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Accounting For Income Taxes
Accounting For Income Taxes
Accounting For Income Taxes
Coby Harmon
University of California, Santa Barbara
Westmont College
19-1
CHAPTER 19
Accounting for Income Taxes
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe the fundamentals of 3. Explain the accounting for loss
accounting for income taxes. carrybacks and loss
carryforwards.
2. Identify additional issues in
accounting for income taxes. 4. Describe the presentation of
deferred income taxes in
financial statements.
19-2
PREVIEW OF CHAPTER 19
Intermediate Accounting
IFRS 3rd Edition
Kieso ● Weygandt ● Warfield
19-3
Accounting for Income LEARNING OBJECTIVE 1
Describe the fundamentals of
Taxes accounting for income taxes.
19-4 LO 1
Accounting for Income Taxes
vs.
19-5 LO 1
Accounting for Income Taxes
19-6 LO 1
Financial vs. Taxable Differences ILLUSTRATION 19.2
Financial Reporting
Income
19-8 LO 1
Financial Reporting for 2019
Expenses:
Liabilities:
Deferred taxes 12,000
Income taxes payable 16,000
Income tax expense 28,000
Equity:
Net income (loss)
Where does the “deferred tax liability” get reported in the financial
statements?
19-9 LO 1
Future Taxable and Deductible Amounts
ILLUSTRATION 19.5
Temporary Difference, Accounts Receivable
19-11 LO 1
Future Taxable Amounts and Deferred Taxes
Chelsea assumes that it will collect the accounts receivable and report
the $30,000 collection as taxable revenues in future tax returns.
Chelsea does this by recording a deferred tax liability.
19-12 LO 1
Future Taxable Amounts and Deferred Taxes
ILLUSTRATION 19.4
Comparison of Income Tax Expense
to Income Taxes Payable
19-13 LO 1
Deferred Tax Liability
ILLUSTRATION 19.9
Computation of Income Tax Expense, 2019
19-14 LO 1
Deferred Tax Liability ILLUSTRATION 19.4
Comparison of Income Tax Expense
to Income Taxes Payable
19-15 LO 1
Deferred Tax Liability ILLUSTRATION 19.4
Comparison of Income Tax Expense
to Income Taxes Payable
19-16 LO 1
Deferred Tax Liability ILLUSTRATION 19.4
Comparison of Income Tax Expense
to Income Taxes Payable
19-17 LO 1
Deferred Tax Liability
The entry to record income taxes at the end of 2021 reduces the
Deferred Tax Liability by $4,000. The Deferred Tax Liability account
appears as follows at the end of 2021 .
ILLUSTRATION 19.12
Deferred Tax Liability Account after Reversals
19-18 LO 1
Financial Statement Effects
ILLUSTRATION 19.13
Balance Sheet Presentation,
Deferred Tax Liabilities
2019
2020
2021
ILLUSTRATION 19.14
Income Statement Presentation,
Income Tax Expense
19-19 LO 1
Financial Statement Effects
ILLUSTRATION 19.14
Income Statement
Presentation, Income
Tax Expense
ILLUSTRATION 19.15
Components of Income Tax Expense
19-20 LO 1
Deferred Tax Liability
Instructions
19-22 LO 1
Future Deductible Amounts and Deferred
Taxes
Illustration: During 2019, Cunningham Inc. estimated its warranty
costs related to the sale of microwave ovens to be $500,000, paid
evenly over the next two years. For book purposes, in 2019
Cunningham reported warranty expense and a related estimated
liability for warranties of $500,000 in its financial statements. For
tax purposes, the warranty tax deduction is not allowed until paid.
ILLUSTRATION 19.16
Temporary Difference, Warranty Liability
19-23 LO 1
Future Deductible Amounts and Deferred
Taxes
Illustration: Reversal of Temporary Difference.
ILLUSTRATION 19.17
19-25 LO 1
Deferred Tax Asset
19-26 LO 1
ILLUSTRATION 19.18
IFRS and Tax Reporting, Hunt Company
19-27 LO 1
Deferred Tax Asset
ILLUSTRATION 19.19
Computation of Deferred Tax Asset, End of 2019
19-28 LO 1
Deferred Tax Asset
ILLUSTRATION 19.20
Schedule of Future Deductible Amounts
19-29 LO 1
Deferred Tax Asset
Assume that 2019 is Hunt’s first year of operations, and income tax
payable is $200,000, compute income tax expense. ILLUSTRATION 19.21
Computation of Income
Tax Expense, 2019
ILLUSTRATION 19.24
Income Statement
Presentation, Deferred
Tax Asset
19-32
Deferred Tax Asset
The entry to record income taxes at the end of 2020 reduces the
Deferred Tax Asset by $20,000.
