Chapter 19

Accounting for Income

Taxes
Intermediate Accounting 10th edition
Nikolai Bazley Jones
An
Anelectronic
electronicpresentation
presentation
by
byNorman
NormanSunderman
Sunderman
Angelo
AngeloState
StateUniversity
University
COPYRIGHT 2007 Thomson South-Western, a part of The Thomson Corporation.
Thomson, the Star logo, and South-Western are trademarks used herein under license.

Objectives
1. Understand permanent and temporary
differences.
2. Explain the conceptual issues
regarding interperiod tax allocation.
3. Record and report deferred tax
liabilities.
4. Record and report deferred tax assets.
5. Explain an operating loss carryback
and carryforward.

Objectives
6. Account for an operating loss carryback.
7. Account for an operating loss
carryforward.
8. Apply intraperiod tax allocation.
9. Classify deferred tax liabilities and
assets.

Differences Between Taxable and

Financial Income
1.
1. Because
Because there
thereare
aredifferences
differences between
between when
when an
an
event
eventisisrecognized
recognized for
fortax
tax purposes
purposes and
andwhen
when itit
isis recognized
recognized for
forfinancial
financial purposes,
purposes, there
therewill
will be
be
differences
differences between
between tax
tax expense
expense on
on the
the income
income
statement
statement and
and taxes
taxes actually
actually paid.
paid.
2.
2. The
The objective
objective of
of accounting
accounting for
forincome
income taxes
taxes on
on
the
the accrual
accrual basis
basis isis to
to recognize
recognize the
the amount
amount of
of
current
current and
and deferred
deferred taxes
taxes payable
payable or
orrefundable
refundable
at
at the
the date
date of
of the
the financial
financial statements.
statements.
Continued
Continued

Differences Between Taxable and

Financial Income
3.
3. These
These differences
differences require
requirethe
theuse
useof
of Deferred
Deferred
Income
IncomeTax
Tax accounts
accounts to
to reflect
reflect the
the tax
tax
consequences
consequences of
of events
events recognized
recognized in
in different
different
periods
periods for
forfinancial
financial and
and tax
tax reporting.
reporting.
4.
4. Recognition
Recognition of
of deferred
deferred tax
tax liabilities
liabilities and
and
deferred
deferred tax
tax assets
assets isis required
required for
fordomestic
domestic
federal
federal income
income taxes,
taxes, and
and foreign,
foreign, state,
state, and
and local
local
(including
(including franchise)
franchise) taxes
taxes based
based on
on income.
income.

Overview and Definitions

The
The objective
objective of
of financial
financial
reporting
reporting isis to
to provide
provide
useful
useful information
information about
about
companies
companies to
to decision
decision
makers.
makers.

Income
Statement

Income
Tax
Return

Overview and Definitions

Income
Statement

Income
Tax
Return

Frees Corporation
Income Statement
For Year Ended 12/31/07
Revenues
$180,000
Cost of goods sold
(78,000)
Gross profit
$105,000
Other expenses
(60,000)
Pretax income from
continuing operations $ 45,000
Income taxes
(11,000)
Net income
$ 34,000

Overview and Definitions

Income
Statement

Income
Tax
Return

Frees Corporation
Income Tax Return
For Year Ended 12/31/07
Revenues
$170,000
Cost of goods sold
(70,000)
Gross profit
$100,000
Other expenses
(60,000)
Pretax income from
continuing operations $ 40,000
Income taxes
( 9,200)
Net income
$ 30,800

Causes of Differences
Permanent differences.
Temporary differences.
Operating loss
carrybacks and
carryforwards.
Tax credits.
Intraperiod tax
allocations.

10

Conceptual Issues
1. Should corporations be required to make
interperiod income tax allocations for
temporary differences, or should there be no
interperiod tax allocation?
2. If interperiod tax allocation is required, should
it be based on a comprehensive approach for
all temporary differences or on a partial
approach for certain temporary differences?
3. Should interperiod tax allocation be applied
using the asset/liability method or the deferred
method?

