Asc 740 Investment Accounting Income Tax by jfn37636

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									                                     Accounting for Income Taxes

Intraperiod tax allocation (ASC 740-20)
          Involves WHERE we present income tax expense during a single year. The "net of tax"
          items are generally the same items for which we present an EPS number plus any prior
          period adjustments.
Interperiod tax allocation (ASC 740-10)
          Related to temporary differences between accounting and taxable income
Deferral approach to tax allocation (APB Opinion 11)
          Income tax expense = amount of taxes that would be paid if income statement numbers
          appeared on the current year's tax return. Deferred taxes was the plug figure (difference
          between taxes payable and tax expense). The effect of subsequent changes in tax rates on
          deferred tax account were essentially ignored.
Liability approach to tax allocation (FASB 96, 109) ASC 740
          Income tax expense = taxes currently payable plus change in deferred taxes. If tax rates
          change, the effect on deferred tax amounts affect income tax expense in the year the
          change is enacted. If there are no changes in tax rates, income tax expense should be
          approximately the same as under APB Opinion 11.




Permanent Differences (this terminology is not actually used in ASC)
          Permanent differences affect both the computation of taxable income and income tax
          expense as reported on the income statement. Examples:
Interest revenue on Municipal Bonds
Life insurance premiums and proceeds when coporation is beneficiary
Fines and penalties
Dividend exclusion
Statutory depletion
Temporary Differences (starting ASC 740-10-25-18)
          Temporary differences occur when an item appears on financial statements in one year
          and on the tax return in a different year.
Taxable temporary differences give rise to deferred tax liabilities
Deductible temporary differences give rise to deferred tax assets




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                                           TEMPORARY DIFFERENCES
                                                  Examples
Taxable temporary differences (See ASC 740-20-25-20 & 25-21)
Revenues or gains that are taxable after they are recognized on books:

           Installment method for tax returns, accrual method for financial accounting purposes

           Completed contract method for tax returns, percentage of completion method for financial accounting purposes (now uncommon)

Expenses or losses that are deductible before they are recognized on books:

           Accelerated depreciation for tax returns, straightline for financial accounting purposes

           Goodwill, deductable on tax return but not an expense for GAAP. However, impairment
           of goodwill, if it occurs, would cause the write-down of goodwill and a loss on GAAP
           financial statements. Impairment is NOT deductible for tax purposes.
Business combinations: if assigned values of identifiable assets are higher than their tax basis,
       the difference is a taxable temporary difference and the related deferred tax liability
       would increase the goodwill to be recorded
A reduction in the tax basis of depreciable assets because of tax credits (under 1982 law, it was possible to get a larger investment tax credit if
          the depreciable basis of the assets were reduced); similar result if we capitalize interest for book purposes but deduct it on tax return
          as paid.

Deductible temporary differences
Expenses or losses that are deductible after they are recognized on books:

           Warranty expenses accrued in year of sale according to GAAP, deductible on tax return
           only when paid

           Unrealized losses/gains on marketable securities (FASB 115), deductible on tax return
           only when the securities are actually sold (affects trading securities on income statement
           and available for sale securities on statement of comprehensive income).

           Losses related to contingent liabilities (compensated absenses, lawsuits, etc.) are
           deductible on tax return only when actually paid.
Revenues or gains that are taxable before they are recognized on books:

           Subscription revenue recognized when earned per GAAP but taxable when collected.

           Rent revenue received in advance (deferred revenue under GAAP) is taxable when
           received.
Investment tax credits accounted for by the deferral method
An increase in the tax basis of assets because of indexing whenever the local currency is the functional currency




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Net operating carrybacks and carryforwards
Under current laws, a net operating loss in a particular year can be carried back for two years or
forward for 20 years. The NOL would be handled as a deduction on the tax return of the year it
is carried to.
If you carry back an NOL, record "income tax refund receivable" using the tax rate in effect the
year you are carrying to. If you elect to carryforward, you would use the current tax rate (or
enacted future tax rate) and record a "deferred tax asset."
Unused Tax credits may also be carried forward and would affect the amounts in the
deferred tax accounts.


