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Tax Return Book - DOC

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					                                     Accounting for Income Taxes

Intraperiod tax allocation
          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
          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)
          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
          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
          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
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


Business combinations (goodwill): 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
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).




Example Problems (get excel files from web page)


First Place Place Inc.
2nd Best Corporation




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Intraperiod Tax Allocation
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 (paragraph 36).
                                                                                                                        FAS109, Par. 35
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 under Statement 52 and changes in the unrealized
          holding gains and losses of securities classified as available-for-sale under FASB
          Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities)
c.        An increase or decrease in contributed capital (for example, deductible expenditures
          reported as a reduction of the proceeds from issuing capital stock)
d.        An increase in the tax basis of assets acquired in a taxable business combination accounted for as a pooling of interests and for which
          a tax benefit is recognized at the date of the business combination

e.        Expenses for employee stock options recognized differently for financial reporting and
          tax purposes (refer to paragraphs 58-63 of FASB Statement No. 123 (revised 2004),
          Share-Based Payment)
f.        Dividends that are paid on unallocated shares held by an ESOP and that are charged to retained earnings
g.        Deductible temporary differences and carryforwards that existed at the date of a quasi reorganization (except as set forth in paragraph
          39).

                                                                                                                        FAS109, Par. 36




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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




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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




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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




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Partial Solution - First Place, Inc. – The “complicated method”
If the current tax rate for 2005 is 34% and no new tax law has been enacted, we would make the following
journal entry:
2005
Income tax expense (100,500 * .34)                                      34,170
Deferred tax asset - current (10,000 * .34)                              3,400
       Income taxes payable (80,500 * .34)                                            27,370
       Deferred tax liability - noncurrent (30,000 * .34)                             10,200


If a new tax law is enacted in 2006 (36% tax rate) and no other rate changes have been enacted, we would
make the following entry if we elect to carry the NOL back to 2000 when the tax rate was 34%:
2006
Income tax expense (plug figure)                                        36,710
Income tax refund receivable (6,500 * .34)                               2,210
Deferred tax asset - current (1,000 * .36)                                 360
       Deferred tax liability - noncurrent (108,000 * .36)                            38,880
Deferred tax asset - current (10,000 * .02)                               200
       Deferred tax liability - noncurrent (30,000 * .02)                                  600
Alternate computation:
Accumulated taxable TDs (30,000 + 108,000) * .36 =                               49,680
Accumulated deductible TDs (10,000 + 1,000) * .36 =                              - 3,960
Correct net amount for deferred taxes                                            45,720
Currently on books (10,200 - 3,400)                                                6,800
Change in deferred taxes                                                         38,920
Add taxes payble, subtract tax refunds                                            -2,210
Income tax expense for 1990                                                      36,710
If we plan to carry the NOL forward, the entry would be: ($130 diff = 6,500 * .02)
2006
Income tax expense                                                      36,580
 [Book TI 100,500 * .36 = 36,180
 + change in previousl recorded dfd tax (20,000 * .02)]
Deferred tax asset - current (6,500 * .36)                               2,340
Deferred tax asset - current (1,000 * .36)                                 360
Deferred tax asset - current (10,000 * .02)                                200
       Deferred tax liability - noncurrent (108,000 * .36)                            38,880
       Deferred tax liability - noncurrent (30,000 * .02)                                600
As a practical matter, it may be easier to use just one account for "net deferred taxes" on the books and
reclassify as asset/liability, current/noncurrent on the balance sheet when you do your external reporting.
Using 4 accounts makes the entries look a lot more complicated!




