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FRA > Income taxes > Flashcards

Income taxes Flashcards

1
Q

What is the use of the tax return?

A

It is prepared to calculate taxes payable to the authorities.

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2
Q

Describe the purpose of the tax return.

A
  • Taxes payable result in an outflow of cash from the firm, so firms try to minimize taxes payable and retain cash.
  • This objective is achieved by recognizing higher expenses on the tax return, which leads to lower taxable income and, consequently, lower taxes payable.
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3
Q

What is the use of financial statements?

A

They are prepared to report the company’s operating performance over the year to shareholders, financial institutions,s and other stakeholders.

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4
Q

Describe the purpose of the financial statements.

A
  • For financial reporting purposes, companies try to show healthy performance and profitability.
  • This objective is achieved by recognizing lower expenses on the IS, which lead to higher pretax income, and (despite higher income tax expense) higher NI than on tax return.
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5
Q

What is the tax base of an asset or liability?

A

It is the amount that is recognized on the BS for tax purposes.

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6
Q

What is the carrying value?

A

It is the amount recognized on the BS for financial reporting purposes.

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7
Q

What is an asset’s tax base?

A

It is the amount that will be expensed on tax returns in the future as economic benefits are realized from the asset.

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8
Q

What is the carrying value of an asset?

A

It is the historical cost of the asset minus the accumulated depreciation charged against it in previous years on the company’s financial statement.

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9
Q

What happens to the carrying value and tax base of an asset that is not taxable?

A

The carrying value equals the tax base.

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10
Q

What are the 2 types of liabilities that can result from accrual accounting?

A
  • Unearned revenues
  • Accrued expenses
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11
Q

What is the carrying value of unearned revenues and accrued expenses?

A

It is the amount recognized on the BS in the financial statements.

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12
Q

How do you calculate the tax base of accrued expense liability?

A

It is equal to the carrying amount of the liability minus amounts that have not been expensed for tax purposes yet; but can be expensed in the future.

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13
Q

How do you calculate the tax base of unearned revenue liability?

A

It is equal to the carrying value of the liability minus the amount of revenue that has already been taxed and, therefore, will not be taxed in the future.

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14
Q

What is the reporting strategy for depreciation for the 2 statements under US GAAP?

A
  • Firms try to record higher depreciation expenses on their tax returns to minimize taxes payable.
  • Firms try to recognize lower depreciation expenses on their financial reports to maximize reported profits.
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15
Q

What is a temporary difference?

A

It is a difference in expense recognition across the 2 statements that reverses.

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16
Q

What are the major sources of temporary difference?

A
  • Depreciation of fixed assets.
  • Amortization of financial assets.
  • Revenue recognition policies.
  • Asset write-ups/Write-downs
  • Fair value adjustments in business combinations (excluding goodwill)
  • Unused losses/tax credits.
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17
Q

What happens if the expense recognition for tax purposes is relatively aggressive?

A

It will give rise to a deferred tax liability (DTL) which will make the company pay less taxes now and pay more taxes in the future.

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18
Q

What is the formula to calculate DTL?

A

(Carrying value of an asset - tax base) * tax rate

19
Q

When does a DTL arise?

A
  • When higher expenses are charged on the tax return compared to the financial statements.
  • When taxable income is lower than pretax or accounting profit.
  • When taxes payable are lower than income tax expense.
  • When an asset’s tax base is lower than its carrying value.
  • It can also arise due to temporary differences resulting from revenues (or gains) being recognized on the IS before they are included on the tax return.
20
Q

What is a deferred tax asset (DTA)?

A

The company pays more taxes based on its tax return than it should pay, according to its financial statement. It is a sort of prepayment and therefore counts as an asset.

21
Q

When does a DTA arise?

A
  • When higher expenses are charged on the financial statements than on the tax return.
  • When taxable income is higher than pretax or accounting profit.
  • When taxes payable are greater than income tax expense.
  • When a liability’s tax base is lower than its carrying value.
    -It can also result from a temporary difference arising due to revenues (or gains) being recognized on the tax return before being recognized on the IS.
22
Q

What is the formula to calculate DTA?

A

(carrying value of liability - tax base of liability) * tax rate

23
Q

What is the relationship between taxes payable, DTA, and income tax expense (ITE)?

A

ITE = taxes payable - change in DTA

24
Q

What is the accounting treatment for an increase in DTA?

A
  • An increase in DTA increase total assets on the BS.
  • The increase in DTA is subtracted from taxes payable in the calculation of income tax expense, so it increases net income, retained earnings, and equity.
25
Q

What is the accounting treatment for an increase in DTL?

