Chapter 17 - Income Taxes

What is a Net Operating Loss carry forward?

An NOL carry forward occurs when a company’s expenses exceed its revenue, creating a tax loss that can be used in future years to reduce taxable income and lower payments.

When can a company recognize an NOL as a Deferred Tax Asset?

If the company expects to have enough future taxable income to use the NOL with greater than 50% probability, it can record the tax benefit as a DTA

How does an NOL impact the income Statement?

If an NOL is expected to be used in the future, the company records a tax benefit, which increase reported net income.

Why do companies create a valuation allowance for NOLs?

If there is less than 50% chance that the company will earn enough taxable income to use the NOL, the valuation allowance ensures that the tax benefit is not recognized prematurely

What happens if the company later earns enough taxable income to use the NOL?

The valuation allowance is removed, and the tax benefit is recognized when the NOL is actually applied.

What are the permanent differences in financial and taxable income?

Permanent differences occur when income or expense items are treated differently under GAAP and tax law(IRC), meaning they never reverse or align over time.

How should permanent differences be handled in financial statements?

Adjust pretax income to align with taxable income, ensuring proper reconciliation

What happens when there are NO timing or permanent difference in taxable income?

Tax expense equals tax payable, so diving the tax expense by pretax income gives the effective tax rate.

Why do we need to use the marginal tax rate for differed tax items?

Because timing differences affect when income is taxed, we must use the rate applied to the next dollar earned to ensure accurate tax calculations.

What relationship does taxable amounts have on taxable income and tax payable?

The temporary differences give rise to higher future taxable income and higher tax payable.

What relationship does Deferred Tax Liability have with expected future taxable income?

The Deferred Tax Liability is an expected future increase in Tax Payable.

What relationship does Deductibles have on taxable income and tax payable?

They cause comparatively lower taxable income and tax payable in the future.

What relationship does Deferred Tax Asset have with future taxable income?

It is expected future decrease in Tax Payable and decrease current tax expense.

What are the problems with Deferred Tax Asset realization?

In order to use higher tax deductions in future years, we must have taxable income to deduct against.