Flashcards in Income Taxes Deck (49)
When is income tax expense recognized?
Income tax expense is recognized when it is incurred, regardless of when the payment is actually made to the Internal Revenue Service. The process of recognizing income tax expense is called interperiod tax allocation. This process ensures proper matching of income tax expense with revenues.
Does GAAP emphasize the matching concept on income tax accounting?
No, the emphasis is on the correct measurement of the income tax assets and liabilities.
What are the main effects of applying the asset/liability approach in income tax accounting?
1. Income tax expense for the period reflects the amount that will ultimately be payable on the year's transactions.
2. The income tax payable account, deferred tax asset account, and deferred tax liability account report the remaining tax receivables and obligations facing the firm from transactions that have already occurred as of the balance sheet date.
3. Income tax expense is an amount derived from the changes in the tax-related assets and liabilities. It is no longer a directly computed value.
What is a taxable item?
Amounts that cause income tax to increase. This is an Internal Revenue Code term and typically refers to revenues that cause taxable income to increase.
What is a deductible item?
Amounts that cause income tax to decrease. This is an Internal Revenue Code term and typically refers to expenses that cause taxable income to decrease.
What is pretax income?
Income before income tax for financial accounting purposes determined by applying GAAP.
What is taxable income?
Income before tax for tax purposes. This is the analogue of pretax accounting income. Taxable income is the amount to which the tax rates are applied in determining the income tax liability for the year.
What is an income tax liability?
The amount of income tax the firm must pay on taxable income for a year.
What is an income tax expense?
The account reported in the income statement that measures the income tax cost for the year's transactions. Income tax expense equals the income tax liability plus or minus the net change in the deferred tax accounts for the period.
What is the current income tax provision?
This term is used in the income statement to refer to the amount of income taxes due for the year. This amount is the same as the income tax liability for the year.
What is the deferred income tax provision?
The amount of income tax expense that is not currently due. This amount equals the net sum of the change in the deferred tax accounts.
What is a permanent difference?
An amount that appears in the tax return or income statement but never both. These include items of revenue or expense that are never taxable or deductible; also taxable and deductible items that never appear in the income statement. This type of difference is also called a nontemporary difference.
What is a temporary difference?
An item of revenue or expense that, over the total life of the item, will affect pretax accounting income and taxable income in the same total amount, but will be recognized in different amounts in any given year for financial reporting and tax purposes.
What is a net operating loss?
Negative taxable income (strictly a tax term). A net operating loss can be carried back 2 years to reduce taxable income in those years for a refund of taxes, and carried forward 20 years to reduce taxable income and therefore the tax liability in future years.
What is a deferred tax asset?
The recognized tax effect of future deductible temporary differences. These differences, caused by transactions that have occurred as of the balance sheet date, will cause future taxable income to decrease relative to pretax accounting income.
What is a deferred tax liability?
The recognized tax effect of future taxable temporary differences. These differences, caused by transactions that have occurred as of the balance sheet date, will cause future taxable income to increase relative to pretax accounting income.
What is interperiod tax allocation?
The process of measuring and recognizing the total income tax consequences of transactions in the year. Only temporary differences and net operating loss carry forwards enter into this process.
What are some examples of permanent differences?
Tax-Free Interest Income
Life insurance expense
Proceeds on Life Insurance
Dividends Received Deduction
Fines and Penalties
What are the 4 types of temporary differences
A. Taxable After Recognized for the Books -- Revenues or Gains that are Taxable after they are Recognized in Financial Income
B. Deductible After Recognized for the Books -- Expenses or Losses that are Deductible after they are Recognized in Financial Income
C. Taxable Before Recognized for the Books -- Revenues or Gains that are Taxable before they are Recognized in Financial Income
D. Deductible Before Recognized for the Books -- Expenses or Losses that are Deductible before they are Recognized in Financial Income
What is an originating difference?
When an item causing a temporary difference first occurs
What is a taxable temporary difference?
involves differences that initially cause a postponement in the payment of taxes
In the year of origination, the item causes taxable income to decline relative to pretax accounting income
When the item reverses, the item causes future taxable income to exceed pretax accounting income
Future taxable differences give rise to deferred tax liabilities
What is a deductible temporary difference?
Involves differences that initially cause a prepayment of taxes.
In the year of origination, the item causes taxable income to increase relative to pretax accounting income.
When the item reverses, the item causes future taxable income to be less than pretax accounting income.
Future deductible differences give rise to deferred tax assets.
What are examples of Taxable Temporary Differences (DTL)?
Completed contract for tax, % of completion on books
Unrealized Gain on trading securities
What are examples of DeductibleTemporary Differences (DTA)?
Carryforward of NOL
Recognized Estimate from Lawsuit
What is the equation for taxable income?
+/- Originating Temporary Differences
+/- Permanent differences
= Taxable income
How do you calculate deferred tax expense?
= increased rate on future taxable amounts outstanding at beginning of year + amount related to current year originating temporary differences
What journal entries are used to report income tax expense?
