ACCT 202B Chapter 16

temporary difference

arise when tax rules and accounting rules recognize income in different periods

deferred tax liabilities

recognized when activities reported in current period’s income statement will produce future taxable amounts

reports lower taxable income in current periods and pays less tax in current period. eventually will report higher taxable income and pay more tax

deferred tax assets

recognized when activities reported in the current period’s income statement will produce future deductible amounts

report higher taxable income and pay higher tax in current period. eventually will report lower taxable income and pay less tax

key to understanding accounting for income taxes

tax expense is a plug in the journal entry that records any current tax payable as well as any changes in deferred tax assets and liabilities

step 1

calculate tax payable

step 2

calculate ending deferred tax assets and deferred tax liabilities

step 3

calculate change in deferred tax assets and deferred tax liabilities

step 4

plug tax expense

revenues reported in the income statement now, but on the tax return later

created deferred tax liabilities because they result in taxable amounts on a tax return in some future years

expenses reported in the income statement now, but on the tax return later

created deferred tax assets because they result in deductible amounts on a tax return in some future years

revenues reported in the tax return now, but on the income statement later

created deferred tax assets because they result in deductible amounts on a tax return in some future years

expenses reported in the tax return now, but on the income statement later

created deferred tax liabilities because they result in taxable amounts on a tax return in some future years

installment sales of property (installment method for taxes)

created deferred tax liabilities because they result in taxable amounts on a tax return in some future years

unrealized gain from recording investments at fair value (taxable when asset is sold)

created deferred tax liabilities because they result in taxable amounts on a tax return in some future years

estimated expenses and losses (tax deductible when paid)

created deferred tax assets because they result in deductible amounts on a tax return in some future years

unrealized loss from recording investments at fair value or inventory at LCM (tax-deductible when asset is sold)

created deferred tax assets because they result in deductible amounts on a tax return in some future years

rent collected in advance

created deferred tax assets because they result in deductible amounts on a tax return in some future years

subscriptions collected in advance

created deferred tax assets because they result in deductible amounts on a tax return in some future years

other revenue collected in advance

created deferred tax assets because they result in deductible amounts on a tax return in some future years

accelerated depreciation on the tax return in excess of straight-line depreciation in the income statement

created deferred tax liabilities because they result in taxable amounts on a tax return in some future years

prepaid expenses (tax deductible when paid)

created deferred tax liabilities because they result in taxable amounts on a tax return in some future years

balance sheet effect

just as assets and liabilities have a book value that is shown on the balance sheet, they have an equivalent tax basis

tax basis

an asset or liability’s original value for tax purposes adjusted by any amounts included to date on tax returns

book-tax difference

a difference between book value and tax basis, which implies a future taxable or deductible amount and can be used to calculate deferred tax assets and liabilities

book value

original value reduced by amortization, impairment, or other amounts recognized for accounting purposes

future taxable amounts

the increase in taxable income expected in future periods due to current temporary differences between tax rules and financial reporting

future deductible amounts

situations where future tax consequence of a temporary difference will be to decrease taxable income relative to accounting income

valuation allowance

used to reduce the carrying value of deferred tax assets if we believe it is “more likely than not” that there will not be enough taxable income to utilize the tax deduction

permanent difference

caused by transactions and events that under existing tax law will never affect taxable income or taxes payable

effective tax rate

company’s tax expense divided by its pretax accounting income

permanent difference reduces pretax accounting income

increase effective tax rate

permanent difference increases pretax accounting income

reduce effective tax rate

effective tax rate reconciliation

shows major reasons why company’s effective tax rate differs from what it would have been if tax expense was based on only the federal statutory rate

times that commonly appear in effective tax rate reconciliation

permanent differences

state and local taxes

tax credits

changes in valuation allowance

starting in 2025, companies must also separately disclose the effects of the following additional reconciliation items

foreign tax effects

cross-border tax laws

new tax laws

changes in unrecognized tax benefits

to measure deferred tax liability or asset

multiply a temporary difference by the currently enacted tax rate that will be effective in the years the temporary difference reverses

when phased-in change in rates is scheduled to occur

the specific tax rates of each future year are multiplied by the amounts reversing in each of those years

when tax laws change

any existing deferred tax liability or asset must be adjusted to reflect the effects one the change

the change affects

amount that should be in ending balance of deferred tax asset or liability

adjustment necessary to reach that balance

income tax expense in that year

if the multiple temporary differences create future taxable amounts

the total of the future taxable amounts is multiplied by the future tax rate to determine the appropriate balance for the deferred tax liability

