Intermediate accounting 19th by stice stice chapter 16

Chapter 16 19th Edition Income Taxes Intermediate Accounting James D Stice Earl K Stice PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University © 2014 Cengage Learning 16-1 Deferred Income Tax Overview • Corporations in the United States compute two different income numbers:  Financial income for reporting to stockholders and  Taxable income for reporting to the Internal Revenue Service (IRS) (continued) 16-2 Deferred Income Tax Overview • The primary goal of financial accounting is to • provide useful information to management, stockholders, creditors, and others properly interested; the major responsibility of the accountant is to protect these parties from being misled The primary goal of the income tax system is the equitable collection of revenue (continued) 16-3 Deferred Income Tax Overview The difficulty of determining what is “income tax expense” stems from two basic considerations: How to account for revenues and expenses that have already been recognized and reported to shareholders in a company’s financial statements but will not affect taxable income until subsequent years (continued) 16-4 Deferred Income Tax Overview How to account for revenues and expenses that have already been reported to the IRS but will not be recognized in the financial statements until subsequent years 16-5 Example 1: Simple Deferred Income Tax Liability • In 2013, Ibanez Company earned revenues of • • $30,000 Ibanez has no expenses other than income taxes In this case, the income tax law specifies that income is taxed when received in cash and that Ibanez received $10,000 in 2013 and expects to receive $20,000 in 2014 The income tax rate is 40% and it is expected to remain the same into the foreseeable future (continued) 16-6 Example 1: Simple Deferred Income Tax Liability The journal entry to record all the tax-related information for Ibanez for 2013 is as follows: Income Tax Expense Income Taxes Payable Deferred Tax Liability 12,000 4,000 8,000 $30,000 × 40 $4,000 current year + $8,000 deferred (continued) $10,000 × 40 $20,000 × 40 16-7 Example 1: Simple Deferred Income Tax Liability Ibanez Company Income Statement For the Year Ended December 31, 2013 Revenues Income tax expense: Current Deferred Net income $30,000 $4,000 8,000 12,000 $18,000 16-8 Example 2: Simple Deferred Income Tax Asset • In 2013, its first year of operation, Gupta • • Company generated service revenues totaling $60,000, all taxable in 2013 No warranty claims were made in 2013, but Gupta estimates that in 2014 warranty costs of $10,000 will be incurred for claims related to 2013 service revenues Assume a 40% tax rate and that Gupta Company had no expenses in 2013 other than warranty costs and income taxes (continued) 16-9 Example 2: Simple Deferred Income Tax Asset The journal entry to record all the tax-related information for Gupta for 2013 is as follows: Income Tax Expense Deferred Tax Asset Income Taxes Payable $24,000 current year – $4,000 deferred (continued) 20,000 4,000 24,000 $50,000 × 40 $10,000 × 40 $60,000 × 40 16-10 Accounting for Uncertain Tax Positions Topic 740 requires the use of a 2-step process to determine the recognition of any tax benefit associated with an uncertain tax position Step 1—Determine if it is more likely than not that a tax position would be sustained if it were examined, and it must be assumed that the tax position will be examined Step 2—The measurement of the tax benefit is based on a probability assessment of the likelihood of specific outcomes and the amounts of those outcomes (continued) 16-43 Accounting for Uncertain Tax Positions Case Case1: 1: Highly HighlyCertain CertainTax TaxPosition Position If the probability that the tax benefit of $100 would be achieved were greater than 50%, this would be deemed a “highly certain” position In other words, it is more likely than not that the position taken and the amount in question would be upheld if reviewed 16-44 Accounting for Uncertain Tax Positions Case Case2: 2:Uncertain UncertainTax Tax Position— Position— More MoreLikely LikelyThan ThanNot Not Assume the following assessment of probabilities: (continued) 16-45 Accounting for Uncertain Tax Positions Case Case3: 3: Uncertain UncertainTax TaxPosition— Position— NOT NOTMore MoreLikely LikelyThan ThanNot Not If the