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Accounting 352 Accounting for Income Taxes
A. Intraperiod Tax Allocation
statement only only applies to income operations.
Refers to requirement that the line item "income tax" on income statement applies to income from from operations.
Items after Net income from operations include the following:
Results from Discontinued Operations Gain or loss on Disposal of Business Segment
Extraordinary gains/losses Cumulative Effect of change in accounting principle
All of these items are reported "Net of Tax"
Example: Income Statement
Data Revenue #######
Revenue $100,000 CGS ($52,000)
CGS ($52,000) Gross margin $48,000
Operating expenses ($12,000) Operating expenses ($12,000)
Gain on sale of truck $500 Gain on sale of truck $500
Loss from discontinued operations ($30,000) Income from operations $36,500
Gain on sale of discontinued segment $4,000 income taxes ($10,950)
Effective tax rate 30.00% Net income from continuing operations$25,550
Discontinued operations:
loss from discontinued
operations (net of 30% tax) ($21,000)
gain on sale of segment (net) $2,800 ($18,200)
Net income $7,350
B. Differences between Financial reporting income and taxable income
a. Differences due to income(expenses) that are never taxable or deductible due to different rules for financial vs tax reporting
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1. Some income is never taxable: E.g. interest on municipal bonds
proceeds from life insurance
2. Some expenses are never deductible for tax purposes: life insurance premiums
3. Some expenses are deductible for tax, Excess depletion (percentage depletion) over cost
but not for reporting purposes for oil and gas properties
Special dividend deduction (80% of dividends received)
If permanent differences arise between financial reporting and tax reporting, it results in the calculation of higher (lower) tax expense
based on what is reported to the IRS, not what is included in the financial reporting income statement.
>>> Tax expense will be the same for both financial reporting and tax return. Tax expense = tax payable
Example
Revenue $100,000
CGS ($52,000)
Operating expenses ($12,000)
Gain on sale of truck $500
Proceeds from life insurance policy $20,000
Dividend income $6,000
Effective tax rate 30.00%
Journal entry:
dr. income tax expense $12,750
cr. income tax payable $12,750
Income tax return: Income Statement:
Revenue $100,000 Revenue #######
CGS ($52,000) CGS ($52,000)
Gross margin $48,000 Gross margin $48,000
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Operating expenses ($12,000) Operating expenses ($12,000)
Other income: Other income:
Gain on sale of truck $500 Gain on sale of truck $500
Proceeds from life insurance policy Proceeds from life insurance policy $20,000
Dividend income $6,000 Dividend income $6,000
less special dividend deduction (80%) ($4,800) Income before income taxes $62,500
Income before income taxes $42,500 Income tax expense 30%) ($12,750)
Income tax payable 30%) ($12,750) Net income from continuing operations$49,750
Note the difference in income tax expense as a result of permanent differences between financial reporting and tax reporting
$62,500 * 30%
If no permanent differences existed, income tax expense would have been reported as: = $18,750
due to permanent differences, actual income tax expense = $12,750
C. Temporary differences between financial reporting and tax reporting (no tax loss or tax credit forwards)
These differences are due to TIMING of expense and/or revenue recognition for financial reporting as compared to tax reporting. Over
Over time these differences will reverse and total revenue/expenses reported will be the same for financial and tax reporting. However,
income tax expense and payable will be different each period. Only the total amount of expense and tax paid over time is the same.
Reasons for temporary differences:
i. Revenue recognized for financial purposes before recognition for tax purposes:
Financial reporting Tax reporting
% completion completed contract
point of sale installment method
investment income (equity method) when cash dividends received
ii. Revenue recognized for financial purposes after recognition for tax purposes:
Financial reporting Tax reporting
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when earned when cash received
(unearned rent income)
(unearned royalties income)
(unearned interest income)
gains on sale/leaseback
iii. Expenses recognized for financial reporting before tax purposes:
Financial reporting Tax reporting
warranty expense as accrued when performed (paid)
bad debts as accrued when written off
when sold
temporary losses on equity investment: as incurred
inventory write-down: when decline recognized when sold (or attempted to sell)
contingent liability: when incurred when paid
iv. Expenses recognized for financial reporting after tax purposes:
Financial reporting Tax reporting
depreciation expense: straight line accelerated method
interest during construction: capitalized deducted as paid
Accounting problem: 1. What should be reported as income tax expense?
