Accounting for Income Taxes | Intermediate Accounting | CPA Exam FAR | Chapter 19

This chapter covers accounting for income taxes, including deferred tax asset, deferred tax liability, deferred income tax, temporary and permanent differences, valuation allowance, net operating loss (NOL), NOL carryback and carryforward.

Accounting for Income Taxes

Deferred Tax Liability

Deferred Tax Asset

Deferred Tax Asset--Valuation Allowance

Temporary and Permanent Differences | Deferred Tax Asset/Liability

Net Operating Losses (NOL) | Carryback, Carryforward

Examples: BE 19-1 to BE 19-10 (older lecture)| Deferred Tax Assets/Liabilities

Examples: BE 19-1 to BE 19-8 | Deferred Tax Assets/Liabilities

Examples: BE 19-9 to BE 19-15 |Deferred Tax Assets/Liabilities

Chapter 19 addresses the issues related to accounting for income taxes. Taxable income is computed in accordance with prescribed tax regulations and rules, whereas accounting income is measured in accordance with generally accepted accounting principles.

Due to the fact that tax regulations and generally accepted accounting principles differ in many ways, taxable income and financial income frequently differ. Examples of events that can result in such differences include: (a) depreciation computed on a straight-line basis for financial reporting purposes and on an accelerated basis for tax purposes, (b) income recognized on the accrual basis for financial reporting purposes and on the installment basis for tax purposes, and (c) warranty costs recognized in the period incurred for financial reporting purposes and when they are paid for tax purposes.

The items discussed in paragraph 2 above can result in temporary differences between the amounts reported for book purposes and those reported for tax purposes. A temporary difference is the difference between the tax basis of an asset or liability and its reported amount in the financial statements that will result in taxable amounts (increase in taxable income) or deductible amounts (decrease in taxable income) in future years when the reported amount of the asset is recovered or when the reported amount of the liability is settled. When the book amount of an asset or liability differs from the tax basis as a result of a temporary difference, the future tax effects on taxable income must be reported in the current financial statements.

A deferred tax liability is the amount of deferred tax consequence attributable to the temporary differences that will result in net taxable amounts in future years. The liability is the amount of taxes payable on these net taxable amounts in future years based on existing provisions of the tax law

Due to the fact that deductible amounts can arise in the future as a result of temporary differences at the end of the current year, the deferred tax consequences of these deductible amounts should be recognized as a deferred tax asset. A deferred tax asset is the amount of taxes (computed in accordance with provisions of the tax law) that will be refundable in future years as a result of these deductible amounts.

A key issue in accounting for income taxes is whether a deferred tax asset should be recognized in the financial records. Deferred tax assets meet the definition of an asset and therefore should be reported in the financial statements. The three main conditions for an item to be reported as an asset are: (a) it results from past transactions; (b) it gives rise to a probable benefit in the future; and (c) the company controls access to the benefits. These conditions are met by the deferred tax asset.

A deferred tax asset is recognized for all deductible temporary differences. However, deferred tax assets should be reduced by a valuation allowance if, based on available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized.For example, assume Angie Company has a deductible temporary difference of $2,500,000 at the end of its initial year of operations. Its tax rate is 45%. A deferred tax asset of $1,125,000 or ($2,500,000 × .45) is recorded. Assuming taxes payable equals $2,000,000, the required journal entry is:

Income Tax Expense………………………………………           875,000

Deferred Tax Asset………………………………………….       1,125,000

Income Taxes Payable………………………………                               2,000,000