(1) How to calculate current tax EXPENSE?
(2) Unique Scenario: find income tax expense for 2nd interim F/S period with the following fact pattern:
Brand Corp., a calendar-year corporation, reported income before income tax expense of $10,000 and income tax expense of $1,500 in its interim income statement for the first quarter of the year. Brand had income before income tax expense of $20,000 for the second quarter and an estimated effective annual rate of 25%. What amount should Brand report as income tax expense in its interim income statement for the second quarter?
Taxable income (not temporary difference)
x Current tax rate or enacted tax rate
= Current Tax Expense --> this go to Income statement
(2) Unique scenario: 2nd quarter income tax expense in its interm F/S:
INCOME before tax:
$10,000 First quarter
+ 20,000 2nd quarter
x 0.25 second tax rate
$7,500 total inc. tax - 2nd quarter
- 1,500 prior quarter tax
$6,000 income tax expense - 2nd quarter
(1) How to calculate deferred income tax expense?
(2) Example: what is the deferred tax expense with the following fact pattern:
Temp. Diff. Year 1 Year 2 Year 3
Depreciation (900) (1400) 3,000
Warranty costs 500 (100) (400)
Enacted tax rate 30% 25% 20%
(3) Example: Find the Deferred portion for Income tax expense with the following fact patttern:
intererest on municipal bonds is 60,000
Lower Deprec. per finc' stmts: 100,000
income tax rate is 30% for year 1. The depreciation differences will reverse equally over the next 3 years at these enacted tax rates:
Years Tax rates
(4) Example: (Net temporary adjustment) to deferred tax expense: Company has taxable income of $500,000 in year 2 and Pretax financial income of $600,000. Company has $200,000 cumulative difference between its taxable income and pretax financial statement income on Dec. 31 year 1. These differences tied to only accelerated deprecaiton methods used for income tax purposes. The enacted tax rate icnreased to 30 percent in year 2 compared to an enacted tax rate of 20 percent in prior year. What is the deferred tax expense on Dec. 31, year 2?
(1) Temporary Differences (Current Period)
x Enacted Future tax rate
= Deferred income tax expense
Note: Only use the future enacted tax rate in the period that temp. differences reverse itself.
(2) Find Deferred Income Tax expense
DTL (depr. exp.):
$900 x 0.20 = 180 DTL
(year 3's when (900) becomes + # in yr 3)
DTA (Warranty costs)
100 x 0.25 = 25 (year 2's tax rate)
400 x 0.20 = 80 (year 3's tax rate0
Total DTA: $25 + 80 = $105
* Y2 tax rate when portion reverse in year 2
* Y3 tax rrate when portion reverse in year 3
Total Deferred Tax Expense:
DTL - DTA: $180 - [$25 + $80]
= $180 - 105
= $75 deferred tax expense
$100,000 deprecation expense / 3 years (of reversal) = $33,333
Year 1: 0.30 x $33,333 = $10000
Year 2: 0.25 x $33,333 = $8333
Year 3: 0.25 x $33,333 = $8333
Total Deferred portion of income tax expense = $10,000 + $8,333 + $8,333 = $26,666
(4) Example: In this situation: it deals with net temporary adjustment. This occurs when there is a newly enacted tax rate (like enacted tax rate increased to some amount).
So what to do here is that:
You have current period's deferred tax expense MINUS beginning deferred tax expense via:
$200,000 cumulative difference
+ 100,000 new temp diff. ($500K tax - $600K f/s)
x 0.30 tax rate
$90,000 deferred tax expense
- ($200,000 x 0.20 old tax rate) beg. diff
$50,000 deferred tax expense in year 2
(1) How to calculate deferred income tax liability?
(2) Example: Find the deferred tax liability as of Dec 31, year 1 with the following fact pattern:
Year Complete Contract % Completion
1 $-- $300,000
2 $400,000 600,000
3 $500,000 850,000
income tax rate for year 1 to year 3 is 0.30. Income tax rate after year 3 is 0.25.
