Accounting For Income Taxes (Deferred Taxes)

Question 1

Are fees and fines incurred during the year deductible for tax reporting? What type of difference is created (if any)?

Answer 1

No! This is permanent difference between book and tax

Question 2

Are warranty expenses deductible for tax reporting? What type of difference is created (if any)?

Answer 2

Only the cash payments made towards warranty expense/repairs are deductible each year. Thus, a temporary difference (usually a deferred tax asset for warranties) has been created between book and tax, as GAAP requires all warranty expense to be matched with its associated revenue at the time of sale.

Question 3

Is municipal bond interest deductible for tax reporting? What type of difference is created (if any)?

Answer 3

100% for the interest received each year. This is an example of a permanent difference.

Question 4

What are permanent differences? Provide examples.

Answer 4

Permanent differences between book income (F/S) and taxable income (tax return). Examples include municipal bond interest, life insurance expense, fines and penalties incurred by the firm, 50% of meals and entertainment expenses, and federal income tax payments.

Question 5

What effect do permanent differences have on deferred income taxes?

Answer 5

ZERO tax impact.

When calculating the total differences between book and tax income, subtract the permanent differences from the total before applying a future enacted tax rate

Question 6

What are temporary differences?

Answer 6

Timing differences between book income and taxable income income. Certain items may be recognized in tax returns for a year that is different in which their financial-statement effects are recognized.

Question 7

What is a temporary difference related to deferred taxes?

Answer 7

GAAP says to recognize a revenue/expense in one period and tax laws say to recognize it in another

Example: Dividends from a subsidiary accounted for using the Equity Method - tax income but not book income

Question 8

What is the liability method used for? How does it work?

Answer 8

Used to report deferred income tax expense. Calculate the current and deferred income tax assets and liabilities. The plug that results is the annual income tax expense.

Question 9

What is deferred income tax expense?

Answer 9

The sum of Net Changes in Deferred Tax Assets and Deferred Tax Liabilities

GAAP Method for calculating is the Asset and Liability Approach

Note: IFRS uses the Liability approach only

Question 10

Distinguish between book taxable income and taxable income.

Answer 10

Book taxable income is the net of pretax book income +/- permanent differences. Taxable income is book taxable net of any temporary differences.

Question 11

What arise when current book taxable income exceeds taxable income?

Answer 11

Deferred tax liabilities

Question 12

What arise when current book taxable income is lower than taxable income?

Answer 12

Deferred tax assets

Question 13

What arise when current book expense exceeds tax expense?

Answer 13

Deferred tax assets

Question 14

What arise when current book expense is lower than tax expense?

Answer 14

Deferred tax liabilities

Question 15

What arise when expected future taxable income will exceed book income?

Answer 15

Deferred tax liabilities

Question 16

What arise when expected future taxable income will be less than book income?

Answer 16

Deferred tax assets

Question 17

What is another name for deferred tax liabilities?

Answer 17

Taxable temporary difference

Question 18

What is another name for deferred tax assets?

Answer 18

Deductible temporary difference

Question 19

What are some examples of deferred tax liabilities?

Answer 19

1) Accelerated tax depreciation (MACRS)
2) Prepaid expenses (cash basis for tax purposes)
3) Goodwill (15 year amortization for tax, while tested for impairment annually with GAAP)
4) Investments accounted for under equity method for book purposes, cost for tax
5) Accrual sales for book, installment sales for tax

Question 20

What are some examples of deferred tax assets?

Answer 20

1) Warranty expenses (since they are expensed entirely at point of sale for reporting, as opposed to when the cash is parted with for tax purposes)
2) Rent, Royalty, and Interest received in advance (taxed upon received, but prior to completing earnings process for GAAP)
3) Bad debt expense (direct write off for tax, but allowance method for GAAP)
4) Contingent liabilities

Question 21

What account is a contra account to the deferred tax asset?