Income Tax Expense a "plug" figure
Deferred Tax Asset * see below
Deferred Tax Liability ** see below
Income Tax Payable taxable income x current tax rate
* The amount to increase the deferred tax asset to its required ending balance, which is the total future deductible temporary difference multiplied by the future enacted tax rate.
** The amount to increase the deferred tax liability to its required ending balance which is the total future taxable temporary difference multiplied by the future enacted tax rate.
What is the effective tax rate?
The effective tax rate is the ratio of income tax expense to pretax accounting income.
What are the general steps for interperiod tax allocation?
Steps Leading to the Tax Accrual Entry:
1. Compute taxable income and multiply by current tax rate.
2. Analyze all future individual temporary differences, separating them into taxable and deductible categories.
3. Apply the future enacted rate(s) to the taxable differences and aggregate.
4. Apply the future enacted rate(s) to the deductible differences and aggregate.
5. Net sum equals income tax expense
What is the equation for income tax expense?
Income Tax Payable + Increase in Deferred Tax Liability – Increase in Deferred Tax Asset = Income Tax Expense
How do you account for a tax rate that changes during the year?
the new rate is applied as of the beginning of the year (estimate change) to recompute the deferred tax balances
How are deferred tax accounts classified?
As Current Liability or Asset or Noncurrent Asset or Liability (4 accounts)
How are deferred tax accounts classified for external reporting?
the current deferred tax accounts are netted together to form one current deferred tax asset or liability, and the noncurrent deferred tax accounts are likewise netted to form one noncurrent deferred tax asset or liability.
When is a valuation account necessary with a deferred tax asset?
When there is better than a 50% chance of realizing the deferred tax asset, it is reported free of any valuation account.
When there is a 50% or less chance of the deferred tax asset being fully realized, it is reported but also is reduced by a valuation allowance (contra to deferred tax asset) to the amount that has a better than 50% chance of being realized.
What items signifiy that a valuation account may be necessary?
1. A history of unused net operating losses;
2. A history of operating losses;
3. Losses expected in future years;
4. Very unfavorable contingencies.
5. very vried carryback or carry forward period
What items signifiy that a valuation account may NOT be necessary?
1. Existing contracts or sales backlog will produce more than enough taxable income to realize the deferred tax asset;
2. An excess of appreciated asset value over the tax basis of the entity's net assets will produce more than enough taxable income to realize the deferred tax asset;
3. A strong earnings history that suggests that taxable income in the future will be enough to realize the deferred tax asset.
What is an uncertain tax postion?
those that may not be sustainable on audit by the IRS.
If there is at least a 1/3 probability that the tax position will be sustained, there is no legal or professional censure for taking that position.
What is the 2 step approach for addressing uncertainty in income taxes?
(1) Is the uncertain position more likely than not to be sustained?, (2) If yes, then a probabilistic approach is applied to determine the amount of benefit recognized in the current year.
What happens if it is NOT "more likely than not" that a tax position will be sustained upon audit by the IRS?
then income tax expense is not reduced and an additional tax liability is recognized. No benefit is recognized in the current year.
What happens if it is IS "more likely than not" that a tax position will be sustained upon audit by the IRS?
then the firm must estimate specific outcomes of the audit and probabilities associated with each. The amount of benefit recognized is the largest amount for which the cumulative probability of realization exceeds 50%.
What is a net operating loss?
is negative taxable income for a year - a loss for income tax purposes. An NOL occurs when taxable deductions exceed taxable revenues. This provision is solely within the tax code. There is no counterpart in financial accounting. However, financial accounting must report the economic effects of the operating loss
How far are you able to carry back/forward a NOL?
The tax law allows an NOL to be carried back 2 years, or forward 20 years. Thus, a 23 year period (including the NOL year) is the basis for taxation
What are the 2 options available for a NOL?
1 - Carryback, carryforward option
2 - Carryforward only
What is the carryback, carryforward option?
the NOL is first carried back to the 2 years before the year of the NOL. The NOL absorbs prior years' taxable income for an immediate refund of taxes paid in those prior years.
If the NOL exceeds taxable income for the 2 preceding years, the remainder then is carried forward for at most 20 years to absorb future taxable income. Earliest years are used first. No taxes are paid on taxable income absorbed by the NOL in those future years.
What is the carryforward option?
In this option the firm chooses only to carry forward the NOL, rather than carry it back first. The 20 year limitation is in effect in this option. There is no refund of income taxes paid in the past
The main reason for choosing this is to take advanctage of significantly higher tax rates in the future
This creates a future deductible difference
Can multiple NOLs be used at the same time?
An NOL must be completely utilized before a later NOL can be carried back or forward.
What is the journal entry for a carry back?
Refund Receivable amount of refund
Income Tax Benefit amount of refund
What is the journal entry for a carry forward?
Deferred Tax Asset (future enacted rate )(remaining NOL)
Income Tax Benefit (future enacted rate )(remaining NOL)