11

Conceptual Issues
The FASB concluded that- Interperiod income tax allocation of
temporary differences is appropriate.
The comprehensive allocation approach is

to be applied.
The asset/liability method of income tax

allocation is to be used.

12

Permanent Differences
Some items of revenue and
expense that a corporation
reports for financial
accounting purposes are
never reported for income
tax purposes. These
permanent differences never
reverse in a later accounting
period.

13

Permanent Differences

14

Permanent Differences

1.
1.
2.
2.

Revenues
Revenues that
that are
are recognized
recognized for
for
financial
financial reporting
reporting purposes
purposes but
but are
are
never
never taxable
taxable
Interest
Interest on
on state
state and
and local
local government
government
bonds
bonds
Life
Life insurance
insurance proceeds
proceeds payable
payable to
to aa
corporation
corporation upon
upon death
death of
of insured
insured
Continued
Continued

15

Permanent Differences

1.
1.
2.
2.
3.
3.

Expenses
Expenses that
that are
are recognized
recognized for
for
financial
financial reporting
reporting purposes
purposes but
but are
are
never
never deductible
deductible for
for income
income tax
tax
purposes
purposes
Life
Life insurance
insurance premiums
premiums on
on officers
officers
Fines
Fines resulting
resulting from
from aa violation
violation of
of the
the
law
law
Expenses
Expenses incurred
incurred in
in obtaining
obtaining taxtaxexempt
exempt income
income
Continued
Continued

16

Permanent Differences

1.
1.
2.
2.

Deductions
Deductions that
that are
are allowed
allowed for
for income
income
tax
tax purposes
purposes but
but do
do not
not qualify
qualify as
as
expenses
expenses under
under generally
generally accepted
accepted
accounting
accounting principles
principles
Percentage
Percentage depletion
depletion in
in excess
excess of
of cost
cost
depletion
depletion
Dividend
Dividend received
received deduction
deduction

Permanent differences affect either a corporations

reported pretax financial income or its taxable
income, but not both.

17

Dividend Received Deduction

Corporations
Corporationsreceive
receiveaa70%
70%
deduction
deductionfor
fordividends
dividendsreceived
receivedifif
less
lessthan
than20%
20%of
ofaaU.S.
U.S.corporation
corporationisis
owned,
owned,an
an80%
80%deduction
deductionfor
for
dividends
dividendsreceived
receivedifif80%
80%or
orless
lessof
ofaa
U.S.
U.S.corporation
corporationisisowned,
owned,and
andaa
100%
100%deduction
deductionfor
fordividends
dividends
received
receivedififmore
morethan
than80%
80%of
ofaaU.S.
U.S.
corporation
corporationisisowned.
owned.

18

Temporary Differences
A temporary difference
causes a difference
between a
corporations pretax
financial income and
taxable income that
originates in one or
more years and
reverses in later
years.

19

Temporary DifferencesFuture Taxable Amounts

Future Taxable Income Will Be Higher Than
Future Pretax Financial Income

T
Over = Taxable
F

1.
1. For
Forexample,
example, aa depreciable
depreciable asset
asset may
may be
be
depreciated
depreciated using
using MACRS
MACRS over
overthe
the
prescribed
prescribed tax
tax life
life for
forincome
income purposes,
purposes, but
but
using
using straight-line
straight-line depreciation
depreciation over
overaa longer
longer
life
life for
forfinancial
financial reporting
reporting purposes.
purposes.
Continued
Continued

20

Temporary DifferencesFuture Taxable Amounts

Future Taxable Income Will Be Higher Than
Future Pretax Financial Income
2.
2. Gross
Gross profit
profit on
on installment
installment sales
sales normally
normallyisis
recognized
recognized at
at the
the point
point of
of sale
salefor
forfinancial
financial
reporting
reporting purposes,
purposes, but
but for
forincome
income tax
tax
purposes,
purposes,in
in certain
certain situations
situations itit isis recognized
recognized
as
as cash
cash isis collected.
collected.

