ACCY 113 3/17/25 Notes

Underlying Assets and Liabilities

• Underlying assets lead to future taxable amounts and create deferred tax liabilities (DTLs).

• Underlying liabilities create future deductible amounts and lead to deferred tax assets (DTAs).

Exceptions for Deferred Taxes

• Unrealized Gains on Investments: Credit the unrealized gain account.

• Unrealized Losses on Investments: Debit the unrealized loss and credit the fair value adjustment account.

• Lower Cost or Net Realizable Value Losses on Inventory: Debit the loss; credit the allowance account.

• Bad Debt Expense: Credit allowance for uncollectible accounts.

Basic Rules to Remember

• Assets have debit balances leading to DTLs, while liabilities have credit balances leading to DTAs.

• Use the debit balance on the balance sheet accounts to identify DTLs and DTAs.

Accounting Income vs. Taxable Income

• Understand what to ignore for exam preparation (focus on the current year for specific income measures).

• Know the concept of netting DTLs and DTAs only on the balance sheet presentation, not in schedules or journal entries.

Balance Sheet Presentations

• All deferred tax accounts are classified as noncurrent, as per the simplification process by FASB.

• Net DTAs against DTLs only for balance sheet presentation purposes.

Income Statement Presentation

• Disclose the current portion of income tax expense equal to income taxes payable and the deferred portion reflecting changes in deferred tax accounts.

Tax Rates

• Use only tax rates enacted into law for calculations, not estimates.

Journal Entries for Deferred Taxes

• For year-end, the desired ending balance in accounts must be reflected accurately; journal entries adjust the beginning balance to match the desired ending balance.

• Identify if each year's differences are originating or reversing; this impacts the journal entries.

Example Using a Depreciable Asset

• If tax depreciation exceeds financial depreciation, it creates a temporary difference affecting taxable income.

• The origin of the difference is critical in defining its future implications (taxable or deductible).

Future Taxable Amounts and Deductions

• Always track future taxable amounts based on sales or deductions expected in future years to ensure correct accounting.

Warranty Liability

• Create a Deferred Tax Asset (DTA) when warranty costs are recognized but not yet deductible for tax purposes.

• Adjust taxable income calculations by recognizing these liabilities effectively.

Multiple Temporary Differences Example

• Distinguish between installment accounts receivable (future taxable amounts) and warranty liabilities (future deductible amounts).

• Not until cash is collected do installment sales become taxable; thus, differ in accounting and taxable income calculations.

Final Tips

• Ensure clarity on journal entry preparations and differentiate values during balance realization to avoid confusion in calculations.

• Be aware of how journal entries reflect increased or decreased expenses, especially in relation to deferred tax accounts.

Underlying Assets and Liabilities

• Underlying assets lead to future taxable amounts and create deferred tax liabilities (DTLs). For example, if a company has equipment that depreciates faster for tax purposes than for accounting purposes, this creates a DTL as the taxable income will be lower in the future when the tax deductions are reduced.

• Underlying liabilities create future deductible amounts and lead to deferred tax assets (DTAs). An example is a warranty obligation; when a company recognizes a warranty liability but hasn't yet incurred the expenses, this will create a DTA since the expenses will reduce future taxable income.

Exceptions for Deferred Taxes

• Unrealized Gains on Investments: Credit the unrealized gain account. For instance, if a company holds shares valued at $100,000 but hasn't sold them, the unrealized gain may not be taxed yet.

• Unrealized Losses on Investments: Debit the unrealized loss and credit the fair value adjustment account. If a company holds an investment now worth $75,000 when it cost $100,000, they would record an unrealized loss adjustment.

• Lower Cost or Net Realizable Value Losses on Inventory: Debit the loss; credit the allowance account. For example, if inventory costing $50,000 can only be sold for $40,000, a loss must be recognized.

• Bad Debt Expense: Credit allowance for uncollectible accounts. If a company estimates that $10,000 in accounts receivable won't be collected, it needs to record this as a bad debt expense.

Basic Rules to Remember

• Assets have debit balances leading to DTLs, while liabilities have credit balances leading to DTAs.

• Use the debit balance on the balance sheet accounts to identify DTLs and DTAs.

Accounting Income vs. Taxable Income

• Understand what to ignore for exam preparation (focus on the current year for specific income measures). For instance, temporary differences in depreciation calculations between tax reporting and financial accounting can skew perceptions of income.

• Know the concept of netting DTLs and DTAs only on the balance sheet presentation, not in schedules or journal entries.

Balance Sheet Presentations

• All deferred tax accounts are classified as noncurrent, as per the simplification process by FASB.

• Net DTAs against DTLs only for balance sheet presentation purposes. If a company has a $20,000 DTA and a $15,000 DTL, it would present a net asset of $5,000.

Income Statement Presentation

• Disclose the current portion of income tax expense equal to income taxes payable and the deferred portion reflecting changes in deferred tax accounts. If a company incurs $10,000 in current taxes and has a $2,000 decrease in DTL, this needs to be reflected accordingly.

Tax Rates

• Use only tax rates enacted into law for calculations, not estimates. For example, if the corporate tax rate is legislated at 21%, use that for all tax calculations related to income.

Journal Entries for Deferred Taxes

• For year-end, the desired ending balance in accounts must be reflected accurately; journal entries adjust the beginning balance to match the desired ending balance. If beginning DTL is $5,000 and the target is $7,000, record an increase.

• Identify if each year's differences are originating or reversing; this impacts the journal entries. An originating difference requires recognition in the current period, while a reversing difference means it’s anticipated to balance out in future periods.

Example Using a Depreciable Asset

• If tax depreciation exceeds financial depreciation, it creates a temporary difference affecting taxable income. For example, if a company depreciates an asset by $30,000 for tax whereas $20,000 is used for book purposes, this $10,000 difference leads to a DTL.

• The origin of the difference is critical in defining its future implications (taxable or deductible). If, in the future, the depreciation expense for tax Reporting goes down, the previous DTL may reverse, leading to increased taxable income.

Future Taxable Amounts and Deductions

• Always track future taxable amounts based on sales or deductions expected in future years to ensure correct accounting. For instance, if a company sells products with deferred revenue recognized, ensure sales will be supported in future tax returns when revenue is ultimately realized.

Warranty Liability

• Create a Deferred Tax Asset (DTA) when warranty costs are recognized but not yet deductible for tax purposes. If a company anticipates $5,000 in warranty claims but hasn't paid them yet, this represents a DTA on the balance sheet.

• Adjust taxable income calculations by recognizing these liabilities effectively. The warranty expense recognized will be deductible in the future, lowering taxable income.

Multiple Temporary Differences Example

• Distinguish between installment accounts receivable (future taxable amounts) and warranty liabilities (future deductible amounts). If a company sells on installment, they recognize revenue but only pay taxes when cash is received, leading to a DTL.

• Not until cash is collected do installment sales become taxable; thus, differ in accounting and taxable income calculations. Warranty liabilities will reduce future taxable income, whereas installment sales increase it until realized.

Final Tips

• Ensure clarity on journal entry preparations and differentiate values during balance realization to avoid confusion in calculations. This means knowing how to input entries based on DTL versus DTA balances accurately.

• Be aware of how journal entries reflect increased or decreased expenses, especially in relation to deferred tax accounts. For instance, when warranty costs are recorded, accounts may reflect reductions in net income and adjustments in DTAs accordingly.