Answer: Yes
2. Do these differences result in a deferred liability or deferred asset?
Rule: 1. Identify all temporary differences between financial reporting income and taxable income
2. determine the total deferred tax liability or deferred tax asset, using enacted marginal tax rates
3. In the case of deferred tax assets, determine the likelihood that deferred tax asset will be realized.
4. Establish a valuation allowance to reduce the deferred tax asset to amount that is considered net realizable
Example; One temporary difference, no tax credits or loss carryforwards $100,000 1
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financial tax purposes DDB, w switch to sl) $1,000 2
Depreciation expense reporting (st. line) difference 5 3
year 1 $19,800 $40,000 ($20,200) cost 4 4
year 2 $19,800 $24,000 ($4,200) salvage 3 5
year 3 $19,800 $11,667 $8,133 life 2
year 4 $19,800 $11,667 $8,133 1
year 5 $19,800 $11,667 $8,133 tax rate: 0.3
$99,000 $99,000 $0
multiply
Calculation of deferred tax liability/asset: deductible (taxable) amount by enacted future tax rate
Future taxable deferred tax liability/
(deductible) amount tax rate asset
($4,200) 0.3 ($1,260)
$8,133 0.3 $2,440
$8,133 0.3 $2,440
$8,133 0.3 $2,440
deferred tax liability year 1 (-1260+2440+2440+2440)= $6,060
deferred tax liability year 2 (2440+2440+2440)= $1
deferred tax liability year 3 (2440+2440)= $1
deferred tax liability year 4 (2440)= $0
deferred tax liability year 5 $0
Note, if future tax rates stay the same, the same results will occur by multiplying financial reporting income and taxable income by the tax rate
Assume income each year exclusive of depreciation of $100,000
Financial tax taxable tax deferred tax
income expense income payable liability (end of year)
year 1 $80,200 $24,060 $60,000 $18,000 $6,060
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year 2 $80,200 $24,060 $76,000 $22,800 $7,320
year 3 $80,200 $24,060 $88,333 $26,500 $4,880
year 4 $80,200 $24,060 $88,333 $26,500 $2,440
year 5 $80,200 $24,060 $88,333 $26,500 ($0)
D. Tax credits, tax loss carryforwards and carrybacks
Tax credit: a dollar for dollar reduction of taxes payable, due to a provision in tax law that provides for tax incentives
incentives for particular activities, for example, in the past we had an "investment tax credit" where purchase of certain assets resulted
resulted in e.g., 20% tax credit. If the asset cost $100,000, then $20,000 could be deducted from taxes payable.
NOTE: tax credits are subtracted from taxes due, TAX DEDUCTIONS are subtracted from taxable income
D. Accounting for Losses.
For tax purposes losses can be carried back two (2) years and carried forward twenty (20) years. The choice depends on whether
income was reported in the earlier years and/or expected tax rates in future years.
Carrybacks result in income tax refunds, carryforwards in lower taxes in future years and possibly a deferred tax asset.
NOTE: If there is material uncertainty regarding the likelihood that future income will be reportable/offset with the loss carry forward, then
a valuation allowance must be established to reduce the deferred tax asset to its net realizable value.
EXAMPLE: refund/
Income tax tax paid deferred tax asset
Year rate
(loss) (000) Back/for. forwared only
2008 $5 30.00% $1.50
2009 $9 30.00% $2.70 $2.70
2010 $11 30.00% $3.30 $3.30
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2011 ($35) 35.00%
2012 $10 35.00% $3.50 $3.50
2013 $5 40.00% $2.00 $2.00
2014 $50 40.00% $8.00
Total tax benefit from loss in 1994: $11.50 $13.50
The reason for the difference is strictly due to the higher tax rate effective in 2013 and 2014
Journal entries to record tax refund, deferred tax asset:
dr. tax refund receivable $6.00
dr. deferred tax asset $5.50
cr. income taxes (loss from operations) $11.50