if the multiple temporary differences create future deductible amounts

the total of the future deductible amounts is multiplied by the future tax rate to determine the appropriate balance for the deferred tax asset

net operating loss

negative taxable income: tax-deductible expenses exceed taxable revenues

when net operating loss occurs

there’s no tax payable

tax laws permit net operating loss

to be used to reduce taxable income in subsequent profitable years

net operating loss carryforward

when we use a net operating loss to reduce taxable income in a future year

current federal tax laws and net operating loss

limit most companies to offsetting a maximum of 80% of taxable income with NOL carry forwards in any given year

net operating loss expiration

NOLs don’t expire

companies can carry forward a NOL indefinitely

net income

pretax income minus income tax expense

noncurrent

balance sheet classification for deferred tax liabilities

noncurrent

balance sheet classification for deferred tax assets

noncurrent

balance sheet classification for any valuation allowance against deferred tax assets

if deferred tax accounts relate to same tax-paying component of the company and same tax jurisdiction

they are netted together and shown as a single number in balance sheet

if deferred tax liabilities and assets relate to components of a company that are separate for tax purposes, or relate to different tax jurisdictions

they should not be offset

disclosure notes should include…

current portion of the tax expense or benefit

deferred portion of the tax expense or benefit with separate disclosure of amounts attributable to portions that do not include effect of separately disclosed amounts and operating loss carryforwards

adjustments due to changes in tax laws or rates

adjustments to the beginning-of-the-year valuation allowance due to revised estimates

tax credits

companies must disclose

total of all deferred tax liabilities

total of all deferred tax assets

total valuation allowance recognized for deferred tax assets

net change in valuation allowance

approximate tax effect of each type of temporal difference and carryforward

NOL carryforward disclosure

must disclose amounts of any NOL carry forwards and any applicable expiration dates

December 31, 2017

NOLs arising in tax years beginning after this date can be carried forward indefinitely for federal taxes

uncertain tax positions

the position management takes with respect to an element of tax expense might different from the IRS or other taxing authorities’ position on said item

if uncertainty resolves unfavorably

company could have to pay more tax that it originally recognized

step 1 for recognizing and measuring a liability for uncertain tax positions

A tax benefit may be reflected in the financial statements only if it is “more likely than not” that the company will be able to sustain the tax position, based on its technical merits

step 2 for recognizing and measuring a liability for uncertain tax positions

A tax benefit should be measured as the largest amount of benefits that is “cumulatively greater than 50 percent likely to be realized”

tax benefit or reduction in tax expense

not recorded in current year

income tax expense recording

must be record at the same amount as if the tax deduction was not taken

resolution of uncertainty

“liability - uncertain tax position” gets reduced to zero in the period in which the uncertainty is resolved

deferred tax liability - (deferred tax asset - valuation allowance)

balance sheet representation of deferred tax accounts related to same tax-paying component of the company and same tax jurisdiction

calculating tax payable (1)

pretax accounting income - permanent difference ± temporary difference = taxable income

calculating tax payable (2)

taxable income x enacted tax rate

calculating DTA/DTL end balance

future taxable/deductible amounts x enacted tax rate

calculating change in DTA/DTL

adjust current DTA or DTL so it equals end balance

calculating change in DTA/DTL example

if current DTA/DTL is 0 and the end balance is 10, the change in DTA/DTL is 10

DTL current and end balance

credited

DTA current and end balance

debited

plugging tax expense (1)

record DTA/DTL and income tax payable on journal entry

plugging tax expense (2)

income tax expense should balance out DTA/DTL and income tax payable

Credited

Income tax payable journal entry

calculating DTL temporary difference

deduct in year 1 and add in future years

calculating DTA temporary difference

add in year 1 and deduct in future years

tax return reporting for DTL

revenue later, expense now

tax return reporting for DTA

revenue now, expense later

DTA examples

anything CIA

estimated expense and loss

unrealized loss

CIA

collected in advance

unrealized

gives connotation of “let’s record now and think about it later”

valuation allowance formula

DTA - valuation allowance = net DTA

anything prepaid

future taxable amount (deferred tax liability)

anything accrued

future deductible amount (deferred tax asset)

Worst case scenario

entire position is disallowed and you must owe entire tax

Best case scenario

The entire position is upheld, so you owe no additional tax

Expected scenario

The most likely amount is allowed, so you owe the expected tax

The income tax benefit of an operating loss carryforward reduces the tax expense reported in the income statement

unless it’s more likely than not that the future tax savings will not be realized.

Typically, the tax effects of an operating loss carryforward on net income are

Recognized in the year the loss occurs.