CPA FAR 1-75 Income Taxes

Question 1

defer taxes

Answer 1

when possible, under normal conditions, companies want to defer taxes

-created b/c differences US GAAP and IR Code

*GAAP: Income when income earned
expense when incurred
fair representation, matching principle, conservatism

*IRS: income when collected
expense when paid
different rules book vs GAAP

Question 2

Different rules book vs GAAP

Answer 2

different rules book vs GAAP

book income: financial reporting, US GAAP

taxable income: income for tax filing, Internal Revenue Code

deferred tax liability = more tax later
deferred tax asset= less tax later

Question 3

deferred tax liability

Answer 3

more tax later

Question 4

deferred tax asset

Answer 4

less tax later

higher taxable income now = higher book income later

Question 5

permanent differences

Answer 5

any difference between book income and taxable income that has no future tax impact

permanent difference = will not create a deferred tax issue, but permanent differences will impact the current year

Ex interest income muni bond

Question 6

Which is a permanent difference?
1. income that is includible on the books YR 1 and includible on future tax return
2. life ins proceeds payable to company upon death of officer

Answer 6

Correct: 2. life ins proceeds payable to company upon death of officer

Question 7

Which is a permanent difference?
1. includes amounts recd as interest from muni bond
2. includes premiums paid on life ins policy (company is not beneficiary)

Answer 7

Correct: 1. includes amounts recd as interest from muni bond

company not beneficiary = deductible

Question 8

Which is a permanent difference?
1. interest income from US Savings bonds
2. interest income from City of Phoenix bonds

Answer 8

Correct: 2. interest income from City of Phoenix bonds

municipal bond = tax exempt

Question 9

other permanent differences

Answer 9

-entertainment expense NOT deductible
-dividend recd deduction DRD for corps- not expense for GAAP
-Life ins premiums where company is not beneficiary= no tax deduction
-penalties paid
any portion of meals that is not deductible = perm difference

Question 10

which is not a permanent difference between book and taxable income?
-entertainment expense
-DRD- dividends recd deduction
-life insurance premiums where company is not beneficiary
-penalties paid on polluting the river

Answer 10

NOT: -life insurance premiums where company is not beneficiary

Question 11

temporary differences

Answer 11

affect current and deferred tax computation

items that are first recognized for tax purposes will eventually be recognized for GAAP purposes and therefore items are temporary and will eventually reverse

temporary differences = deferred taxes are required

Question 12

temporary differences and deferred taxes

Answer 12

temp differences are items of revenue and expense that may enter into pretax GAAP financial income before they hit the tax return- warranty expense and bad debt expense = deferred taxes required

deferred tax asset: taxable income higher now and book income higher later

cash collected in advance (unearned revenue)

Question 13

temporary differences- income

Answer 13

book income this year, taxable income next year, installment method (cash not collected yet for accrued income/AR)

taxable income this year, book income next year, collecting cash in advance (unearned income- cash collected this year)

Question 14

types of temporary differences (4)

Answer 14

2 relate to income:
-income on the books this year/tax return next year
-income on tax return this year (when collected), books next year (when earned)

2 relate to expense/deductions:
-expense this year (est), deduct next year when paid
-deduct this year tax return, expense next year on books (depreciation)

Question 15

Temp differences: Income

Answer 15

2 relate to income:

-income on the books this year/tax return next year - accrual basis for books and cash basis for tax return

-income on tax return this year (when cash collected), books next year (when earned)

Question 16

Temp differences: Expenses and deductions

Answer 16

2 relate to expense/deductions:

-expense this year (est), deduct next year when paid
Ex. bad debt expense, warranty expense, pension expense

-deduct this year tax return, expense next year on books (depreciation)
Depreciation always greater first years for tax and often straight line for books

Question 17

Tax and bad debt

Answer 17

BAD DEBT= cannot be estimated for tax purposes (bad debt is only deductible for tax purposes when recv is worthless)

book = bad debt is estimated via US GAAP

Question 18

Deferred tax issue: 2 possibilities

Answer 18

temporary difference = creates deferred tax issue
1. pay more tax later because taxable income will be higher than book income in later years
OR
2. pay less tax later because taxable income lower than book in later years

