F5 M6 Income Taxes: Part 1

intraperiod tax allocation

involves apportioning the total tax provision for financial accounting purposes in between the income and loss from continuing operations, discontinued operations, accounting principle change (retrospective), OCI, and components of equity; matches a portion of the provision for income ta to the applicable components of net income and retained earnings

taxable income

is the amount of income subject to tax under law

financial (book) income

(pretax income) is income calculated under GAAP for financial reporting

components of intraperiod tax allocation

any amount not allocated to continuing operations is allocated to other income statement items, where these components are individually net of tax (or benefit) such as discontinued operations, OCI, and retrospective accounting change in principle

income tax expense allocated for continuing operations

is the tax effect of pretax income or loss from continuing operations plus or minus the tax effects of changes in tax laws or rates, expected realization of a DTA, and tax status of the entity; is the remaining tax expense after assigning the appropriate tax effects to other items

objective of intraperiod tax allocation

is to recognize through the matching principle the amount of current and future tax related to events that have been recognized in financial accounting income; current year taxes are payable (liability) or refundable (asset) and future year taxes are DTA or DTL

permanent differences

is a transaction that affects only income per books or taxable income, but not both; they do not affect the deferred tax computation, but only affect the current tax computation; only affect in the period they incur, not in future periods; these items will never reverse in future periods; no interperiod tax allocation is necessary for this

temporary differences

are differences between financial (book) income and taxable income that will reverse in future periods, since they reverse, it will create a deferred tax asset (DTA) or a deferred tax liability (DT:); items that are recognized for tax purposes will eventually be recognized for GAAP purposes (or vice verse); should be recognized in the financial statement until the difference turns around completely; future taxable (liability) and future deductible (asset)

comprehensive allocation

GAAP requires the asset and liability method (balance sheet approach) for this; under this, intraperiod tax allocation is applied to all temporary differences between book income and tax income

asset and liability method

(balance sheet approach) is the GAAP method for accounting for deferred taxes and requires that either income taxes payable or a DTA/DTL be recorded for all tax consequences of the current period

interperiod tax allocation

assigns tax effects between the current and future periods, using DTA and DTL; assigns tax affects to the period in which the related income or expense is recognized for financial reporting, even if the tax effect occurs in a different period

total income tax expense

is the tax expense reported under GAAP for the period

*current tax expense + DTL - DTA

current income tax expense

based on taxable income and current taxes payable

*taxable income x tax rate

permanent differences qualities

are either nontaxable, nondeductible, or special tax allowances

types of permanent differences

municipal or state tax-exempt interest, life insurance proceeds on officer’s key person policy, life insurance premiums when corporation is beneficiary, certain penalties fines bribes & kickbacks, nondeductible portion of meal & entertainment expense, dividends-received deduction for corporations, and excess percentage depletion over cost depletion

permanent difference only entry

a debit to income tax expense and a credit to income tax payable for taxable income times the tax rate

tax income later

results in a future tax liability (DTL) and book income is recognized first; types of this include installment sales, contractors accounting (% of completion vs. completed contract), and equity method (undistributed dividends)

tax expense (deduction) first

results in a future tax liability (DTL) and book expense is recognized later; types of this include depreciation expense, amortization of franchise, and prepaid expenses (cash-basis for tax)

tax income first

results in a future tax benefit (DTA) and book income is recognized later; types of this include prepaid rent, prepaid interest, prepaid royalties, etc. (unearned for GAAP and prepaid for tax)

tax expense (deduction) later

results in a future tax benefit (DTA) and book expense is recognized first; types of this include bad debt expense (allowance vs. direct write-off), estimated liability/warranty expense, and start-up expenses

deferred tax liability (DTL)

is the future tax amount (pay later, I like) a company expects to pay because of a temporary difference between book income and taxable income; arises when current taxable income is less than current book income, but in future, tax income will be greater than book income; are all recognized on the balance sheet

deferred tax asset (DTA)

is a future tax benefit created by a temporary difference between book income and taxable income; arises when current taxable income is greater than current book income, but in future, tax income will be less than book income

additional causes of temporary differences

differences between the financial reporting and tax basis of assets and liabilities arising in a business combination accounted for as an acquisition; differences in the tax basis of assets due to indexing, whenever the local currency is the functional currency

permanent/temporary differences calculation

*(permanent differences + temporary differences) x tax rate

current year DTL entry

a debit to income tax expense-current for taxable income times tax rate, a debit to income tax expense-deferred for temporary difference times tax rate, a credit to income tax payable, and a credit to DTL

future year DTL reversal entry

a debit to DTL and a credit to income tax expense-deferred for temporary difference times tax rate

valuation allowance (DTA)

is a contra-account of a DTA; is recognized when it is more likely than not (a likelihood or more than 50%) that part of all DTA will not be realized; could not be realized through future tax deductions, carrybacks or carryforwards, and future taxable income

*gross DTA - valuation allowance = net DTA

portion of DTA reversal in future years

*specific year amount (year 2 temporary difference) x tax rate

future year DTA reversal entry

a debit to income tax expense-deferred and a credit to DTA for a portion of DTA reversal in future year or just the DTA amount as a whole

warranty expense allocation

*total temporary difference/years allocated to = temporary difference per year

current year DTA entry

a debit to DTA for total temporary difference times tax rate, a debit to income tax expense-current for taxable income times tax rate, a credit to income tax benefit-deferred, and a credit to income tax payable

DTA limit to be realized with a valuation allowance

maximum DTA reported on the balance sheet is the amount expected to be realized; in future years where no taxable income will exists (more likely than not, 50%), a valuation allowance will be created for that amount unable to be realized

DTA and valuation allowance entry

a debit to DTA for total temporary difference times tax rate, a debit to income tax expense-current for taxable income times tax rate, a credit to income tax payable for current tax expense amount, a credit to income tax benefit-deferred for specific portion of DTA reversal amount, and a credit to DTA valuation allowance for the total DTA minus specific portion of DTA reversal amount