A
  • An increase in DTL increases total liabilities on the BS.
  • The increase in DTL is added to taxes payable in the income tax expense calculation, decreasing NI, RE, and owner’s equity.
26
Q

What happens if a company has a net DTL?

A
  • If there is a reduction in tax rates: it would reduce liabilities, reduce income tax expense, and increase equity.
  • If there is an increase in tax rates: it would increase liabilities, increase income tax expense, and reduce equity.
27
Q

What happens if a company has a net DTA?

A
  • If there is a reduction in tax rates: it would reduce assets, increase income tax expense, and decrease equity.
  • If there is an increase in tax rates: it would increase assets, decrease income tax expense, and increase equity
28
Q

What are the main items that give rise to permanent differences?

A
  • Revenue items that are not taxable.
  • Expense items that are not tax deductible.
  • Tax credits for some expenses that directly reduce taxes.
29
Q

What is the impact of permanent differences?

A

They do not result in deferred taxes, but they result in differences between effective and statutory tax rates and should be considered in the analysis of effective tax rates.

30
Q

What are the 2 types of temporary differences?

A
  • Taxable temporary differences
  • Deductible temporary differences
31
Q

What are temporary taxable differences? When do they arise?

A

They result in future taxable income.
They arise when:
- The carrying amount of an asset exceeds its tax base.
- The carrying amount of liability is less than its tax base.

32
Q

What are temporary deductible differences? When do they arise?

A

They are expected to provide tax deductions in the future.
They arise when:
- The tax base of an asset exceeds its carrying amount.
- The tax base of a liability is less than its carrying amount.

33
Q

When should DTA and DTL not be recognized?

A

It should not be recognized in cases that would arise from the initial recognition of an asset or a liability in transactions that are not a business combination and when, at the time of the transaction, there is no impact on either accounting or taxable profit.

34
Q

When can deferred taxes be recognized in business combinations?

A

If the fair value of acquired intangible assets is different from their carrying amounts, deferred taxes can be recognized.

35
Q

When can DTL not be recognized with regard to investments in subsidiaries, branches, associates, and interest in joint ventures?

A
  • If the parent is in a position to control the timing of the future reversal of the company difference.
  • If it is probable that the temporary difference will not reverse in the future.
36
Q

When can DTA be recognized with regard to investments in subsidiaries, branches, associates, and interest in joint ventures?

A
  • When the temporary difference will reverse in the future.
  • Sufficient taxable profits exist against which the temporary difference can be used.
37
Q

How are tax losses and tax credits recognized under IFRS and US GAAP?

A
  • IFRS: unused tax losses and credits may only be recognized to the extent of probable future taxable income against which these can be applied.
  • US GAAP: deferred tax assets are recognized in full and then reduced through a valuation allowance if they are unlikely to be realized.
38
Q

When does deferred taxes and income taxes shouldn’t be recognized?

A
  • When taxes or deferred taxes are charged directly to equity.
  • When a possible provision for deferred taxes related to a business combination.
39
Q

When can the carrying amount of DTA and DTL change?

A
  • When there are changes in tax rates.
  • When there are reassessments of recoverability of DTA.
  • When there is a change in expectations as to how the DTA or DTL will be realized.
40
Q

What is a valuation allowance under US GAAP?

A
  • It is a contra-asset account created when doubts exist about the actual realization of DTAs.
  • It reduces DTA.
  • Reversals are permitted if circumstances change.
  • The timing and the amount are determined by management.
41
Q

What is the accounting treatment of taxable temporary differences investments in a subsidiary, joint venture, and associate under IFRS?

A

Deferred taxes are not recognized in which the parent is able to control the timing of the reversal and it is probable that the temporary difference will not reverse in the foreseeable future.

42
Q

What is the accounting treatment of taxable temporary differences investments in a subsidiary, joint venture, and associate under US GAAP?

A
  • No deferred taxes for domestic subsidiaries.
  • No deferred taxes for foreign subsidiaries that meet the indefinite reversal criterion.
43
Q

What is the accounting treatment of deferred tax asset recognition under US GAAP and IFRS?

A
  • US GAAP: recognized in full and reduces by a valuation allowance if most probable that some/all of the tax asset will not be realized.
  • IFRS: recognized if probable that taxable profit will be available to recover tax assets.
44
Q

What is the accounting treatment of tax rate used to measure deferred taxes under US GAAP and IFRS?

A
  • IFRS: rates that have been enacted or substantively enacted.
  • US GAAP: substantively enacted tax rate not permitted.

FRA (18 decks)

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