(3) Example: Find the Deferred Tax liability on Aprl 20 20X3 with the following formation
4/30/20x1 4/30/20x2 4/30/20x3
Temp. Diff. 200,000 100,000 150,000
Enact tax rate 20% 25% 30%
Scenario 1) If given only the Future CUMULATIVE Temporary Differences for the current period, Then, it's only:
Future Cumulative Temporary (for current period)
x Future Enacted Tax Rate
= Deferred Income Tax Liability.
Scenario 2) Gives you a series of cumulative difference $$ amounts. Then:
Cumulative Temporary differences (Yr 1 + Yr 2 + Yr current)
x Future tax rate
= Deferred income tax liability
Note: Do not confuse deferred tax liability with deferred tax expense.
They are two different things. Also, Deferred tax liability use FUTURE cumulative temporary difference amount.
It does NOT use current temporary difference amounts.
Complete Contract % Completion Difference
$-- $300,000 300,000
$400,000 600,000 200,000
$500,000 850,000 350,000
$900,000 $1,750,000 $850,000
$850,000 temp differences x 0.25 yr tax rate
= $212,500 deferred income tax liability
(3) Example: Deferred tax liabilty on the later date (like 4/30/x3) you need to calculate the Cumulative Temporary differences x the enacted tax rate w/ of course an adjustment in yr 2 and yr 3.
Deferred Tax liability:
Yr 1: 200,000 x 0.20 tax rate = $40,000 (first year; no cumulative temporary differences yet)
$200,000 x (0.25 yr 2 - 0.20 yr 1) = $10,000
$100,000 x 0.25 (yr 2) = $25,000
Yr 2 Cumlative DTL= $40,000 (yr 1) + $10,000 + 25,000 = $65,000 DTL
Here: you need to calcuate an adjustment on the Yr1 temp diff. of $200,000 via ($200K x (0.25 - 0.20) since deferred taxes over the years (cumaltive) is counted as a incremental expense in each period. This is done to avoid double counting of prior years temporary differences in future years. Also, whenever there is a different tax rate in later different years, need to adjust the deferred tax liablity in the later periods.
$300,000 (200,000 y1 + 100,000 y2) x [0.30 yr 3 - 0.25 yr 2]) = $15,000
$150,000 (yr 3) x 0.30 (yr 3) = 45,000
Cumulative DTL for yr 3 =
= $135,000 DTL cumulative for year 3
What is the balance sheet presentation in determining the Current/Non-current Deferred tax asset and deferred tax liability?
Rule 1: All deferred current tax asset must offset all deferred current tax liability and Rule 2: All NON-current deferred tax asset must offset ALL non-current deferred tax liability. Both of these to get Net current deferred tax asset / liability and Net non-current deferred tax asset / liability
How to calculate current tax liability?
What is the other name of current tax liability?
Taxable income (in current period)
x current enacted or current effective tax rate
= Current tax liability
Other word for Current tax liability = Income Tax Payable.
Note: FYI - the calculation to get current tax liability (a.k.a. Income tax payabe) is the same as calculating to find Current tax expense. Hence: Dr. Income tax expense Cr. Income tax payable
What are the other words for current income tax expense? Deferred income tax expense?
Current income tax expense other words
= Current portion of its provision for income taxes
= Current portion of tax expense
= Current provision for income tax expense
= Current tax expense = income tax expense - current portion
Deferred income tax expense
= Deferred portion of its provision for income taxes = Deferred portion of tax expense
= Deferred portion for income tax expense
= Deferred tax expense
= income tax expense - deferred portion
What account type/category when you have Financial income First --> Before Tax return income later?
(Income reported in financial statement/book statement then later reported on tax return)
Name 3 examples.
(Future) tax liability (Deferred Tax Liability)
3 examples =
1) Installment sales
2) contractors accounting (% of completion vs. Completed contract method)
3) Equity method (undistributed dividend)
4) Rent receivable
5) Gain on condemnation on property
What account type/category when you have Tax (return) income First --> Before financial income later?
(Income reported in Tax return FIRST --> then later reported in BOOK / financial statements)
Name 3 examples.