T
Over = Taxable
F
Continued
Continued

21

Temporary DifferencesFuture Taxable Amounts

Future Taxable Income Will Be Higher Than
Future Pretax Financial Income
3.
3. It
It isis assumed
assumed that
that investment
investment income
income
reported
reported under
underthe
the equity
equitymethod
methodfor
for
financial
financial purposes,
purposes, but
but not
not received
received as
as aa
dividend,
dividend, will
will eventually
eventuallybe
be received
received as
as
dividends
dividends or
oras
as aa gain
gain when
when the
the stock
stockisis sold.
sold.

T
Over = Taxable
F
Continued
Continued

22

Temporary DifferencesFuture Taxable Amounts

Future Taxable Income Will Be Higher Than
Future Pretax Financial Income
4.
4. Prepaid
Prepaid expenses
expenses are
aredeductible
deductible when
when paid
paid
for
fortax
tax purposes,
purposes, but
but are
arenot
not recorded
recorded as
as
expenses
expenses under
underused
used for
forfinancial
financial purposes.
purposes.
5.
5. Unrealized
Unrealized gains
gains on
on trading
trading securities
securities are
arenot
not
taxable
taxable until
until realized.
realized.

T
Over = Taxable
F
Continued
Continued

23

Temporary DifferencesFuture Taxable Amounts

Future Taxable Income Will Be Higher Than
Future Pretax Financial Income
6.
6. Profit
Profit recognized,
recognized, but
but not
not realized,
realized, under
underthe
the
percentage
percentage of
of completion
completion method
method for
for
financial
financial reporting
reporting that
thatwill
willnot
not be
betaxable
taxable
until
until aa later
lateryear.
year.

T
Over = Taxable
F
Continued
Continued

24

Temporary DifferencesFuture Deductible Amounts

Future Pretax Financial Income Higher Than
Future Taxable Income
1.
1. For
Forexample,
example, items
items such
such as
as rent,
rent, interest,
interest, and
and
royalties
royalties received
received in
in advance
advance are
aretaxable
taxable
when
when received
received but
but are
arenot
not reported
reported for
for
financial
financial reporting
reporting purposes
purposes until
until the
the service
service
actually
actually has
has been
been provided.
provided.

F
Over = Deductible
T
Continued
Continued

25

Temporary DifferencesFuture Deductible Amounts

Future Pretax Financial Income Higher Than
Future Taxable Income
2.
2. Product
Product warranty
warranty costs
costs may
maybe
be estimated
estimated and
and
recorded
recorded as
as expenses
expenses in
in the
the current
current year
yearfor
for
financial
financial reporting
reporting purposes
purposes but
but deducted,
deducted, as
as
actually
actually incurred,
incurred, for
forthe
the determination
determination of
of
taxable
taxable income.
income.

F
Over = Deductible
T
Continued
Continued

26

Temporary DifferencesFuture Deductible Amounts

Future Pretax Financial Income Higher Than
Future Taxable Income
3.
3. Bad
Bad debts
debts expense
expenseestimated
estimatedfor
forfinancial
financial
reporting,
reporting, but
butnot
not deductible
deductibleuntil
untilthe
the
receivable
receivable isis written
written off
off for
fortax
tax purposes.
purposes.
4.
4. Portion
Portion of
of depreciation
depreciation capitalized
capitalized for
fortax
tax
purposes
purposesinto
into inventory.
inventory.

F
Over = Deductible
T
Continued
Continued

27

Temporary DifferencesFuture Deductible Amounts

Future Pretax Financial Income Higher Than
Future Taxable Income
5.
5. Accrued
Accrued litigation
litigation losses
losses for
forfinancial
financial
reporting,
reporting, but
butnot
not deducted
deducted until
until paid
paid for
fortax
tax
purposes.
purposes.
6.
6. Losses
Losses on
on investments
investments classified
classified as
as trading
trading
securities.
securities.
7.
7. Unrealized
Unrealized profit
profit on
on sale
sale and
and leaseback
leasebackfor
for
financial
financial reporting
reporting and
andaa profit
profit on
onthe
thesale
salefor
for
tax
tax purposes.
purposes.

F
Over = Deductible
T

28

Conceptual Issues
The
The FASB
FASB established
established
four
fourbasic
basic principles
principles that
that
aa corporation
corporation isis to
to apply
apply
in
in accounting
accounting for
forits
its
income
income taxes
taxes at
at the
thedate
date
of
of its
its financial
financial
statements.
statements.

