Chapter 19: Accounting for Income TaxesSlide 2Slide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Slide 26Slide 27Chapter 19: Accounting Chapter 19: Accounting for Income Taxesfor Income TaxesIntermediate Accounting, 11th ed.Kieso, Weygandt, and WarfieldPrepared byJep Robertson and Renae ClarkNew Mexico State University1. Identify differences between pretax financial income and taxable income.2. Describe a temporary difference that results in future taxable amounts.3. Describe a temporary difference that results in future deductible amounts.4. Explain the purpose of a deferred tax asset valuation allowance.After studying this chapter, you should be able to:Chapter 19: Accounting Chapter 19: Accounting for Income Taxesfor Income Taxes5. Describe the presentation of income tax expense in the the income statement.6. Describe various temporary and permanent differences.7. Explain the effect of various tax rates and tax rate changes on deferred income taxes.8. Apply accounting procedures for a loss carryback and a loss carryforward.Chapter 19: Accounting Chapter 19: Accounting for Income Taxesfor Income Taxes9. Describe the presentation of deferred income taxes in financial statements.10.Indicate the basic principles of the asset-liability method.Chapter 19: Accounting Chapter 19: Accounting for Income Taxesfor Income TaxesFundamental Differences Fundamental Differences between Financial and Tax between Financial and Tax ReportingReporting•Deferred taxes arise when income tax expense differs from income tax liability.•The tax expense is determined under GAAP.•The income tax liability is determined under the Internal Revenue Code.•Some of these differences are temporary and reverse over time.•Others are permanent and do not reverse. Deferred Taxes: BasicsDeferred Taxes: Basics•Revenues and gains, recognized in financial income, are later taxed for income tax purposes.•Expenses and losses, recognized in financial income, are later deducted for income tax purposes.•Revenues and gains are taxed for income tax purposes before they are recognized in financial income.•Expenses and losses are deducted for income tax purposes before they are recognized in financial income.Temporary Differences: Temporary Differences: ExamplesExamplesTransactionWhen recordedin booksWhen recordedon tax returnDeferredtax effectRev or Gain Earlier LaterLiabilityRev or Gain Later EarlierAssetExp or Loss Earlier LaterAssetExp or Loss Later EarlierLiabilitySummary of Temporary Summary of Temporary DifferencesDifferencesItems, recognized for financial accounting purposes, but not for income tax purposes:•interest income received on tax exempt securities•fines and expenses resulting from violations of law•Premiums paid for life insurance on key officers/employeesPermanent Differences: Permanent Differences: ExamplesExamplesItems, recognized for tax purposes, but not for financial accounting purposes:•the dividends received deduction under the Code•percentage depletion of natural resources in excess of their cost Permanent Differences: Permanent Differences: ExamplesExamplesSources of Permanent DifferencesNo deferred tax effectsfor permanent differencesSome itemsare recordedin Booksbut NEVERon tax returnOther itemsare NEVERrecorded in booksbut recordedon tax returnSummary of Permanent Summary of Permanent DifferencesDifferencesDeferred taxes may be a: •Deferred tax liability, or•Deferred tax asset Deferred tax liability arises due to net taxable amounts in the future.Deferred tax asset arises due to net deductible amounts in the future.Deferred Tax Asset & Deferred Tax Asset & Deferred Tax Liability: Deferred Tax Liability: SourcesSourcesIf the deferred tax asset appears doubtful, a Valuation Allowance account is needed.Journal entry: Income Tax Expense $$Allowance to Reduce Deferred Tax Asset to Expected Realizable Value $$The entry records a potential future tax benefit that is not expected to be realized in the future.Recording a Valuation Recording a Valuation Allowance for Doubtful Allowance for Doubtful Deferred Tax AssetsDeferred Tax Assets•Basic Rule: Apply the yearly tax rate to calculate deferred tax effects.•If future tax rates change: use the enacted tax rate expected to apply in the future year.•If new rates are not yet enacted into law for future years, the current rate should be used. •The appropriate enacted rate for a year is the average tax rate [based on graduated tax brackets].Deferred Taxes: Applying Deferred Taxes: Applying Tax RatesTax Rates•When a change in tax rate is enacted, its effect should be recorded immediately.•The effect is reported as an adjustment to tax expense in the period of change.•Changes in tax rates are treated just like any other change in estimate, prospectively.Revision of Future Tax Revision of Future Tax RatesRatesEnd of 2002, corporate tax rate is changed from 40% to 35%.The new rate is effective January 1, 2004.The deferred tax account (1/1/2002) is as follows: Excess tax depreciation: $3 million Deferred tax liability: $1.2 millionRelated taxable amounts are expected to occur equally over 2003, 2004, and 2005.Provide the journal entry to reflect the change. Revision of Future Tax Revision of Future Tax Rates: ExampleRates: ExampleThe deferred tax liability end of 2005 is as follows: 2003 2004 2005Future tax inc $1,000,000 1,000,0001,000,000Tax rate 40% 35% 35%Deferred tax $400,000 350,000 350,000liability Entry:Deferred Tax Liability $100,000 Income Tax Expense $100,000**$1,200,000 – $1,100,000Revision of Future Tax Revision of Future Tax Rates: ExampleRates: ExampleBalance Sheet Presentation:•The deferred tax classification relates to its underlying asset or liability.•Classify the deferred tax amounts as current or non-current.•Sum the various deferred tax assets and liabilities classified as current.•Sum the various deferred tax assets and liabilities classified as non-current. Balance Sheet Balance Sheet PresentationPresentationBalance Sheet Presentation:•Sum the various deferred tax assets and liabilities classified as current:•If net result is an asset, report as current asset•If net result is a liability, report as current liability•Sum the various deferred tax assets and liabilities classified as non-current:•If