PREPAID Tax asset a.k.a. Tax benefit (Deferred Tax Asset)
1) Prepaid rent
2) Prepaid interest
3) Prepaid royalties
Note: The IRS uses prepaid. GAAP uses unearned for these examples.
What account type/category when you have Financial expense First --> Before Tax return expense later?
(Expense reported in Book / financial statement FIRST --> then later reported on Tax return)
Name 3 examples.
(Future) tax asset (Deferred Tax Asset)
1) bad debt expense (allowance vs direct write off)
2) Estimate liability / warranty expense
3) Start-up expenses
What account type/category when you have Tax (return) expense First --> Before financial expense later?
(Expense reported in Tax return First --> then later reported on Book / financial statements)
Name 3 examples.
(Future) tax liability (Deferred Tax Liability)
1) Depreciation expense (Tax: MACRS vs Financial statement = straight line)
2) Amortization of franchise
3) Prepaid expenses (cash basis for tax)
Deferred Tax liability occurs when:
FUTURE tax accounting income is ___ than FUTURE financial income.
Deferred Tax Asset occurs when:
FUTURE tax income is ___ than FUTURE financial (book) income.
Deferred Tax liability (DTL) occurs when:
FUTURE tax accounting income is > than FUTURE financial income.
Deferred Tax Asset occurs when:
FUTURE tax income is < than Future financial income
When you have: * Asset book basis > tax basis = you get deferred _____ * Asset book basis
* Asset book basis > tax basis = you get deferred tax LIABILITY * Asset book basis
How to calculate effective tax rate?
Step 1) Get taxable income Pre-tax income
+ Difference (permanent OR temporary)
- Difference (permanent OR temporary)
= Taxable income
Step 2) Get Income tax expense
x tax rate (current)
= income tax expense
Income tax expense = Effective tax rate
What are permanent differences?
Transactions that only affects Income per books (financial accounting/ financial statements; US GAAP)
Taxable income (not both).
Only affect current tax computation; does not affect future financial income or future taxable income.
They can be (a) non-taxable, (b) non-deductible, or (c) special tax allowance
Name examples of permanent diferences
1) Tax exempt interest (municipal, state)
2) Life insurance proceeds on officer's key man policy
3) Life insurance when corporation is beneficiary
4) Certain penalties, fines, bribes, and kickbacks
5) Non-deductible portion of meal and entertainment expense
6) Dividends- received deduction for corporation and
(7) Excess percentage depletion over cost deplrection
Total tax expense for financial statements is the combination of __________________.
Current tax expense + or - deferred taxes
Why you should not calculate total income tax expense by Financial statement income x current tax rate?
1) Using financial statements income contains permanent differences gives the incorrect total tax expense amount
2) Use of current tax rate ignore future change to the enacted tax rate.
What is the objective of intra-period tax allocation?
The matching period on the amount of current and future tax related to events recognized via Assets and liabilities (the balance sheet approach)
(1) What is a valuation allowance used for inter-period tax allocation?
(2) Valuation example: Walker Corporation began operations on Jan 1 year 1. Walker in year reported $400,000 warranty expense during year 1. This is the only difference between pre-tax F/S income and tax income. Its tax income is $900,000. Walker is required to pay these warranties (liability) at $100,000 per year rate, starting on Year 2. Although Walker corp. expects to earn in excess of $100,000 in year 2 and year 3, the company believes it is more likely than not that it will incur a loss after year 3. The enacted tax rate is 25% in current and futuer periods. What will Walker record as its income tax expense in year 1?
(1) Valuation allowance (valuation account) is a CONTRA ACCOUNT. It is used to reduce a deferred tax asset when it is more than 50% that part or all of deferred tax asset will not be realized.
(2) Valuation to find income tax expense:
$225,000 current tax expense
x 0.25 future enacted tax rate
($100,000) Deferred tax expense
$225,000 current + (100,000) deferred = $125,000 (on I/S)
$100,000 pay warrantie per year for Yr 2 and Yr 3:
$100,000 x 2 = $200,000
x 0.25 future enacted tax rate
$125,000 income tax expense + $50,00 valuation
= $175,000 income tax expense
How is valuation allowance used in the calculation for deferred taxes and temporary differences?