Other temporary differences:
Unremitted earnings of subsidiaries
We report share of subsidiary's reported net income on parent company's books -- this is not a
taxable item currently. However, if we collect dividends they are probably partially taxable
(assuming 80% exclusion is in effect).
Valuation Allowance for Deferred Tax Assets
Deferred tax assets must be reduced by a valuation allowance (contra asset account) if it is more
likely than not (50% probability) that they will not be realized.
CLASSIFICATION OF DEFERRED TAXES (ASC 740-10-45-7 thru 45-10)
Deferred tax assets and liabilities are classified as current or noncurrent as follows:
          If the amount is associated with a balance sheet account, the deferred taxes are classified
          the same way. For example, differences in depreciation methods would give rise to
          noncurrent deferred tax liability because accumulated depreciation is noncurrent account.
          If the amount is not associated with a balance sheet account, the deferred taxes are
          classified on the basis of when the difference is expected to reverse (if they reverse during
          next year, classify as current, otherwise as noncurrent).
For each taxing jurisdiction, current temporary differences are combined and presented as either current asset (net
debit balance) or current liability (net credit balance). The same procedure is used for noncurrent temporary
differences. Therefore, there will be (at most) two lines on the balance sheet for deferred income tax assets or
liabilities for each taxing authority (state, federal, etc.)
RECENT CHANGES: (Not in just one part of Topic 740)
FIN48 (June 2006) clarifies the accounting for uncertainty in income taxes recognized by prescribing a recognition
threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. The Interpretation also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and transition. Detailed notes are contained in the
PowerPoint lecture slides.

     •    The key points in the Interpretation are:
               –    A tax benefit may be reflected in the financial statements only if it is “more likely than not” that
                    the company will be able to sustain the tax return position, based on its technical merits


1aa6060f-c84d-4007-bbc8-27b375917640.doc created by T. Gordon 2/1/11
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               –     A tax benefit should be measured as the largest amount of benefit that is cumulatively greater than
                     50-percent likely to be realized

Intraperiod Tax Allocation (ASC 740-20)
Income Statement
Income tax expense or benefit for the year shall be allocated among
      continuing operations,
      discontinued operations,
      extraordinary items,
      other comprehensive income,
      and items charged or credited directly to shareholders' equity .
                                                        ASC 740-20-60-2, 45-2, 05-2, 45-11 (FAS109, Par. 35, 36)
Balance Sheet (Owners Equity) or Statement of Retained Earnings
     a. Adjustments of the opening balance of retained earnings for certain changes in accounting
        principles or a correction of an error

     b. Gains and losses included in comprehensive income but excluded from net income (for
        example, translation adjustments accounted for under the requirements of Topic 830 and
        changes in the unrealized holding gains and losses of securities classified as available-for-
        sale as required by Topic 320).

     c. An increase or decrease in contributed capital (for example, deductible expenditures
        reported as a reduction of the proceeds from issuing capital stock).

     d.   Expenses for employee stock options recognized differently for financial reporting and
          tax purposes as required by Subtopic 718-740. An employee stock ownership plan and a stock option
          plan are analogous. Both are compensatory arrangements and both sometimes result in tax deductions for amounts that
          are not presently recognized as compensation expense in the financial statements under existing generally accepted
          accounting principles (GAAP). The tax benefits of both are reported as a credit to shareholders' equity.

     e.   Dividends that are paid on unallocated shares held by an employee stock ownership plan and that are
          charged to retained earnings. This is different from a tax deduction received for the payment of dividends
          on allocated shares held by an employee stock ownership plan that represents, in substance, an exemption
          from taxation of an equivalent amount of earnings for which the tax benefit shall be recognized as a
          reduction of tax expense and shall not be allocated directly to shareholders' equity.

     f.   Deductible temporary differences and carryforwards that existed at the date of a quasi reorganization.

     g.   All changes in the tax bases of assets and liabilities caused by transactions among or with shareholders shall be included in equity
          including the effect of valuation allowances initially required upon recognition of any related deferred tax assets. Changes in
          valuation allowances occurring in subsequent periods shall be included in the income statement.