ILLUSTRATION 19.25
Deferred Tax Asset Account after Reversals
19-33 LO 1
Deferred Tax Asset
Instructions
19-34 LO 1
Deferred Tax Asset
19-35 LO 1
Accounting for Income Taxes
19-36 LO 1
Deferred Tax Asset (Non-Recognition)
Instructions:
Assuming that it is probable that €30,000 of the deferred tax asset
will not be realized, prepare the journal entry at the end of 2019 to
recognize this probability.
19-37 LO 1
Deferred Tax Asset (Non-Recognition)
Illustration: Current Yr.
INCOME: 2018 2019 2020 2021
Financial income (IFRS) 725,000
Temporary difference 375,000 125,000 (500,000)
Taxable income (TA) 375,000 850,000 (500,000) -
Tax rate 40% 40% 40% 40%
Income tax 150,000 340,000 (200,000) -
19-39 LO 2
Income Statement Presentation
ILLUSTRATION 19.28
19-40 LO 2
Additional Issues
Specific Differences
Temporary Differences
Taxable temporary differences - Deferred tax liability
Deductible temporary differences - Deferred tax
Asset
19-41 LO 2
Temporary Differences ILLUSTRATION 19.29
Examples of Temporary
Differences
Revenues or gains are taxable after they are recognized in financial income.
Expenses or losses are deductible after they are recognized in financial income.
A liability (or contra asset) may be recognized for expenses or losses that will result in
deductible amounts in future years when the liability is settled. Examples:
1. Product warranty liabilities.
2. Estimated liabilities related to discontinued operations or restructurings.
3. Litigation accruals.
4. Bad debt expense recognized using the allowance method for financial reporting
purposes; direct write-off method used for tax purposes.
5. Share-based compensation expense.
6. Unrealized holding losses for financial reporting purposes (including use of the fair
value option), but deferred for tax purposes.
19-43 LO 2
Temporary Differences ILLUSTRATION 19.29
Examples of Temporary
Differences
Revenues or gains are taxable before they are recognized in financial income.
19-44 LO 2
Temporary Differences ILLUSTRATION 19.29
Examples of Temporary
Differences
Expenses or losses are deductible before they are recognized in financial income.
The cost of an asset may have been deducted for tax purposes faster than it was
expensed for financial reporting purposes. Amounts received upon future recovery of
the amount of the asset for financial reporting (through use or sale) will exceed the
remaining tax basis of the asset and thereby result in taxable amounts in future
years. Examples:
1. Depreciable property, depletable resources, and intangibles.
2. Deductible pension funding exceeding expense.
3. Prepaid expenses that are deducted on the tax return in the period paid.
4. Development costs that are deducted on the tax return in the period paid.
19-45 LO 2
Specific Differences
19-46 LO 2
Specific Differences
Permanent Differences
Result from items that
► enter into pretax financial income but never into
taxable income or
Items are recognized for financial reporting purposes but not for tax purposes.
Examples:
1. Interest received on certain types of government obligations.
2. Expenses incurred in obtaining tax-exempt income.
3. Fines and expenses resulting from a violation of law.
4. Charitable donations recognized as expense but sometimes not deductible for tax
purposes.
Items are recognized for tax purposes but not for financial reporting purposes.
Examples:
1. “Percentage depletion” of natural resources in excess of their cost.
2. The deduction for dividends received from other corporations, sometimes considered
tax-exempt.
19-48 LO 2
Specific Differences
Illustration
Do the following generate:
Future Deductible Amount = Deferred Tax Asset
Future Taxable Amount = Deferred Tax Liability
Permanent Difference
received. Asset
19-49 LO 2
Specific Differences
Illustration
Do the following generate:
Future Deductible Amount = Deferred Tax Asset
Future Taxable Amount = Deferred Tax Liability
Permanent Difference
Future Deductible
4. Costs of guarantees and warranties are estimated Amount
and accrued for financial reporting purposes. Asset
19-50 LO 2
Specific Differences
E19-4: Havaci SpA reports pretax financial income of €80,000 for
2019. The following items cause taxable income to be different than
pretax financial income.
1. Depreciation on the tax return is greater than depreciation on
the income statement by €16,000.
2. Rent collected on the tax return is greater than rent earned on
the income statement by €27,000.
3. Fines for pollution appear as an expense of €11,000 on the
income statement.
Havaci’s tax rate is 30% for all years, and the company expects to
report taxable income in all future years. There are no deferred taxes
at the beginning of 2019.