Answer 21

Deferred Tax Asset Valuation Allowance

Question 22

What is the annual income tax journal entry comprised of?

Answer 22

Dr. Income Tax Expense
Dr. Deferred Tax Asset
Cr. Current Tax Liability
Cr. Deferred Tax Liability

Question 23

Does the equity method of accounting create temporary differences? Which ones and how?

Answer 23

Yes! Deferred tax liabilities are created as cash profits received from dividends result in taxable income that is usually comparatively smaller than than the book net income (equity in earnings) that is earned.

Question 24

What is the Dividends Received Deduction?

Answer 24

Under the Equity Method,

Question 25

What is the timeframe for when a Net Operating Loss can be applied (carried)?

Answer 25

Back 2 years, forward 20 years.

Question 26

What should tax carryforwards be recognized as?

Answer 26

Deferred Tax Assets (in the period of occurrence).

**Keep in mind that a Deferred Tax Valuation Allowance must be accrued, in addition.

Question 27

If applying a net operating loss against a prior period, what is created?

Answer 27

Income Tax Refund Receivable (debit). This combined with the Deferred Tax Asset offset against the Income Tax benefit (credit I/S)

Question 28

Which period’s tax rate is used to calculate a deferred tax asset or liability?

Answer 28

The FUTURE enacted tax rate, not the current one.

It is never discounted to present value.

Question 29

What valuation allowance is used with respect to a deferred tax asset?

Answer 29

If it is probable that not all of a Deferred Tax Asset (debit) will be realized, then a Deferred Tax Asset Valuation Allowance contra account must be used to write down down (credit) to reflect this.

Question 30

How are deferred tax assets and liabilities classified as current or non-current on the balance sheet?

Answer 30

Current Deferred Tax Assets and Liabilities will impact income tax expense within 12 months. All current amounts are netted and reported as a single amount on the Balance Sheet

Non-Current Deferred Tax Assets and Liabilities will impact income tax expense 12 months or more from the Balance Sheet Date. All non-current amounts are netted and reported as a single amount on the Balance Sheet

Question 31

How are current and noncurrent deferred tax assets and liabilities presented on the income statement? What are they called?

Answer 31

They are presented as one single amount on the Income Statement (as opposed to two on the Balance Sheet) and are simply referred to as deferred income tax expense.

Question 32

What temporary difference items are generally current?

Answer 32

Bad debt expense. Warrany expense falling within the current operating cycle is also current (although future warranty expense beyond the current operating cycle is noncurrent)

Question 33

What temporary difference items are generally noncurrent?

Answer 33

Accelerated depreciation (MACRS) for tax purposes. Warranty expense beyond the current operating cycle.

Question 34

Do permanent differences require disclosure?

Answer 34

No!

Question 35

Do temporary differences require disclosure?

Answer 35

Yes! Every single item that comprises the temporary differences is required to be disclosed.

Question 36

What temporary differences add to future taxable income?

Answer 36

Deferred tax liabilities

Question 37

Should each type of operating loss and tax credit carryforward be disclosed in a company’s financial statements?

Answer 37

Yes!

Question 38

Under IFRS, are there current deferred tax assets and liabilities?

Answer 38

No! All deferred income taxes and liabilities are considered noncurrent.

Question 39

Under IFRS, differentiate between the enacted and substantially enacted tax rates? Which ones are permitted for financial reporting?

Answer 39

The substantially enacted tax rate is one that has been announced by the tax authority, but may take several months to implement. Both are permitted for financial reporting under IFRS (whereas GAAP only permits the enacted tax rate).

Question 40

Under IFRS, what is required in order for deferred tax assets and liabilities to offset against one another?

Answer 40

The deferred tax assets and liabilities need to fall under the same taxing authority (ala, same country)

Question 41

Under IFRS, what temporary differences are recognized only when reasonably assured of realization and only to the extent it is probable that they will be realized?

Answer 41

Deferred Tax Assets