Question 19

Deferred tax asset related to bad debt

Answer 19

pay taxes on full income now (add back bad debt expense that was deducted from income), future tax benefit

I/S (book)
provision for income tax:
current expense $21,000
deferred benefit ($2,100)
total expense $18,900

book (total tax expense) < taxes paid

Question 20

Temporary differences: warranty expense

Answer 20

financial reporting: warranty exp are accrued based on estimates

tax purposes: warranties can only be deducted when an actual cost is incurred

any estimate on the books for warranty expense = temp difference = deferred tax issue

Question 21

Which of the following would result in a deferred tax liability?
1. warranty expense
2. bad debt expense

Answer 21

Neither!

both result in deferred tax assets

Question 22

With respect to deferred taxes, organization costs and start up expenditures result in
1. deferred tax asset
2. deferred tax liability

Answer 22

deferred tax asset

org expenditures and start-up costs are an exp on I/S but are amortized over 180 months for tax = tax benefit later in future tax years

Question 23

Taxes and warranty expense

Answer 23

for tax purposes, a company can only deduct warranty costs that have been paid

not estimates

Question 24

Prepaid Expense = deduction first and expense later

Answer 24

similar to depreciation, this is a temp difference resulting in tax deduction first and book expense later

Ex rent, prepaid ins
rent $12,000 prepaid, expense as incurred $1,000/month

Question 25

Which would result in deferred tax liability?
1. increase in prepaid rent from beg of year to end of year
2. depreciation is higher yr 1 for tax return vs book

Answer 25

Both!

both result in less taxes paid now and more taxes paid later =deferred tax liability

Question 26

A deferred tax liability may result from which of the following:
1. penalties paid for legal violation
2. Life insurance proceeds recd upon death of key employee
3. depreciation of tangible assets
4. interest on muni bonds

Answer 26

3. depreciation of tangible assets (more deprec for tax = less tax now and more later)

depreciation for tax purposes is generally higher vs book which results in less taxes paid now and more taxes paid later

penalties= not deductible for tax (added back/was book exp/perm difference= no reversal)
life ins proceeds/key employee and interest on muni = perm differences (tax exempt) = income for book but not tax

Question 27

Result in less taxable income in future year = deferred tax asset
1. warranty exp deducted YR 1
2. bad debt exp deducted YR 1
3. premium paid on life ins where company is not beneficiary

Answer 27

1 and 2

bad debt and warranty = temp difference (high book vs tax) results less tax later (more tax now as not expensed) when expensed upon actual payment

life ins premium with no company benefit = expensed now = no difference temp or perm (If company was beneficiary = perm difference)

Question 28

Temporary differences resulting in deferred tax assets
1. arise when revenues are taxable before they are recognized in financial income
2. include expenses that are deductible after they are recognized in financial income

Answer 28

1. DTA (more income tax now, less tax later = less book tax now, more income book later)
   Ex prepaid rent
2. DTA (book income less now, tax income more now and less later)
   Ex bad debt or warranty exp

Question 29

another term for future taxable amounts?
1. deferred tax asset
2. deferred tax liability
3. permanent difference

Answer 29

2. deferred tax liability

less tax now and more tax later

Question 30

For plant assets, depreciation expense deducted for tax purposes is:

Answer 30

in excess of depreciation used for financial reporting purposes

DTL less tax now, more tax later
taxable income < book income

Question 31

Asset cost is $50,000
depreciated straight line for book purpose over 10 years
book depreciation is $5,000/year

For tax purposes, depreciation is per IR Code 10 year life and DDB

Answer 31

DTL more deprec now = less tax now
more tax later

Question 32

Prepaid rent taxable in period recd

Answer 32

DTA

rental income taxed as cash recd not earned = more tax now and less tax later (when rent earned)

Question 33

life insurance proceeds are collected by the company on the death of a key officer

Answer 33

permanent difference (not taxable)

when company pays for life insurance for a key employee and company recv proceeds = perm difference (income on the books but not income for tax)

Question 34

Interest of $500 is recd on an investment in US govt obligations

Answer 34

no difference book vs tax

conversely, muni bonds = permanent

Question 35

Life insurance premiums are paid by a corp on behalf of the employees as a fringe benefit. Death benefit is paid to family member not the company.

