforward 16,500 Net loss (59,500)$
Garson, Inc.Partial Income Statement
For the Year Ended December 31, 2009
The deferred tax asset account created by the benefit of the carryforward will be used to lower
income taxes payable in future years.
The deferred tax asset account created by the benefit of the carryforward will be used to lower
income taxes payable in future years.
Slide 29 Slide 29
16-29
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).
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.
Deferred tax assets/liabilities are classified as
current or noncurrent based
on the classification of the related asset
or liability.
Balance Sheet ClassificationBalance Sheet Classification
Slide 30 Slide 30
16-30
Current portion of tax expense (benefit)Deferred portion of tax expense (benefit), with
separate disclosure for Portion that does not include the effect of
the following separately disclosed amounts. Operating loss carryforwards. Adjustments due to changes in tax laws or
rates. Adjustments to the beginning-of-the-year
valuation allowance due to revised estimates.
Investment tax credits.
Current portion of tax expense (benefit)Deferred portion of tax expense (benefit), with
separate disclosure for Portion that does not include the effect of
the following separately disclosed amounts. Operating loss carryforwards. Adjustments due to changes in tax laws or
rates. Adjustments to the beginning-of-the-year
valuation allowance due to revised estimates.
Investment tax credits.
Additional DisclosuresAdditional Disclosures
Slide 31
16-31
Coping with Uncertainty in Income TaxesCoping with Uncertainty in Income Taxes
FASB Interpretation No. 48 Step 1. A tax benefit may be reflected in the financial statements only if it is “more likely than not” that the company will be able to sustain the tax return position, based on its technical merits.
Step 2. A tax benefit should be measured as the largest amount of benefit that is cumulatively greater than 50-percent likely to be realized.
Not “more likely than not” = none of the tax benefit is allowed to be recorded
Slide 32
16-32
Intraperiod Tax AllocationIntraperiod Tax Allocation
SFAS No. 109 requires intraperiod tax allocation for:• Income from continuing
operations.• Discontinued operations.• Extraordinary items.
SFAS No. 109 requires intraperiod tax allocation for:• Income from continuing
operations.• Discontinued operations.• Extraordinary items.
Slide 33
16-33
Conceptual ConcernsConceptual Concerns
Should deferred taxes be recognized?
Should deferred taxes be recognized for only some items?
Should deferred taxes be discounted?
Should classification be based on the timing of temporary difference reversals?
Some accountants disagree with the FASB’s approach to accounting for income taxes.
McGraw-Hill /Irwin © 2009 The McGraw-Hill Companies, Inc.
End of Chapter 16End of Chapter 16