ACCT 301B Exam #3 Conceptual

temporary difference

a difference between the tax basis of an asset or liability and its reported amount in the financial statements what will result in taxable or deductible amounts in future years

financial income

income before taxes reported in the GAAP income statement

taxable income

the excess of taxable revenues over tax-deductible expenses and exemptions for the year as defined by the governmental taxing authority (IRS)

deductible temporary difference

temporary differences that result in deductible amounts in future years when recovering or settling the related asset or liability, respectively

taxable temporary difference

temporary differences that result in taxable amounts in future years when recovering or settling the related asset or liability respectively

financial reporting

financial statements; pretax financial income → income tax expense

tax reporting

tax return; taxable income → income taxes payable

pretax financial income

(income before taxes, income for financial reporting purposes, or income before book purposes) must follow accrual-based accounting & measure with the objective of providing useful information to investors and creditors

taxable income/income for tax purposes

amount used to compute income taxes payable to the IRS; determined according to the tax code (cash-based accounting approach)

for financial reporting

companies use the full accrual method to report revenues, which tend to be fixed year to year

for tax purposes

a cash basis is generally used to determine taxable income which results in taxable income fluctuating from year to year; classifies income taxes payable as a current liability on the balance sheet

income tax expense (benefit)

the sum of current tax expense (benefit) and deferred tax expense (benefit)

a taxable amount

increases taxable income in future years

a deductible amount

decreases taxable income in future years

DTL cumulative temporary difference

taxable income lower than pretax financial income

DTL future taxable amounts

taxable income higher than pretax financial income

deferred tax liability

represents the increase in taxes payable in future years as a result of taxable temporary differences exiting at the end of the current year; the deferred tax consequences attributable to taxable temporary differences

current tax expense (benefit)

the amount of income taxes paid or payable (or refundable) for a year as determined by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues for that year

deferred tax expense (benefit)

the change during the year in a company’s deferred tax liabilities and assets

deferred tax asset

the deferred tax consequences attributable to deductible temporary differences and carryforwards; 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

on the balance sheet (DTL)

income taxes payable if reported as a current liability and the deferred tax liability is reported as a noncurrent liability

in the income statement or in the notes to financial statements (DTL),

a company should disclose the significant components of income tax expense attributable to continuing operations

DTA cumulative temporary difference

taxable income higher than pretax financial income

DTA future deductible amounts

taxable income lower than pretax financial income

deferred tax benefit

results from the increase in the deferred tax asset from the beginning to the end of the accounting period; is a negative component of income tax expense

on the balance sheet (DTA)

income taxes payable is reported as a current liability and the deferred tax asset is reported as a noncurrent liability

on the income statement (DTA)

reports both the current portion (the amount of income taxes payable for the period) and the deferred portion of the income tax expense

valuation allowance

the portion of a deferred tax asset for which it is more likely than not that a company will not realize a tax benefit

a company should reduce a deferred tax asset by a valuation allowance if…

based on available evidence, it is more likely than not that it will not realize some portion or all of the deferred tax asset (at lease slightly more than 50%)

the valuation account “allowance to reduce deferred tax asset to expected realizable value” is a

contra account

temporary differences resulting in deferred tax liabilities

taxable income is less than financial income

temporary differences resulting in deferred tax liabilities examples

• revenues or gains are taxable after they are recognized in financial income that will result in taxable amounts in future years

• expenses or losses are deductible before they are recognized in financial income that will result in taxable amount in future years

temporary differences resulting in deferred tax asset

taxable income is greater than financial income

temporary differences resulting in deferred tax assets examples

• revenues or gains are taxable before they are recognized in financial income that will result in deductible amounts in future years

• expenses or losses are deductible after they are recognized in financial income that will result in deductible amounts in future years

originating temporary difference

an initial difference between the book basis and the tax basis of an asset or liability, regardless of whether the tax basis of the asset or liability exceeds or is exceeded by the book basis of the 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

permanent differences result from either

1. enter into pretax financial income but never into taxable income

   1. enter into taxable income but never into pretax financial income

items recognized for financial reporting purposes but not for tax purposes

(DTL permanent difference)

1. interest received on state and municipal obligations (- from book)

2. expenses incurred in obtaining tax-exempt income (+ to book)

3. proceeds from life insurance carried by the company on key officers or employees (- from book)

4. premiums paid for life insurance carried by the company on key officers or employees (company is beneficiary) (+ to book)

5. fines and expenses resulting from a violation of law (+ to book)

items recognized for tax purposes but not for financial reporting purposes

(DTA permanent difference)

1. “percentage of depletion” of natural resources in excess of their cost (- from book)

2. the deduction for dividends received from U.S. corporations, generally 70% or 80% (- from book)

total income tax expense or benefit =

income taxes payable or refundable ± change in deferred income taxes

taxable is computed as follows

pretax financial income - permanent differences - originating temporary differences

like finance leases, for operating leases the lessee…

records a right-of-use (ROU) asset and lease liability at commencement of the lease

unlike finance leases, for operating leases the lessee…

records the same amount for lease expense each period over the lease term

lease expense

a straight-line expense on the income statement for operating leases and is comprised of interest on the lease liability and amortization of the ROU asset

to calculate lease expenses

1. calculate interest on the lease liability using the effective interest methods

2. “plug” amortization of the ROU asset to arrive at a straight-line expense

total lease payments for present value test =

fixed rental payments + known variable payments + guaranteed residual value + purchase or termination option

present value test

if the present value of the lease payments is reasonably close to the fair value of the asset, a company is effectively purchasing the asset and should therefore classify it as a finance lease

a bargain purchase option allows…

the lessee to purchase the leased property for a future price that is substantially lower than the asset’s expected future fair value; exercise of the option appears to be reasonably certain

by virtue of considering the purchase option a bargain,

we can consider this payment a present obligation to transfer an economic benefit

for a bargain purchase option, the lessee must…

increase the present value of the lease payments by the present value of the option prices

in the case of a bargain purchase option.

amortize over the economic life of the underlying asset, given that the lessee takes ownership of the asset at the end of the lease

in the case of a guaranteed residual value,

amortize the right-of-use asset over the lease term

lease classification tests

transfer of ownership test, purchase option test, lease term test, present value test, alternative test

for a lease to be a finance/sales-type lease

it must meet at least one of the five tests

1) transfer of ownership test

does the lease transfer ownership of the underlying asset to the lessee by the end of the lease term

2) purchase option test

does the lease grant the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise

3) lease term test

is the lease term for a major part of the remaining economic life of the underlying asset

4) present value test

does the present value of the sum of (1) the lease payments and (2) any residual value guaranteed by the lessee (that is not included in the lease payments) equal or exceed substantially all of the underlying asset’s fair value

5) alternative use test

is the underlying asset of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term

present value of lease payments = lease payment * PV of an annuity due of 1

the lessor depreciates on the asset leased, while

the lessee amortizes on the asset leased