Chapter 18 - Accounting for Income Taxes

What are the two types of differences between financial (book) income and taxable income?

Temporary differences and permanent differences.

What do temporary differences give rise to?

Deferred tax liabilities or assets.

Define a temporary difference in accounting.

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

What is a deferred tax liability?

It represents the increase in taxes payable in future years due to taxable temporary differences existing at the end of the current year.

What is a deferred tax asset?

It represents the increase in taxes saved in future years due to deductible temporary differences existing at the end of the current year.

Give an example of a future taxable amount.

Revenue recognized in financial income before included in taxable income, such as accrual basis revenue for book and cash basis for tax.

Give an example of a future deductible amount.

Expenses recognized in financial income before deductible for taxable income, such as product warranty expense.

What is the difference between originating and reversing differences?

Originating differences create deferred tax liabilities or assets, while reversing differences reduce them in future periods.

What is the impact of permanent differences on financial statements?

They affect only the current period and do not give rise to deferred tax liabilities or assets.

What is the purpose of accounting for income taxes?

To account for differences in financial statements and tax returns.

What must a company do if it is more likely than not that it will not realize a deferred tax asset?

Reduce the deferred tax asset by a valuation allowance.

What does 'more likely than not' mean in the context of deferred tax assets?

It means a likelihood of at least slightly more than 50 percent.

What is the impact of permanent differences on future taxable amounts?

They do not give rise to future taxable or deductible amounts.

What type of expense did Havaci Company incur that is permanently non-deductible?

Fines for pollution.

How does a permanent difference affect tax expense and tax payable?

It increases both tax expense and tax payable without affecting deferred tax.

What is a net operating loss (NOL)?

When tax-deductible expenses exceed taxable revenues.

What must a company do if it determines that it is unlikely to realize a deferred tax asset?

Establish a valuation allowance.

How should deferred tax liabilities or assets be classified on the balance sheet?

As current or noncurrent based on the classification of the related asset or liability.

What should companies disclose regarding income tax expense?

Significant components attributable to continuing operations, including current and deferred tax expense.

What is the effect of a change in tax rate on existing deferred income tax accounts?

Companies should record its effect immediately.