29

Conceptual Issues
1. A current tax liability or asset is
recognized for the estimated income tax
obligation or refund on its income tax
return for the current year.
2. A deferred tax liability or asset is
recognized for the estimated future tax
effects of each temporary difference.

Continued
Continued

30

Conceptual Issues
3. The measurement of deferred tax
liabilities and assets is based on
provisions of the enacted tax law; the
effects of future changes in tax law or
rates are not anticipated.
4. The measurement of deferred tax
assets is reduced, if necessary, by the
amount of any tax benefits that are
not expected to be realized.

31

Measurement
The FASB addressed two issues regarding
the measurement of deferred tax
liabilities or deferred tax asset in its
financial statements.
1. The applicable income tax
rates.
2. Whether a valuation
allowance should be
established for deferred
tax assets.

Steps in Recording and

Reporting of Current and
Deferred Taxes

Step 1. Measure the income tax obligation by

applying the applicable tax rate to the
current taxable income.
Step 2. Identify the existing temporary differences
and classify each as eithertaxable or
deductible.
Step 3. Measure the deferred tax liability for each
taxable temporary difference using the
applicable tax rate.

Continued
Continued

32

Steps in Recording and

Reporting of Current and
Deferred Taxes

Step 4. Measure the deferred tax asset for each

deductible temporary difference using the
applicable tax rate.
Step 5. Reduce deferred tax assets by a valuation
allowance if, based on available evidence, it
is more likely than not that some or all of the
deferred tax assets will not be realized.
Step 6. Record the income tax obligation, change in
deferred tax liabilities and/or deferred tax
assets, change in valuation allowance (if
any), and plug income tax expense.

33

34

Basic Entries
In
In 2007,
2007,Track
TrackCompany
Company purchased
purchased an
an asset
asset
at
at aa cost
cost of
of $6,000.
$6,000. For
Forfinancial
financial reporting
reporting
purposes,
purposes, the
the asset
asset has
has aa 4-year
4-yearlife,
life, no
no
residual
residual value,
value, and
and isis depreciated
depreciated by
bythe
the
units-of-output
units-of-output method
method over
over6,000
6,000 units
units
(2007:
(2007: 1,600
1,600 units).
units). For
Forincome
income tax
tax purposes
purposes
the
the asset
asset isis depreciated
depreciatedunder
underMACRS
MACRSusing
using
the
the 3-year
3-yearlife
life (33.33%
(33.33%for
for2007).
2007). The
Thetaxable
taxable
income
income isis $7,500
$7,500 and
and the
the income
income tax
tax rate
rate for
for
2007
2007 isis 30%.
30%.
This button will be used later

35

Deferred Tax Liability

In
In the
the future
futuretaxable
taxable income
incomewill
will be
be higher
higher
than
than financial
financial income,
income, so
so the
the taxable
taxable amount
amount
times
times the
the tax
tax rate
rate isis the
the deferred
deferred tax
tax liability.
liability.

Year
2007

Financial
Depreciation
$1,600

Income Tax
Depreciation Difference
$2,000
400

36

Basic Entries
Step 1. $7,500 (taxable income) x 30%
Step 2. The depreciation difference is identified as
the only taxable temporary difference.
Step 3. The $120 total deferred tax liability is
calculated by multiplying the total taxable
temporary difference ($400) times the future
tax rate (30%).
Steps 4 and 5. No deferred tax asset, so not
required.
Step 6. A journal entry is made.

Continued
Continued

37

Basic Entries
Income Tax Expense (plug)
Income Taxes Payable
Deferred Tax Liability

2,370
2,250
120
$2,250 + $120

38

Future Tax Rates Differ

When
When future
futureenacted
enacted
tax
tax rates
rates change,
change,
reversals
reversals are
are
calculated
calculated at
at the
the
future
futuretax
tax rates.
rates.