Allowance valuation is used as a subtraction against temporary difference.
Total CURRENT temporary differences
- Allowance valuation
- Beginning period's deferred tax asset
= New current temporary difference
1) How to calculate the tax benefit of net operating loss (NOL) carry over?
2) What is the Total income tax expense (current tax expense + deferred tax expense) in year 3 based on the following info:
- Year 1: $300,000 operating income
- Year 2: (700,000) operating income
- Year 3: 1,200,000 operating income
- No income taxes before year 1.
- Effective tax rate = 0.20
- In year 2, elect to do a two-year carry back on the loss.
3) Example: Find the deferred portion of provision for income taxes in year 1's income statement with the following fact pattern:
Depr. Diff. Warranty Diff.
Year 2 $80,000 $10,000
Year 3 70,000 20,000
Year 4 50,000 25,000
Total 200,000 55,000
Enacted tax rates is 30% for year 1 and year 2 and 25% for year 3 and year 4.
(1) Tax benefit on NOL carryover = NOL used (if all of it) x effective tax rate (current)
Tax benefit on NOL carryover is NOT -> Taxable income - NOL carryforward.
Year 1: $300,000 - $700,000 loss carry back = $400,000 left to carry over.
- 400,000 (NOL carry over to year 3)
x 0.20 tax rate
$160,000 current tax expense
Year 3: Temporary Differences
$400,00 DTA (carry over from year 1)
- $400,000 (NOL being used up in year 3)
x 0.20 tax rate
+ $80,000 (Carry over on $400K NOL x 0.20)
= $80,000 Deferred tax expense
Total income tax expense:
$160,000 current income tax expense
+ 80,000 deferred tax expense
$240,000 total income tax expense
Depr. Diff. (DTL) Warr'ty Diff. (DTA) Net
Yr 2 $80,000 $10,000 $70000 DTL
Yr 3 70,000 20,000 50,000 DTL Yr 4 50,000 25,000 25,000 DTL
$70,000 DTL x 0.30 (yr 2) = 21,000
$50,000 DTL x 0.25 (yr 3) = 12,500
$25,000 DTL x 0.25 (yr 4) = 6,250
Def. Portion income tax = $39,750
IFRS rule on deferred tax assets and deferred tax liabilities.
Deferred tax assets and deferred tax liabilities are netted and reported as "NON-CURRENT" at all times on the balance sheet. (IFRS)
Do you use the following tax rates? Anticipated Proposed Unsigned
No. This is a CPA exam trick.
What do you do when you have "depreciation expense...reverse equally in later years" to calculate deferred tax expense?
You take the entire depreciation amount divided by the # of future years
Then take each divided up amount and multiply it by each future year's tax rate.
Example: 30,000 total depreciation expense reverse over 3 future years
Yr 2 tax rate = 0.20
Yr 3. tax rate = 0.30
Yr 4. tax rate = 0.30
30,000 / 3 years = 10,000
Yr 2: 10,000 x 20 = 2000
Yr. 3: 10,000 x. 30 = 3000
Yr. 4: 10,000 x .30 = 3000
Total = 2,000 + 3000 + 3000
= 8000 deferred tax expense
When you have Tax expense < book expense you get Deferred tax ____.
This means: expense gets reported in tax return FIRST before in book expense
Deferred tax asset
FYI - Also, Tax exp < book expense = INCREASE deferred tax asset.
Wen you have tax expense > book expense you get deferred _______ This means: expense gets reported in tax return FIRST before in book expense
Deferred tax liability
FYI - Also, Tax exp > book expense = INCREASE deferred tax liability
There are four basic causes of temporary differences, which reverse in future periods. What are they?
There are four basic causes of temporary differences, which reverse in future periods.
1) Revenues or gains that are included in taxable income, after they have been included in financial accounting income, which results in a deferred tax liability.
(Revenues/gain in Financial income First, then in taxable income (later) = Deferred Tax liability)
(FYI): This because: Financial income becomes bigger, thus creates higher tax liability).
