Ch. 6 Accounting for Income Taxes (Taxation)

What is ASC 740?

The accounting standard for reporting current and deferred income taxes in financial statements.

What are the two main objectives of ASC 740?

Recognize current taxes payable or refundable and future tax assets or liabilities.

Which taxes are covered by ASC 740?

Federal, state, local, and foreign taxes based on income.

What is the income tax provision?

The total income tax expense or benefit reported on the income statement.

What is the formula for total income tax provision?

Current income tax expense + deferred income tax expense.

What is the matching principle for income taxes?

Recognize tax expense in the period the related book income is recognized.

What is pretax book income?

Income calculated under financial accounting rules before income taxes.

What is taxable income?

Income calculated under tax law to determine income taxes owed.

What is a permanent book-tax difference?

An item treated differently for book and tax purposes that never reverses.

What is a temporary book-tax difference?

An item recognized for book and tax purposes in different periods that eventually reverses.

What is a favorable book-tax difference?

A difference that decreases current taxable income compared with pretax book income.

What is an unfavorable book-tax difference?

A difference that increases current taxable income compared with pretax book income.

Give two examples of permanent differences.

Tax-exempt municipal bond interest and nondeductible life insurance premiums.

Why are nondeductible life insurance premiums added back to book income?

They are book expenses but cannot be deducted for tax purposes.

Do permanent differences create DTAs or DTLs?

No, because permanent differences never reverse.

Give three examples of temporary differences.

Depreciation, warranty expenses, and bad debt reserves.

What is a deferred tax asset (DTA)?

A future tax benefit from deductible temporary differences or eligible tax carryforwards.

What is a deferred tax liability (DTL)?

A future tax obligation from taxable temporary differences.

What does an initially favorable temporary difference generally create?

A DTL because taxes are lower now but higher when the difference reverses.

What does an initially unfavorable temporary difference generally create?

A DTA because taxes are higher now but lower when the difference reverses.

How is current income tax expense generally calculated?

Taxable income × applicable tax rate, adjusted for other current tax items when necessary.

How are ending DTA and DTL balances calculated?

Cumulative temporary differences × enacted tax rate expected when they reverse.

What is a tax carryforward?

An unused tax deduction or loss that may reduce taxable income in a future year.

What are three common tax carryforwards?

Net operating losses, net capital losses, and charitable contributions.

What is a valuation allowance?

A reduction of a DTA for tax benefits that are not expected to be realized.

When is a valuation allowance required?

When it is more likely than not, meaning greater than 50%, that some or all of a DTA will not be realized.

How is deferred income tax expense calculated from balance changes?

Increase in DTL minus increase in net DTA, assuming the changes affect income tax expense.

What is the effective tax rate (ETR) formula?

Total income tax provision ÷ pretax book income.

What is an uncertain tax position under ASC 740?

A tax position whose benefit must meet recognition and measurement requirements because its tax treatment is uncertain.

What is a return-to-provision true-up?

An adjustment reconciling estimated tax provision amounts with the actual filed tax return.