39

Example 2-Multiple Rates

Assume
Assume the
the same
same facts
facts as
as in
in Slide
Slide 34,
34, except
except that
that the
the
income
income tax
tax rate
rate for
for2007
2007 for
for40%,
40%, but
but Congress
Congress has
has
enacted
enacted tax
tax rates
rates of
of 35%
35%for
for2008,
2008, 33%
33%for
for2009,
2009,
and
and 30%
30%for
for2010
2010 and
and beyond.
beyond.
Year
2007
2008
2009

Financial
Depreciation
$2,800
1,100
500

Income Tax
Depreciation
$2,667
889
444

Click here to review Slide 34, then click

the button on Slide 34 to return.

40

Example 2-Multiple Rates

Deferred Tax Liability
2007
2008
2009
Financial depreciation $2,800 $1,100 $500
Income tax depreciation(2,667 )
(889 )
(444 )
Taxable amount
$ 133 $ 211 $ 56 = $400
Income tax rate
0.35 0.33 0.30
Deferred tax liability $ 47 $ 70 $ 17 = $134

Income Tax Expense (plug)

Deferred Tax Liability
Income Taxes Payable

3,134
134
3,000

41

Deferred Tax Asset

Klemper
KlemperCompany
Company sells
sells aa
product
product on
on which
which itit provides
provides aa
3-year
3-yearwarranty.
warranty. For
For
financial
financial reporting
reporting purposes,
purposes,
the
the company
company estimates
estimates its
its
future
futurewarranty
warrantycosts
costs and
and
records
records aa warranty
warranty
expense/liability
expense/liability at
at year-end.
year-end.
For
Forincome
income tax
tax purposes,
purposes, the
the
company
companydeducts
deducts its
its warranty
warranty
costs
costs when
when paid.
paid.

42

Deferred Tax Asset

At
At the
the beginning
beginning of
of 2007,
2007, the
the company
company had
had aa
deferred
deferred tax
tax asset
asset of
of $330
$330 related
related to
to its
its warranty
warranty
plan.
plan. At
At the
the end
end of
of 2007,
2007, the
the company
company estimates
estimates that
that
its
its ending
ending warranty
warranty liability
liability isis $1,400.
$1,400. In
In 2007,
2007, the
the
company
companyhas
has taxable
taxable income
income of
of $5,000
$5,000 and
and aa tax
tax rate
rate
of
of 30%.
30%.The
The ending
ending Deferred
DeferredAsset
Asset should
should be
be$1,400
$1,400
X
X 30%,
30%, or
or$420.
$420.
Income Tax Expense (plug)
$1,410
Deferred Tax Asset ($420 - $330)
90
Income Taxes Payable ($5,000 x 30%)

1,500

43

Deferred Tax Asset and Valuation

Allowance
If
If itit isis more
more likely
likely than
than
not
not that
that aa deferred
deferred tax
tax
asset
asset will
will not
not be
be realized,
realized,
aa valuation
valuation allowance
allowance
must
must be
be established.
established.

44

Negative Evidence
Negative evidence indicating the need for a valuation
allowance include:
1. A history of operating loss or tax credit carryforwards
expiring unused.
2. Losses expected in early future years (by a presently
profitable entity).
3. Unrecognized loss contingencies that, if unfavorably
resolved, would adversely affect future operations and
profit levels on a continuing basis in future years.
4. A carryback, carryforward period that is so brief that it
would limit realization of tax benefits.

45

Positive Evidence
Positive evidence as to whether existing net deductible
temporary differences and loss carryforwards will be
realized include:
1. Existing contracts or firm sales backlog will produce more
than enough future taxable income to realize the deferred
tax asset based on existing sales prices and cost structures.
2. Income in carryback years prior to the present year.
3. Feasible and presently available tax strategies would result
in more than enough taxable income to realize the deferred
tax asset.
4. Appreciation of assets is sufficient to realize the deferred
tax asset.
5. A strong earnings history exclusive of the charge to income
that created the future deductible amount coupled with
evidence indicating the transaction or event that created
the charge to income (i.e. extraordinary item) is an
aberration rather than a continuing condition.