2) Revenues or gains that are included in taxable income, before they are included in financial accounting income, which results in a deferred tax asset.
(Revenues/gains in Taxable Income FIRST, then later in Financial income = Deferred Tax Asset)
(FYI): This because: Financial income will be smaller (in later period), therefore, lower taxes, thus have Deferred Tax asset (tax benefit) that reduces Current tax expense; reduces Income tax payable, and reduces Deferred Tax Expense.
3) Expenses or losses deducted from taxable income, after they have been deducted from financial accounting income, which results in a deferred tax asset.
(Expenses/Losses in Financial Income FIRST, then later in taxable income = Deferred Tax Asset)
(FYI): This because: Expenses in Financial income first, reduces Financial income to a point where there'll be lower tax liability. Thus have Deferred tax asset that reduces Current tax expense, Reduces Income tax payable; reduces Deferred tax expense.
4) Expenses or losses deducted for taxable income, before they are deducted from financial accounting purposes, which results in a deferred tax liability.
(Expenses/Losses in Taxable Income FIRST, then in Financial income = Deferred Tax Liability)
(FYI): This because having expenses/losses first, results in having Financial income to be HIGHER and higher financial income results in a tax liability.
How to find the Current tax expense and Deferred tax expense on a distribution of dividends and with the following facts?
- Parent Company has 30% ownership in Sub company
- Sub company has Net income $300,000
- Sub company is giving away $40,000 in dividends
- Enacted Tax rate is 25%
- There's a 80% dividend exclusion involved since the Parent company has 30% ownership.
- Ownership 0-19% = 70% exclusion on dividends to be treated as taxable income
- Ownership 20-80% = 80% exclusion on dividends to be treated as taxable income
- Ownerhship over 80% = 100% exclusion on dividends to be treated as taxable income
1) Ownership % x Sub's net income and Dividends pay out to Parent company.
Sub Net income: $300,000 x 0.30 = $90,000
Sub dividends: $40,000 x 0.30 = $12,000
2) Current Tax Expense:
- 9,600 (80% exclusion)
x 0.25 enacted tax rate
$600 current tax expense (and income tax payable)
3) Deferred Tax Expense (liability)
$90,000 net income (after 25% calc.)
- 12,000 dividends (after 25% calc.)
x 0.20 (100% - 80% dividend exclusion)
x 0.25 enacted tax rate
$3,900 deferred tax expense (def. tax liability)
Dr. Income Tax Expense - Current $600
Dr. Income Tax Expense - Deferred $3,900
Cr. Income Taxes Payable $600
Cr. Deferred Tax Liability $3900
What is the Deferred Tax asset on the collecting of rent payment on the day before the lease starts?
- W. Corp. leased building and paid $25,000 rent payment on June 20 in current period.
- This lease starts on July 1. So tis $25,000 rent paid on June 20 is prepaid rent (just FYI)
- Rent money is taxable when received.
- Tax rate is 30% for current year.
- Tax rate is 40% for future years.
- There's no other difference and valuation is not being used.
Deferred tax asset on this prepaid rent:
$25,000 x (6 /12 months (from July 1 to Dec 31) x 0.30 tax rate
= $12,500 x 0.30 tax rate
= $3,750 Deferred Tax Asset.
Taxable Income received first before it's entered in financial income = Deferred Tax Asset.
Examples: Prepaid Rent (rent money received in advance), Prepaid Interest (interest money received in advance), Prepaid royalties (royalties money received in advance).
Rules on NOL Carry back and carry forward
(1) It can be carry back __ years and then carry forward __ years. The company can elect to carry back and then carry forward OR-- just carryforward the entire loss.
(2) Operating Loss carry back does not involve valulation. Also, when the operating loss is used to offset past years taxable income. It does not ___ tax expense in that prior year. Instead, it creates a separate item on the balance sheet called __ ___ receivable. Therefore, the Current income tax expense is left alone (taxable income x % enacted tax rate in current period) and not reduced by this NOL carry back.