19-51 LO 2
Specific Differences
E19-4: Current Yr. Deferred Deferred
INCOME: 2019 Asset Liability
Financial income (IFRS) € 80,000
Excess tax depreciation (16,000) € 16,000
Excess rent collected 27,000 (€ 27,000)
Fines (permanent) 11,000
Taxable income (TA) 102,000 (27,000) 16,000
Tax rate 30% 30% 30%
Income tax € 30,600 (€ 8,100) € 4,800
19-52 LO 2
Additional Issues
If new rates are not yet enacted for future years, Wang should
use the current rate.
19-53 LO 2
Future Tax Rates
Illustration: Wang Group at the end of 2016 has the following
cumulative temporary difference of ¥300,000, computed as shown.
ILLUSTRATION 19.33
Computation of
Cumulative Temporary
Difference
Assume that the ¥300,000 will reverse and result in taxable amounts
in the future, with the enacted tax rates shown.
ILLUSTRATION 19.34
19-54 Deferred Tax Liability Based on Future Rates LO 2
Future Tax Rates
Assume that the ¥300,000 will reverse and result in taxable amounts
in the future, with the enacted tax rates shown.
ILLUSTRATION 19.34
Wang may only use tax rates other than the current rate when
the future tax rates have been enacted.
If new rates are not yet enacted for future years, Wang should
use the current rate.
19-55 LO 2
Tax Rate Considerations
19-56 LO 2
Revision of Future Tax Rates
Illustration: Assume that on December 10, 2018, a new income
tax act is signed into law that lowers the company tax rate from 40
percent to 35 percent, effective January 1, 2020. If Hostel Co. has
one temporary difference at the beginning of 2018 related to $3
million of excess tax depreciation, then it has a Deferred Tax
Liability account with a balance of $1,200,000 ($3,000,000 × 40%)
at January 1, 2018. If taxable amounts related to this difference are
scheduled to occur equally in 2019, 2020, and 2021, the deferred
tax liability at the end of 2018 is $1,100,000.
ILLUSTRATION 19.35
19-57
Schedule of Future Taxable Amounts and Related Tax Rates LO 2
Revision of Future Tax Rates
19-58 LO 2
LEARNING OBJECTIVE 3
Accounting for Net Explain the accounting for loss
carrybacks and loss
Operating Losses carryforwards.
19-59 LO 3
Accounting for Net Operating Losses
Loss Carryback
Back 2 years and forward 20 years.
ILLUSTRATION 19.36
Loss Carryback Procedure
19-60 LO 3
Accounting for Net Operating Losses
Loss Carryforward
May elect to forgo loss carryback and
ILLUSTRATION 19.30
Loss Carryforward Procedure
19-61 LO 3
Loss Carryback Example
19-62 LO 3
Loss Carryback Example
Illustration: 2015 2016 2017 2018
Financial income
Difference
Taxable income (loss) $ 50,000 $ 100,000 $ 200,000 $ (500,000)
Rate 35% 30% 40%
Income tax $ 17,500 $ 30,000 $ 80,000
NOL Schedule
Taxable income $ 50,000 $ 100,000 $ 200,000 $ (500,000)
Carryback (100,000) (200,000) 300,000
Taxable income 50,000 - - (200,000)
Rate 35% 30% 40% 0%
Income tax (revised) $ 17,500 $ - $ - $ -
19-63 LO 3
Loss Carryback Example
Illustration: 2015 2016 2017 2018
NOL Schedule
Taxable income $ 50,000 $ 100,000 $ 200,000 $ (500,000)
Carryback (100,000) (200,000) 300,000
Taxable income 50,000 - - (200,000)
Rate 35% 30% 40% 0%
Income tax (revised) $ 17,500 $ - $ - $ -
19-64 LO 3
Loss Carryback Example
ILLUSTRATION 19.38
Recognition of Benefit of the Loss Carryback in the Loss Year
19-65 LO 3
Loss Carryforward Example
Illustration: 2015 2016 2017 2018
NOL Schedule
Taxable income $ 50,000 $ 100,000 $ 200,000 $ (500,000)
Carryback (100,000) (200,000) 300,000
Taxable income 50,000 - - (200,000)
Rate 35% 30% 40% 40%
Income tax (revised) $ 17,500 $ - $ - $ (80,000)
19-66 LO 3
Carryforward (Recognition)
Illustration: 2015 2016 2017 2018
NOL Schedule
Taxable income $ 50,000 $ 100,000 $ 200,000 $ (500,000)
Carryback (100,000) (200,000) 300,000
Taxable income 50,000 - - (200,000)
Rate 35% 30% 40% 40%
Income tax (revised) $ 17,500 $ - $ - $ (80,000)
19-67 LO 3
Carryforward (Recognition)
The two accounts credited are contra income tax expense items,
which Groh presents on the 2018 income statement shown.