46

Deferred Tax Assets and

Valuation Allowance
At
At the
the end
end of
of 2007,
2007, Klemper
Klemper Corporation
Corporation
decides
decides that
that itit is
is more
more likely
likely than
than not
not that
that
$600
$600 of
of the
the ending
ending temporary
temporary difference
difference
will
will not
not be
be realized.
realized. (30%
(30% tax
tax rate)
rate)
Income Tax Expense
Allowance to Reduce Deferred
Tax Asset to Realizable Value

180
180

47

Determining Taxable Income

Both permanent and temporary differences are
considered when determining taxable income.

PPretax financial income

Add: Deductible temporary items
Fines
Excess charitable contributions
Expenses to earn tax exempt income
Excess of bad debts expense over write-offs (deductible item)
Less: Taxable temporary items
Tax exempt interest
Proceeds of life insurance
Excess of percentage depletion over cost depletion
Equity income not received as dividends (taxable item)
Dividends received deduction
Taxable income

XX
XX
XX
XX
XX
XX
XX
XX
XX
XX
XX

XX

XX
XX

XX
XX

48

Example 5-Pages 959 & 960

Assume the following for Sand Company for 2007:
Interest on municipal bonds
$1,500
Gross profit on installment sales-financial 10,000
Gross profit on installment sales-taxable
2,000
Rent revenue-financial
3,000
Rent revenue-taxable
9,000
Pre-tax financial income
75,500
Deferred tax liability-Jan. 1, 2007
300
Deferred gross profit-installment sales-2006 1,000
Make the journal entry for 2007.

49

Determining Taxable Income

Both permanent and temporary differences are
considered when determining taxable income.
PPretax financial income
Add: Rent revenue collected in advance

$75,500
6,000
$81,500

Less: Tax exempt interest

$1,500
Difference in gross profit on installment sales 8,000
9,500
Taxable income
$72,000

50

Deferred Tax Assets and

Liabilities
$8,000 (2007) + $1,000 (2006)

Income Tax Expense (plug)

Deferred Tax Asset
Deferred Tax Liability
Taxes Payable

22,200
1,800
2,400
21,600

51

Conceptual Issues
FASB
FASB concluded
concluded in
in FASB
FASB
Statement
Statement No.
No. 109
109 that
that
GAAP
GAAPfor
foroperating
operating
carrybacks
carrybacks and
and
carryforwards
carryforwards are...
are...

52

Conceptual Issues
1. A corporation must recognize the tax benefit of
an operating loss carryback in the period of the
loss as an asset on its balance sheet and as a
reduction of the operating loss on its income
statement.
2. A corporation must recognize the tax benefit of
an operating loss carryforward in the period of
the loss as a deferred tax asset. However, it
must reduce the deferred tax asset by a
valuation allowance if it is more likely than not
that the corporation will not realize some or all
of the deferred tax asset.

53

Operating Loss Carrybacks

and Carryforwards

54

Operating Loss Carryback

Monk
MonkCompany
Company reports
reports aa pretax
pretax operating
operating loss
loss of
of
$90,000
$90,000 in
in 2007
2007 for
forboth
bothfinancial
financial reporting
reporting and
and
income
income tax
tax purposes,
purposes, and
and that
that reported
reported pretax
pretax
financial
financial income
income and
and taxable
taxable income
income for
forthe
the previous
previous
22 years
years had
had been:
been: 2005--$40,000
2005--$40,000 (tax
(tax rate
rate 25%);
25%); and
and
2006--$70,000
2006--$70,000 (tax
(tax rate
rate 30%).
30%).
2005 $40,000 x 0.25 = $10,000
2006 $50,000 x 0.30 = 15,000
$25,000

Income Tax Refund Receivable

Income Tax Benefit From
Operating Loss Carryback

25,000
Continued
Continued

25,000

55

Income Statement
An operating loss is reduced by the benefit,
not by the total carryback.
Pretax operating loss
$(90,000)
Less: Income tax benefit from
operating loss carryback
$40,000 x 25% + $50,000 x 30% 25,000
Net loss
$(65,000)