Journal Entry for NOL carry back is ___.
(3) NOL carry forward:
* Is a deferred tax ___ because they create future tax savings
* NOL carry forward is valued via NOL carry forward x ___ tax rate.
* Its journal entries are: __ ___
* Deferred tax asset (debit) ___ tax payable in future.
* Tax benefit (CR) reduce __ __ __ in current period.
(1) (1) It can be carry back 2 years and then carry forward 20 years. The company can elect to carry back and then carry forward OR-- just carryforward the entire loss.
(2) Operating Loss carry back does not involve valulation. Also, when the operating loss is used to offset past years taxable income. It does not REDUCE tax expense in that prior year. Instead, it creates a separate item on the balance sheet called TAX REFUND receivable.
Journal Entry for NOL carry back is:
Dr. Tax Refund Receivable $20,000 (taxes paid in yr prior)
Cr. Tax Benefit $20,000 (taxes paid in yr prior)
(3) NOL carry forward:
* Is a deferred tax ASSET because they create future tax savings
* NOL carry forward is valued via NOL carry forward x enacted tax rate.
* Its journal entries are:
Dr. Deferred Tax Asset $40,000 (100,000 NOL x 0.40 tax)
Cr. Tax benefit $40,000 (100K NOL x 0.40 tax rate)
* Deferred tax asset (debit) REDUCES tax payable in future.
* Tax benefit (CR) reduce NET OPERATING LOSS in current period.
(1) True or false: interperiod tax allocation deals with the following:
Income from continue ops
Extraordinary gains or losses
Accounting princple changes
Pension funded status change
Unrealized gain//loss on available for sale security
Foreign translation gains / loss
Effective portion of cash flow hedge
Evaluation Surplus (IFRS)
(2) True or false:
Only extraordinary gains (not extraordinary losses) would be considered temporary difference if they enter into the determination of taxable income and GAAP basis income in different periods.
(3) End of year, company has a current deferred tax asset. Will the reversal of this deferred tax asset creates taxable amount or deductible amounts. Also, did the company have profit or loss in year 1 for tax purposes?
(4) How is Cash estimate tax payments used to calculate income taxe expenses and income tax liability?
(5) Goodwill deducted on tax return creates Deferred Tax asset or Deferred tax liabillity.
Note: interperiod tax allocation has nothing to deal wtih opearting income
Only extraordinary gains and extraordinary losses would be considered temporary difference if they enter into the determination of taxable income and GAAP basis income in different periods.
(3) Current Deferred tax asset:
When reverse in later years, it creates Tax deductible because Deferred tax asset helps reduce future tax liabilities and thus create future tax savings
Year 1: Profit. This because income in tax purposes first before (enter in F/S) creates Deferred Tax Asset.
Deferred Tax Asset comes from:
Income/gain/profit in Tax purposes first before F/S later (where F/S has low income)
Expenses/losses in F/S first before in Tax later (F/S's income gets reduced down by expenses, so low F/S income).
Deferred Tax liability comes from:
Income/gain/profit in F/S first before enter in tax (where F/S income is high, thus have higher tax)
Expenses/losses in Tax first before enter in F/S (where F/S has low expense, means high income --> higher tax)
(4) estaimte cash tax paymetns are used to ONLY reduce Income taxes payable (liability).
Estiamte cash tax payments are NOT used to reduce Income tax expense.
FYI - Example:
Pre tax income: $300
Less: Permant Diff:
Interest muni bond (10)
Less: Temp. Diff:
Tax depreciation (20)
Taxable Income = 270
x Tax rate 0.30
Tax provision = 81
- Est. cash tax pmt - 50
= Curr. Fed Tax liab = $31
(5) Goodwill deducted on tax return creates Deferred Tax liability. This because goodwill is amortized for tax return purposes. And Goodwill for GAAP/book statements is not amortized but it's tested for impairment (where impairment happens NOT every year; it happens once in a while).
So: amortized goodwill expense in Tax first, then later expense in F/S creates. Deferred Tax liablity where no amort. expense in F/S results in higher F/S income, thus higher taxes.