Answer 35

Benefit paid to family = No difference (premium deductible both I/S and tax)

If benefit paid to company (not family)= permanent difference (tax free proceeds)
paid to company = book = premium expensed I/S
paid to company = premium not deductible for tax

Question 36

company prepays rent for 12 months April 1, YR 1 $24,000 with corporate income tax rate 21%

Answer 36

deferred tax liability (less tax now, more tax later)

tax deduction YR 1 for expense paid in advance = full deduction for tax purposes
less tax now and more tax later

book = expense $18,000 this year and 6,000 next year
$1,260 DTL
tax = expense 24,000 (reverses next tr = temp difference)

Question 37

company uses accrual method for book
installment method for tax

accrual income exceeded installment $360,000
21% tax rate

Answer 37

DTL $75,600
less tax now, more tax later

Question 38

First year of business: company is profitable and expects to remain profitable in future
This year’s sales have a warranty
What is the result?

Answer 38

add back bad debt expense and only deduct actual warranty expenses in future for tax purposes

add back bad debt expense= more tax now and less tax later DTA

Question 39

deferred tax asset

Answer 39

DTA arise then the amount of taxes paid in the current period exceeds the amount of income tax expense for the current period

they are anticipated future benefits derived from situations where future taxable income will be less than future financial accounting income due to temp differences

now: taxable income > book income (pay more tax now, less later)
later: taxable income < book income

Question 40

valuation allowance

Answer 40

if it is more likely than not (likelihood >50%) that part or all of the deferred tax asset will not be realized, the valuation allowance is recognized

the net deferred tax asset should recognize that portion of the deferred tax asset that based on avail evidence is more likely than not to be realized

Question 41

DTA valuation allowance

Answer 41

when there is at least 50% chance of realizing the DTA, it is reported free of any valuation account

when there is less than 50% chance of DTA being fully realized, it is reported but also reduced by a valuation allowance (contra to deferred asset) to the amount that has at least 50% chance of being realized

if sufficient future taxable income is expected, then DTA most likely will be realized

Question 42

Balance sheet reporting of deferred tax assets and liabilities

Answer 42

Under US GAAP, DTL and DTA should be reported as noncurrent amount on B/S

this treatment aligns with IFRS

general rule: DTA and DTL should be netted and presented as one amount
do not net: if DTA or DTL are attributable to different tax paying components of the entity or to different tax jurisdictions = do not net

Question 43

Vogel Corp uses different methods to recognize income from installment sales for financial statement and income tax purposes.
They have temp differences that will reverse in the next year and add to taxable income. Under US GAAP, deferred income taxes that are based on these temp differences should be classified in Vogel’s balance sheet as:

Answer 43

noncurrent liability- DTL

less taxes now and more taxes later

Question 44

Dec 31 YR 12, Haddon Corp had depreciation expense for income tax purposes that exceeded deprec for book purposes. The temp difference was expected to reverse YR 13 and 14. No other temp differences. Under US GAAP, Haddon Corp YR 12 B/S should include:

Answer 44

DTL
noncurrent deferred tax liability

more expense now = less tax now and more tax later

Question 45

Which is correct DTA and DTA-valuation allowance?
1. when there is at least 50% chance of realizing DTA, valuation allowance is needed
2. if sufficient future taxable income is expected a valuation allowance is needed
3. when there is less than 50% chance of DTA being fully realized, DTA is not recorded
4. when there is less than 50% chance of DTA being fully realized, DTA is recorded along with valuation allowance

Answer 45

Correct: 4. when there is less than 50% chance of DTA being fully realized, DTA is recorded along with valuation allowance

Question 46

Net operating loss, NOL

Answer 46

tax term referring to when a business has more deductions than income, negative taxable income

carried forward indefinitely
not carried back

Question 47

Net operating loss, NOL: benefit and journal entry

Answer 47

benefit of NOL in current year: no income tax is paid and no debit to income tax expense on current year income statement

contra income tax expense = benefit

DR Deferred tax asset
CR income tax benefit due to loss carryforward (contra exp)