                                                                                        ASC 740-20-45-11 (FAS109, Par. 36)




1aa6060f-c84d-4007-bbc8-27b375917640.doc created by T. Gordon 2/1/11
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Starr One Inc.                                   Deferred Tax Problem

Starr One Inc. was incorporated in 2007. Information related to its first five years of operation are shown below.
The company's products carry a one-year warranty. The company policy is to always carryback net
operating losses before opting for a carryforward.
Compute income tax expense and the deferred tax liability/asset for each year. Prepare journal entries.


                                                          2007            2008        2009        2010       2011
Pre-tax accounting income                              100,000         120,000     125,000     200,000    225,000

Depreciation schedule
Machinery with 5 year life, no salvage
Acquired 1-1-2007 for
                           1,000,000                      2007             2008        2009       2010       2011     Total
Straight-line method (book)                            200,000          200,000     200,000    200,000    200,000    1,000,000
MACRS method (tax)                                     250,000          380,000     300,000     70,000               1,000,000
Difference                                             (50,000)        (180,000)   (100,000)   130,000    200,000           -

Accounting income includes:
Life insurance premiums on officers                        2,300         2,300       2,500       2,500      2,800
Rent revenue (accrual basis)                                            50,000      50,000
Book depreciation                                      200,000         200,000     200,000     200,000    200,000
Warranty expense (accrual)                              20,000          30,000      35,000      40,000     42,000

Taxable income includes:
MACRS depreciation                                     250,000         380,000     300,000      70,000        -
Rent revenue (cash basis)                                              100,000
Warranty costs paid                                      10,000         21,000      31,000      38,000     39,000

Income tax rates:                            2007                          2008        2009       2010       2011
No changes anticipated                       30%                           30%
New law passed in early 2009 with phased
in increases in tax rate for 2010 and beyond                                           32%        34%         34%


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Deferred Tax Problems - worksheet

Pre-tax accounting income
Permanent Differences:

Book TI
Temporary Differences:




Taxable Income
Applicable Tax Rate
Income taxes payable/(receivable)
Inventory of TDs




Total net temporary differences
Applicable tax rate
Net ending balance (deferred tax
accounts)
Net balance fwd (deferred tax accounts)
Change in net deferred taxes
Taxes (payable)/receivable
Income tax expense




1aa6060f-c84d-4007-bbc8-27b375917640.doc created by T. Gordon 2/1/11
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Deferred Tax Problems - worksheet

Pre-tax accounting income
Permanent Differences:

Book TI
Temporary Differences:




Taxable Income
Applicable Tax Rate
Income taxes payable/(receivable)
Inventory of TDs




Total net temporary differences
Applicable tax rate
Net ending balance (deferred tax
accounts)
Net balance fwd (deferred tax accounts)
Change in net deferred taxes
Taxes (payable)/receivable
Income tax expense




1aa6060f-c84d-4007-bbc8-27b375917640.doc created by T. Gordon 2/1/11
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Deferred Tax Problems - worksheet

Pre-tax accounting income
Permanent Differences:

Book TI
Temporary Differences:




Taxable Income
Applicable Tax Rate
Income taxes payable/(receivable)
Inventory of TDs




Total net temporary differences
Applicable tax rate
Net ending balance (deferred tax
accounts)
Net balance fwd (deferred tax accounts)
Change in net deferred taxes
Taxes (payable)/receivable
Income tax expense




1aa6060f-c84d-4007-bbc8-27b375917640.doc created by T. Gordon 2/1/11
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