Income Tax

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					            Income Tax




11/8/2012                1
            Deferred Taxes: Basics

 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
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            Temporary and Permanent Differences

  Temporary Differences       Permanent Differences
   Example: tax and book        Example: Interest on
   depreciation deductions      municipal obligations is
   may be different             not taxed but is income
  These are differences in     for accounting purposes
   revenue and expense         Items, included on the
   amounts reported on tax      financials but either
   returns and for financial    excluded or not deducted
   purposes                     on tax return
  Over a given period, they   These differences do not
   reverse                      reverse

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            Temporary Differences: Examples
 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
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            Summary of Temporary Differences

                    When recorded   When recorded    Deferred
      Transaction
                      in books       on tax return   tax effect


     Rev or Gain       Earlier          Later        Liability

     Rev or Gain        Later          Earlier        Asset

     Exp or Loss       Earlier          Later         Asset

     Exp or Loss        Later          Earlier       Liability



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            Permanent Differences: Examples
 Items, 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
 Items, 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

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       Summary of Permanent Differences
                 Sources of PERMANENT DIFFERENCES



       Some items                are recorded       but NEVER
                                   in Books         on tax return



                                 are NEVER          but recorded
        Other items           recorded in books     on tax return


                        No deferred tax effects
                       for permanent differences

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      Deferred Tax Asset & Deferred Tax Liability:
                       Sources

 Deferred 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.

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            Recording Deferred Tax Liability: Example

 Book tax expense           =     $20,000
 Tax liability              =     $18,000
 Journal Entry:
       Income Tax Expense       20,000
            Def.Tax Liability       2,000
    Tax Payable               18,000



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       Recording Deferred Tax Asset: Example
  Book tax expense     =     $5,000
  Tax payable          =     $6,000
  Journal Entry:                        Income
   tax expense          5,000            Def. Tax
   Asset                1,000                 Tax
   payable              6,000
  Deferred tax asset is recognized for all
       deductible differences
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                      Temporary Differences:
                      Originating & Reversing
 Year       Tax Expense       Tax Liability    Difference    Nature
            (per GAAP)         (per IRC)                     DTA / DTL


 1          $17,600 $16,000 $1,600             D.Tax Liab

 2          $17,600 $16,800 $ 800              D.Tax Liab


 3          $17,600 $18,400 $ 800              D.Tax Asset


 4          $17,600 $19,200 $1,600             D.Tax Asset


            Net Deferred Tax Effect    $ -0-


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            Recording a Valuation Allowance
            for Doubtful Deferred Tax Assets

 If 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.
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                  Deferred Taxes:
                 Applying Tax Rates
• 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].
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     Procedures for Computing and Reporting Deferred
                         Taxes

                               Identify types and amounts of
                    existing temporary differences and carryforwards



             Measure deferred tax asset            Measure deferred tax liability
              using enacted tax rate.                using enacted tax rate.



                Establish Valuation              On the balance sheet, classify
            Allowance for doubtful asset          deferred taxes as current or
                                                 noncurrent based on asset or
                                                 liability to which they relate.


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            Revision of Future Tax 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
 • See example following slide




11/8/2012                                       15
            Revision of Future Tax Rates: Example

 End of 1999, corporate tax rate is changed from
  40% to 35%
 The new rate is effective January 1, 2001
 The deferred tax account (1.1.1999) is as follows:
  Excess tax depreciation:     $3 million
  Deferred tax liability:      $1.2 million.
 Related taxable amounts are expected to occur
  equally over 2000, 2001, and 2002.
 Provide the journal entry to reflect the change.
11/8/2012                                              16
            Revision of Future Tax Rates: Example

 The deferred tax liability end of 2002 is as follows:
                     2000          2001         2002
  Future tax inc $1,000,000 1,000,000 1,000,000
  Tax rate        40%            35%           35%
  Deferred tax
      liability   $400,000 350,000             350,000
 Entry:
      Deferred Tax Liability       $100,000
         Income Tax Expense                  $100,000
11/8/2012                                             17
            Financial Statement Presentation

 Balance Sheet Presentation:
 The deferred tax classification relates to its
  underlying asset or liability
 Classify the deferred tax amounts as current or
  noncurrent
 Sum the various deferred tax assets and liabilities
  classified as current
 Sum the various deferred tax assets and liabilities
  classified as noncurrent
11/8/2012                                               18
            Financial Statement Presentation

 Balance 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 noncurrent
 If net result is an asset, report as long-term asset
 If net result is a liability, report as long-term liability
11/8/2012                                                       19
            Income Statement Presentation

 Income tax expense, as allocated to:
  Continuing operations
  Discontinued operations
  Extraordinary items
  Cumulative effect of an accounting change, and
  Prior period adjustments
 Other significant components, such as:
  current tax expense, deferred tax expense/benefit

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