ILLUSTRATION 19.39
Recognition of the Benefit of the Loss
Carryback and Carryforward in the Loss Year
19-68 LO 3
Carryforward (Recognition)
2018 2019
NOL Schedule
Taxable income $ (500,000) $ 250,000
Carryback (carryforward) 300,000 (200,000)
Taxable income (200,000) 50,000
Rate 40% 40%
Income tax (revised) $ (80,000) $ 20,000
19-69 LO 3
Carryforward (Recognition)
2018 2019
NOL Schedule
Taxable income $ (500,000) $ 250,000
Carryback (carryforward) 300,000 (200,000)
Taxable income (200,000) 50,000
Rate 40% 40%
Income tax (revised) $ (80,000) $ 20,000
19-70 LO 3
Carryforward (Recognition)
The 2019 income statement does not report the tax effects of
either the loss carryback or the loss carryforward because Groh
had reported both previously.
ILLUSTRATION 19.41
Presentation of the Benefit of Loss Carryforward Realized in 2019, Recognized in 2018
19-71 LO 3
Carryforward (Non-Recognition)
Assume that Groh will not realize the entire NOL carryforward in
future years. In this situation, Groh does not recognize a deferred
tax asset for the loss carryforward because it is probable that it
will not realize the carryforward. Groh makes the following journal
entry in 2018.
19-72 LO 3
Carryforward (Non-Recognition)
ILLUSTRATION 19.42
Recognition of Benefit of Loss Carryback Only
19-73 LO 3
Carryforward (Non-Recognition)
19-74 LO 3
Carryforward (Non-Recognition)
Assuming that Groh derives the income for 2019 from continuing
operations, it prepares the income statement as shown.
ILLUSTRATION 19.43
Recognition of Benefit of Loss Carryforward When Realized
19-75 LO 3
Non-Recognition Revisited
ILLUSTRATION 19.44
Possible Sources of Taxable Income
19-76 LO 3
LEARNING OBJECTIVE 4
Financial Statement Describe the presentation of
deferred income taxes in
Presentation financial statements.
The net deferred tax asset or net deferred tax liability is reported
in the non-current section of the statement of financial position.
19-77 LO 4
Statement of Financial Position
ILLUSTRATION 19.45
Classification of Temporary Differences
19-78 LO 4
Financial Statement Presentation
Income Statement
Companies allocate income tax expense (or benefit) to
continuing operations,
discontinued operations,
other comprehensive income, and
prior period adjustments.
19-79 LO 4
Income Statement
19-80 LO
LO44
Financial Statement Presentation
Tax Reconciliation
Companies either provide:
A numerical reconciliation between tax expense (benefit)
and the product of accounting profit multiplied by the
applicable tax rate(s), disclosing also the basis on which
the applicable tax rate(s) is (are) computed; or
19-81 LO 4
Review of the Asset-Liability Method
ILLUSTRATION 19.50
Basic Principles of the Asset-Liability Method
19-82 LO 4
ILLUSTRATION 19.51
Procedures for Computing
and Reporting Deferred
Income Taxes
19-83 LO 4
Comprehensive Example of Interperiod
APPENDIX 19A
Tax Allocation
LEARNING OBJECTIVE 5
Apply the concepts and procedures of interperiod tax allocation.
Fiscal Year-2018
Akai Ltd., which began operations at the beginning of 2018, produces
various products on a contract basis. Each contract generates an
income of ¥80,000 (amounts in thousands). Some of Akai’s contracts
provide for the customer to pay on an installment basis. Under these
contracts, Akai collects one-fifth of the contract revenue in each of the
following four years. For financial reporting purposes, the company
recognizes income in the year of completion (accrual basis); for tax
purposes, Akai recognizes income in the year cash is collected
(installment basis).
19-84 LO 5
Comprehensive Example of Interperiod
APPENDIX 19A
Tax Allocation
Fiscal Year-2018
Presented below is information related to Akai’s operations for 2018.
19-85 LO 5
Comprehensive Example of Interperiod
APPENDIX 19A
Tax Allocation
19-86 LO 5
Comprehensive Example of Interperiod
APPENDIX 19A
Tax Allocation
3. The company warrants its product for two years from the date of
completion of a contract. During 2018, the product warranty
liability accrued for financial reporting purposes was ¥200,000,
and the amount paid for the satisfaction of warranty liability was
¥44,000. Akai expects to settle the remaining ¥156,000 by
expenditures of ¥56,000 in 2019 and ¥100,000 in 2020.