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First Place, Inc. - continued
If a new tax law is enacted 2007 which provides for 38% tax rates for 2007 and 40% thereafter, the
journal entry would look like this:
Accumulated taxable TDs (138,000 + 102,000) * .40 =                              96,000
Accumulated deductible TDs (11,000 + 0) * .40 =                                  - 4,400
Correct net amount for deferred taxes                                            91,600
Currently on books (10,200 + 38,880 + 600 - 3,400 -360 -200)                     45,720
Change in deferred taxes                                                         45,880
Add taxes payble, subtract tax refunds (1,500 * .34)                              - 510
Income tax expense for 1990                                                      45,370


2007
Income tax expense (plug figure*)                                       45,370
Income tax refund receivable                                               510
Deferred tax asset - current (11,000 * .04)                                440
       Deferred tax liability - noncurrent (102,000 * .40)                            40,800
       Deferred tax liability - noncurrent (138,000 * .04)                             5,520
*Approximately: 100,500 * .40 = 40,200 + change in deferred (138,000 - 11,000) * .04 = 5,080 (off $90
because carryback of NOL is at .34 rate instead of .40 {1,500 * .06})




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The “easier” method – First Place, Inc.
To keep things simple, it is probably easier to do the “bookkeeping” using a single deferred income taxes
account and then reclassify that balance for proper display on the balance sheet when financial statements
are prepared. To illustrate:
2005
Income tax expense                                                         34,170
      Deferred income taxes                                                             6,800
      Income taxes payable                                                             27,370
2006
Income tax expense                                                         36,710
      Deferred income taxes                                                            38,920
Income tax refund receivable                                                2,210
2007
Income tax expense                                                         45,370
      Deferred income taxes                                                            45,880
Income tax refund receivable                                                  510
2008
Income tax expense                                                         40,200
      Deferred income taxes                                                57,600
      Income taxes payable                                                             97,800
2009
Income tax expense                                                         40,200
      Deferred income taxes                                                34,000
      Income taxes payable                                                             74,200

Displayed on Balance Sheet:                               12/31/05      12/31/06    12/31/07    12/31/08
Deferred tax asset - current                                 3,400         3,960       4,400      14,000
Deferred tax asset - noncurrent
Deferred tax liability - current
Deferred tax liability - noncurrent                       (10,200)      (49,680)    (96,000)    (48,000)
                                                           (6,800)      (45,720)    (91,600)    (34,000)




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First Place, Inc.                                 34%                   36%        38%         40%         40%
                                                  2005                  2006       2007        2008        2009
Pre-tax accounting income                          100,000               100,000    100,000     100,000     100,000
Permanent differences                                  500                   500        500         500         500
Book TI                                            100,500               100,500    100,500     100,500     100,500
Temporary differences:
Rent revenue                                              -                 -              -     25,000    (25,000)
Depreciation                                       (30,000)         (108,000)      (102,000)    120,000    120,000
Warranty                                             10,000             1,000              -     (1,000)   (10,000)
                                                     80,500           (6,500)        (1,500)    244,500    185,500
Applicable tax rate                                    34%               34%            34%         40%        40%
Income tax payable (recbl)                           27,370           (2,210)          (510)     97,800      74,200

Change in current year TDs                             6,800             38,520      40,800     (57,600)   (34,000)
Adj prior TDs for rate change                                               400       5,080        4,580          -

Income tax expense                                   34,170              36,710      45,370      44,780     40,200
Old deferral method expense:                         34,170              36,180      38,190      40,200     40,200
Difference related to rate change                         -                 530       7,180       4,580          -

Inventory of TDs                                   12/31/05          12/31/06       12/31/07    12/31/08   12/31/09
Rent revenue                                              -                 -              -      25,000          -
Depreciation                                       (30,000)         (138,000)      (240,000)   (120,000)          -
Warranty                                             10,000            11,000         11,000      10,000          -

Total temp differences                             (20,000)         (127,000)      (229,000)    (85,000)          -
Applicable tax rate                                    34%               36%            40%         40%        40%
Net balance - deferred taxes                        (6,800)          (45,720)       (91,600)    (34,000)          -
Net balance fwd                                                 -     (6,800)       (45,720)    (91,600)   (34,000)
Change in net deferred taxes                        (6,800)          (38,920)       (45,880)      57,600     34,000
Taxes (payable)/receivable                         (27,370)             2,210            510    (97,800)   (74,200)

Income tax expense                                   34,170              36,710      45,370      40,200     40,200




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