56

Operating Loss Carryforward

Lake
Lake Company
Companyreports
reports aa pretax
pretax operating
operating loss
loss of
of
$60,000
$60,000 in
in 2007
2007 for
forboth
both financial
financial reporting
reporting and
and
income
income tax
tax purposes.
purposes. The
The income
income tax
tax rate
rate isis 30%
30%
and
and no
no change
change in
in the
the tax
tax rate
rate has
has been
been enacted
enacted for
for
future
futureyears.
years. The
Thedeferred
deferred tax
taxasset
asset isis calculated
calculated to
to
be
be $18,000
$18,000 ($60,000
($60,000 xx 0.30).
0.30).
Deferred Tax Asset
Income Tax Benefit From
Operating Loss Carryforward
Continued
Continued

18,000
18,000

57

Operating Loss Carryforward

If
If the
the company
companyestablishes
establishes aa valuation
valuation allowance
allowance for
for
the
the entire
entireamount
amount of
of the
the deferred
deferred tax
tax asset,
asset, itit also
also
makes
makes the
the following
following journal
journal entry
entry at
at the
the end
end of
of 2007.
2007.
Income Tax Benefit From Operating
Loss Carryforward
18,000
Allowance to Reduce Deferred Tax
Asset to Realizable Value
18,000

Continued
Continued

58

Operating Loss Carryforward

In
In 2008,
2008, Lake
Lake Company
Company operates
operates successfully
successfully and
and
earns
earns pretax
pretax operating
operating income
income of
of $100,000
$100,000 for
forboth
both
financial
financial reporting
reporting and
and tax
tax purposes.
purposes.
$40,000 x 0.30
Income Tax Expense
Allowance to Reduce Deferred Tax
Asset to Realizable Value
Income Taxes Payable
Deferred Tax Asset

12,000
18,000
12,000
18,000

59

Intraperiod Tax Allocation

Income
Income tax
tax allocation
allocation
within
within aa period
period isis
mandatory
mandatory under
under
GAAP.
GAAP.

60

Intraperiod Tax Allocation

Income tax may appear in five different places
in the financial statements for a period.
1. Income from continuing operations
2. Discontinued operations
3. Extraordinary items
4. Prior period and retrospective adjustments
5. Other comprehensive income

61

Intraperiod Tax Allocation

Kalloway
Kalloway Company
Companyreports
reports the
the following
following items
items of
of
pretax
pretax financial
financial and
and taxable
taxable income
incomefor
for2007:
2007:
Income from continuing operations
[$270,000 (revenues) $190,000 (expenses)] $80,000
Gain on disposal of discontinued Segment X
18,000
Loss from operations of discontinued Segment X (5,000 )
Extraordinary loss on bond redemption
(10,000 )
Cumulative effect of change in accounting
principle (accelerated depreciation to S/L)
15,000
Prior period adjustment (error)
(8,000 )
Amount subject to income taxes
$90,000
Continued
Continued

62

Intraperiod Tax Allocation

Kalloway
Kalloway Company
Company
isis subject
subject to
to income
income
tax
tax rates
rates of
of 20%
20% on
on
the
the first
first $50,000
$50,000 of
of
income
income and
and 30%
30% on
on
all
all income
income in
in excess
excess
of
of $50,000.
$50,000.
Continued
Continued

Lets
Lets take
take aa look
look at
at
Kalloway
Kalloway
Companys
Companys income
income
statement
statement for
for 2007.
2007.

63

Intraperiod Tax Allocation

Component (Pretax)
Income from continuing
operations

Income
Income
Tax
Expense
Tax
Pretax
Amount x Rate = (Cr.)
$50,000
30,000

Gain on disposal of
discontinued Division X
18,000
Extraordinary loss from tornado(5,000)
Continued
Continued

0.20
0.30
0.30
0.30

$10,000
9,000
5,400
(1,500 )

64

Intraperiod Tax Allocation

Component (Pretax)

Income
Income
Tax
Expense
Tax
Pretax
Amount x Rate = (Cr.)

Cumulative effect of change in

accounting principle on prior
years income
$15,000
Prior period adjustment
(8,000)
Total income tax expense

0.20
0.30

$ 4,300
(2,400)
$22,000

65

Intraperiod Tax Allcoation

Now,
Now, lets
lets examine
examine
Kalloway
Kalloway Companys
Companys
income
income statement
statement for
for
2007.
2007.