19-87 LO 5
Comprehensive Example of Interperiod
APPENDIX 19A
Tax Allocation
2018 50%
19-88 LO 5
Comprehensive Example of Interperiod
APPENDIX 19A
Tax Allocation
ILLUSTRATION 19A.1
Computation of Taxable Income, 2018
19-89 LO 5
ILLUSTRATION 19A.1
ILLUSTRATION 19A.2
Computation of Income Taxes Payable, End of 2018
19-90 LO 5
Computing Deferred Income Taxes
ILLUSTRATION 19A.3
– End of 2018 Schedule of Future Taxable and
Deductible Amounts, End of 2018
ILLUSTRATION 19A.4
19-91 Computation of Deferred Income Taxes, End of 2018 LO 5
Deferred Tax Expense (Benefit) and the Journal
Entry to Record Income Taxes - 2018
Computation of Deferred Tax Expense (Benefit), 2018
ILLUSTRATION 19A.5
ILLUSTRATION 19A.6
19-92 Computation of Net Deferred Tax Expense, 2018 LO 5
Comprehensive Example of Interperiod
APPENDIX 19A
Tax Allocation
19-94 LO 5
Financial Statement Presentation - 2018
Statement of Financial Position Presentation for 2018.
ILLUSTRATION 19A.9
ILLUSTRATION 19A.10
19-95 Income Statement Presentation of Income Tax Expense, 2018 LO 5
GLOBAL ACCOUNTING INSIGHTS
LEARNING OBJECTIVE 6
Compare the accounting for income taxes under IFRS and U.S. GAAP.
Similar to IFRS, U.S. GAAP uses the asset and liability approach for recording
deferred taxes. The differences between IFRS and U.S. GAAP involve a few
exceptions to the asset-liability approach; some minor differences in the
recognition, measurement, and disclosure criteria; and differences in
implementation guidance.
19-96 LO 6
GLOBAL ACCOUNTING INSIGHTS
Relevant Facts
Following are the key similarities and differences between U.S. GAAP and
IFRS related to accounting for taxes.
Similarities
• As indicated above, U.S. GAAP and IFRS both use the asset and liability
approach for recording deferred taxes.
• After a recent FASB standard, the classification of deferred taxes under
U.S. GAAP is always non-current, not based on the classification of the
asset or liability to which it relates. This accounting is now converged with
IFRS.
19-97 LO 6
GLOBAL ACCOUNTING INSIGHTS
Relevant Facts
Differences
• U.S. GAAP uses an impairment approach to assess the need for a
valuation allowance. In this approach, the deferred tax asset is recognized
in full. It is then reduced by a valuation account if it is more likely than not
that all or a portion of the deferred tax asset will not be realized. Under
IFRS, an affirmative judgment approach is used, by which a deferred tax
asset is recognized up to the amount that is probable to be realized.
• Under U.S. GAAP, the enacted tax rate must be used in measuring deferred
tax assets and liabilities. IFRS uses the enacted tax rate or substantially
enacted tax rate (“substantially enacted” means virtually certain).
19-98 LO 6
GLOBAL ACCOUNTING INSIGHTS
Relevant Facts
Differences
• Under U.S. GAAP, charges or credits for all tax items are recorded in
income. That is not the case under IFRS, in which the charges or credits
related to certain items are reported in equity.
• U.S. GAAP requires companies to assess the likelihood of uncertain tax
positions being sustainable upon audit. Potential liabilities must be accrued
and disclosed if the position is more likely than not to be disallowed. Under
IFRS, all potential liabilities must be recognized. With respect to
measurement, IFRS uses an expected-value approach to measure the tax
liability, which differs from U.S. GAAP.
19-99 LO 6
GLOBAL ACCOUNTING INSIGHTS
On the Horizon
The IASB and the FASB have been working to address some of the
differences in the accounting for income taxes. One of the issues under
discussion is the term “probable” under IFRS for recognition of a deferred tax
asset, which might be interpreted to mean “more likely than not.” If the term is
changed, the reporting for impairments of deferred tax assets will be
essentially the same between U.S. GAAP and IFRS. In addition, the IASB is
considering adoption of the classification approach used in U.S. GAAP for
deferred assets and liabilities. Also, U.S. GAAP will likely continue to use the
enacted tax rate in computing deferred taxes, except in situations where the
U.S. taxing jurisdiction is not involved. In that case, companies should use
IFRS, which is based on enacted rates or substantially enacted tax rates.
Finally, the issue of allocation of deferred income taxes to equity for certain
transactions under IFRS must be addressed in order to converge with U.S.
GAAP, which allocates the effects to income.
19-100 LO 6
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19-101