company completes Step of the analysis and determines that it is NOT more likely than not that the tax position will be sustained, then the entire amount of the position must be recognized as a liability Income Tax Expense Unrecognized Tax Benefit 100 100 16-46 Net Operating Loss (NOL) Carryforward • If an operating loss exceeds income for the two preceding years, the remaining unused loss may be applied against income earned over the next 20 years as a net operating loss (NOL) carryforward • A valuation allowance is used to reduce the asset if it is more likely than not that some or all of the future benefits will not be realized 16-47 Financial Statement Presentation and Disclosure The income statement must show, either in the body of the statement or in a note, the following components of income taxes related to continuing operations Current tax expense or benefit Deferred tax expense or benefit Investment tax credits Government grants recognized as tax reductions (continued) 16-48 Financial Statement Presentation and Disclosure Benefits of operating loss carryforwards Adjustments of a deferred tax liability or asset for enacted changes in tax laws or rates or a change in the tax status of an enterprise Adjustments in beginning-of-the-year valuation allowance because of a change in circumstances 16-49 Deferred Taxes and the Statement of Cash Flows • FASB ASC Topic 230 requires a separate disclosure of the amount of cash paid for income taxes during a period • This separate disclosure is required for just two items:  Cash paid for income taxes •  Cash paid for interest Income taxes affect the Operating Activities section of the statement of cash flows (continued) 16-50 Deferred Taxes and the Statement of Cash Flows Collazo Company had the following information for 2013: Revenue (all cash) Income tax expense: Current Deferred Net income (continued) $30,000 $10,300 1,700 12,000 $18,000 16-51 Deferred Taxes and the Statement of Cash Flows The operating activities section of Collazo’s statement of cash flows is as follows if the direct method is used Cash collected from customers Income taxes paid Cash provided by operating activities (continued) $30,000 (13,300) $16,700 16-52 Deferred Taxes and the Statement of Cash Flows Collazo Company Statement of Cash Flows (Partial) (Indirect Approach) Cash provided by operating activities: Net income Decrease in income tax refund receivable Decrease in income taxes payable Increase in deferred tax liability Cash provided by operating activities $18,000 (2,000) (1,000) 1,700 $16,700 IfIfthe theindirect indirectmethod methodisisused, used,the theamount amountof of cash cashpaid paidfor forincome incometaxes, taxes,$13,300, $13,300,must must be beseparately separatelydisclosed disclosedeither eitherin inthe theSCF SCFor or in inthe thenotes notesto tothe thefinancial financialstatements statements 16-53 International Accounting for Deferred Taxes • • No-deferral approach: Using this approach, the differences are ignored Income tax expense equal to the amount of tax payable for the year is reported Comprehensive recognition approach: Deferred taxes are included in the computation of income tax expense and reported on the balance sheet The IASB has embraced this approach (continued) 16-54 International Accounting for Deferred Taxes • • • Partial recognition approach: Historically, the United Kingdom employed this innovate technique A deferred tax liability is recorded only to the extent that the deferred taxes are actually expected to be paid in the future In recent years, this method has lost favor internationally because it is so subjective (relying heavily on management expectations about future events) 16-55 Chapter 16 ₵ The The End End $ 16-56 16-57 ... still too complicated (continued) 16- 16 Annual Computation of Deferred Tax Liabilities and Assets The major advantages of the asset and liability method of accounting for deferred taxes are as... 0.40) $75,000 20,000 $95,000 $38,000 (continued) 16- 26 Example 3: Deferred Tax Liability Roland’s Roland’sJournal JournalEntry Entryfor for2 016 2 016 Income Tax Expense Deferred Tax Liability— Noncurrent... substantively enacted by the end of the reporting period.” 16- 28 Subsequent Changes in Enacted Tax Rates Using the Roland, Inc example, assume that the enacted rate for 2 016 changed from 40% to