66

Intraperiod Tax Allocation

Kalloway Company
Income Statement
for Year Ended December 31, 2007

Revenues (listed separately)

$270,000
Expenses (listed separately)
(190,000)
Pretax income from continuing operations$ 80,000
Income tax expense
(19,000)

(0.20 x $50,000) +
(0.30 x $30,000)

67

Kalloway Company
Income Statement
for Year Ended December 31, 2007

Revenues (listed separately)

Expenses (listed separately)
Pretax income from continuing operations
Income tax expense
Income from continuing operations
Results of discontinued operations:
$18,000 x 0.30
Gain on disposal of discontinued
Segment X (net of $5,400 tax)
$12,600
Loss from operations of discontinued
Segment X (net of $1,500 tax credit) (3,500)
Income before extraordinary
item
($5,000) X .30

$270,000
(190,000)
$ 80,000
(19,000)
$ 61,000

9,100
$ 70,100

Statement
Statement Continued
Continued

68

($10,000) x 0.30
Income before extraordinary item
Extraordinary loss from tornado
(net of $3,000 income tax credit)
Net Income

$70,100
(7,000)
$63,100

Prior
Priorperiod
period adjustments
adjustments
on
on the
the statement
statement of
of
retained
retained earnings
earnings also
also
would
would be
be shown
shown net
net of
of tax.
tax.

69

Balance Sheet Presentation

A
Acorporation
corporation must
must report
report
its
its deferred
deferred tax
tax liabilities
liabilities
and
and assets
assets in
in two
two
classifications...
classifications...

a
a net
net current
current
amount
amount and
and aa net
net
noncurrent
noncurrent
amount.
amount.

70

Balance Sheet Presentation

Deferred
Deferred tax
tax liabilities
liabilities and
and
assets
assets are
areclassified
classified as
as
current
current or
ornoncurrent
noncurrent
based
based upon
upon their
theirrelated
related
assets
assets or
orliabilities
liabilities for
for
financial
financial reporting.
reporting.

71

Balance Sheet Presentation

Any
Anydeferred
deferred tax
tax liability
liabilityor
orasset
asset
not
not related
related to
to an
an asset
asset or
orliability
liability
isis classified
classified according
according to
to the
the
expected
expected reversal
reversal date
date of
of the
the
temporary
temporary difference.
difference.

72

Current and Noncurrent

Related
Asset or
Liability
Installment sales
Inventory differences
Allowance for Doubtful
Depreciation differences
Estimated Reversals
Accrued Pension Expense
Warranty Liability
Unearned Revenue
NOL

Classification
Accounts Receivable
Inventory
Accounts Receivable
Plant Assets

Current
Current
Current
Noncurrent

Probably noncurrent
Probably current

73

Balance Sheet Presentation

Deferred Tax Accounts

Account
Balance

Related Balance
Sheet Account

Current
Deferred Tax Liabilities
Installment sales $ 6,000 credit Accounts receivable
Depreciation
$12,000 credit Property, plant, and
equipment
Noncurrent
Current
Deferred Tax Assets
Warranty costs
$ 3,400 debit Warranty liability
Rent revenue
$ 2,500 debit Unearned revenue
Noncurrent

74

The
The next
next slide
slide presents
presents an
an
illustration
illustration that
that includes
includes
several
several temporary
temporary
differences.
differences. Assume
Assume taxable
taxable
income
income of
of $700,000
$700,000 at
at aa
30%
30% tax
tax rate.
rate.

Comprehensive Illustration

Balance
sheet
amounts

Deferred Tax Asset

25,500
Income Tax Expense (plug)
194,500
Deferred Tax Liability
10,000
Taxes Payable
210,000
Continued
Continued

75

76

Current and Deferred Amounts

on INCOME STATEMENT
Taxes Payable (current)
$210,000
Deferred Tax Asset (net)
($25,500 asset - $10,000 liability)
15,500
Income Tax Expense
$194,500

77

Chapter 19

Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.