Int. 2: Ch. 18 Accounting for Income Taxes

Pretax financial income

Financial reporting term, referred to as “income before taxes”, “income for financial reporting purposes”, or “income for book purposes”.

• Companies determine according to GAAP, and must follow accrual-based accounting

  • Measured with the objective of providing useful information to investors and creditors.

Taxable Income

Indicates the amount used to compute income taxes payable to the Internal Revenue Service (IRS), with the objective of calculating taxes owed to support government operations

• Known as “Income for tax purposes”

• Determined by the Internal Revenue Code (the tax code or IRC); cash-based accounting approach.

Temporary Difference

The difference between the tax basis of an asset or liability and its reported carrying or book value in the GAAP-based financial statements.

• Result in taxable amounts or deductible amounts in future years.

Taxable Amount

increases taxable income in future years.

Deductible Amount

Decreases taxable income in future years

Deferred Tax Liability

Represents the increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year

• Deferred tax consequences attributable to taxable temporary differences

Current Tax Expense (Benefit)

The amount of income taxes paid or payable (or refundable) for a year as determined by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues for that year.

Deferred Tax Expense

The change in the deferred tax liability balance from the beginning to the end of the accounting period.

Deferred Tax Asset

Represents the increase in taxes refundable (or saved) in future years as a result of deductible temporary differences existing at the end of the current year

• Deferred tax consequence attributable to deductible temporary differences

Deferred Tax Benefit

Results from the increase in the deferred tax asset from the beginning to the end of the accounting period

Valuation Allowance

Account that reduces a deferred tax asset if based on available evidence, it is “more likely than not” that it will not realize some portion or all of the deferred tax asset.

• The portion of a deferred tax asset for which it is more likely than not that a company will not realize a tax benefit.

More likely than not

Level of likelihood of at least slightly more than 50%.

Taxable Temporary Differences

temporary differences that will result in taxable amounts in future years when the related assets are recovered

Deductible Temporary Differences

Temporary differences that will result in deductible amounts in future years, when the related book liabilities are settled.

Originating Temporary Difference

The initial difference between the book basis and the tax basis of an asset or liability, regardless of whether the tax basis of the asset or liability exceeds or is exceeded by the book basis of the asset or liability.

Reversing Difference

Occurs when eliminating a temporary difference that originated in prior periods and then removing the related tax effect from the deferred tax account.

Permanent Differences

They affect one but not the other; result from items that enter into pretax financial income but never into taxable income or enter into taxable income but never into pretax financial income.

Effective Tax Rate

Dividing total income tax expense for the period by pretax financial income

Enacted Tax Rate

Presently enacted changes in the tax rate that become effective for a particular future year(s) when determining the tax rate to apply to existing temporary differences.

Net Operating Losses (NOL)

Occurs for tax purposes in a year when tax-deductible expenses exceed taxable revenues.

• A company pays no income taxes for a year in which it is incurred

Loss Carryforward

Company may carry the NOL forward indefinitely to offset future taxable income and reduce taxes payable in future years

Asset-Liability Method

Method for accounting for income taxes

• One objective of this approach is to recognize the amount of taxes payable or refundable for the current year.

• A second objective is to recognize deferred tax liabilities and assets for the future tax consequences of events that have been recognized in the financial statements or tax returns.

Carryforwards

Deductions or credits that cannot be utilized on the tax return during a year and that may be carried forward to reduce taxable income or taxes payable in a future year. An operating loss carryforward is an excess of tax deductions over gross income in a year. A tax credit carryforward is the amount by which tax credits available for utilization exceed statutory limitations.

Deferred Tax Consequences

The future effects on income taxes as measured by the enacted tax rate and provisions of the enacted tax law resulting from temporary differences and carryforwards at the end of the current year.

Deferred Tax Expense (Benefit)

The change during the year in a company’s deferred tax liabilities and assets.

Income Taxes

Domestic and foreign federal (national), state, and local (including franchise) taxes based on income.

Income tax Expense (Benefit)

The sum of current tax expense (benefit) and deferred tax expense (benefit).

Tax-Planning Strategy

An action that meets certain criteria and that a company implements to realize a tax benefit for an operating loss or tax credit carryforward. Companies consider tax-planning strategies when assessing the need for and amount of a valuation allowance for deferred tax assets.