Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Chapter 16 Accounting for Income Taxes AACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment To aid faculty in this endeavor, we have labeled each question, exercise, and problem in Intermediate Accounting, 7e, with the following AACSB learning skills: Questions AACSB Tags Exercises (cont.) AACSB Tags 16–1 16–2 16–3 16–4 16–5 16–6 16–7 16–8 16–9 16–10 16–11 16–12 16–13 16–14 16–15 Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Reflective thinking Diversity, Reflective thinking 16–6 16–7 16–8 16–9 16–10 16–11 16–12 16–13 16–14 16–15 16–16 16–17 16–18 16–19 16–20 16–21 16–22 16–23 16–24 16–25 16–26 16–27 16–28 16–29 16–30 Reflective thinking Analytic Analytic Analytic Analytic Analytic Communications Analytic Analytic Analytic Analytic, Reflective thinking Analytic Analytic Analytic Analytic Analytic Analytic Reflective thinking Analytic Analytic, Reflective thinking Analytic, Reflective thinking Reflective thinking Analytic Reflective thinking Communications Brief Exercises 16–1 16–1 16–2 16–3 16–4 16–5 16–6 16–7 16–8 16–9 16–10 16–11 16–12 16–13 16–14 16–15 16–16 Analytic Analytic Analytic Analytic Analytic Analytic Reflective thinking Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Analytic Exercises 16–1 16–2 16–3 16–4 16–5 Solutions Manual, Vol.2, Chapter 16 Analytic Analytic Analytic Analytic Analytic CPA/CMA Analytic Analytic Analytic Analytic Analytic Analytic Analytic Diversity, Reflective thinking Reflective thinking Reflective thinking Reflective thinking © The McGraw-Hill Companies, Inc., 2013 16–1 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Problems AACSB Tags 16–1 16–2 16–3 16–4 16–5 16–6 16–7 16–6 16–7 16–8 16–9 16–10 16–11 16–12 16–13 Analytic Analytic, Communications Analytic Analytic Analytic Reflective thinking Analytic Analytic, Communications Analytic, Communications Analytic, Communications Analytic, Communications Analytic, Communications Analytic, Communications Analytic, Communications Analytic, Communications © The McGraw-Hill Companies, Inc., 2013 16–2 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com QUESTIONS FOR REVIEW OF KEY TOPICS Question 16–1 Income tax expense is comprised of both the current and the deferred tax consequences of events and transactions already recognized Specifically, the $12.3 million expense includes (a) the $7.9 million income tax that is payable currently and (b) the change in the deferred tax liability (or asset) Apparently, in the situation described, temporary differences required a $4.4 million increase in the deferred tax liability, a $4.4 million decrease in the deferred tax asset, or some combination of the two Question 16–2 Temporary differences between the reported amount of an asset or liability in the financial statements and its tax basis are primarily caused by revenues, expenses, gains, and losses being included in taxable income in a year earlier or later than the year in which they are recognized for financial reporting purpose, although there are other, less common, events that can cause these temporary differences Some temporary differences create deferred tax liabilities because they result in taxable amounts in some future year(s) when the related assets are recovered or the related liabilities are settled (when the temporary differences reverse) An example is the receivable created when installment sale gross profit is recognized for financial reporting purposes When this asset is recovered, taxable amounts are produced because the installment sale gross profit is then recognized for tax purposes Some temporary differences create deferred tax assets because they result in deductible amounts in some future year(s) when the related assets are recovered or the related liabilities are settled (when the temporary differences reverse) An example is the liability created when estimated warranty expense is recognized for financial reporting purposes When this liability is settled, deductible amounts are produced because the warranty cost is then deducted for tax purposes The deferred tax liability or asset each year is the tax rate times the temporary difference between the financial statement carrying amount of the receivable or liability and its tax basis Question 16–3 Future deductible amounts mean that taxable income will be decreased relative to pretax accounting income in one or more future years Two examples are (a) estimated expenses that are recognized on income statements when incurred, but deducted on tax returns in later years when actually paid and (b) revenues that are taxed when collected, but are recognized on income statements in later years when actually earned These situations have favorable tax consequences that are recognized as deferred tax assets Question 16–4 Deferred tax assets are recognized for all deductible temporary differences and operating loss carryforwards However, a deferred tax asset is then reduced by a valuation allowance if it is “more likely than not” that some portion or the entire deferred tax asset will not be realized The decision as to whether a valuation allowance is needed should be based on the weight of all available evidence Solutions Manual, Vol.2, Chapter 16 © The McGraw-Hill Companies, Inc., 2013 16–3 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions (continued) Question 16–5 Nontemporary or “permanent” differences are caused by transactions and events that under existing tax law will never affect taxable income or taxes payable Some provisions of the tax laws exempt certain revenues from taxation and prohibit the deduction of certain expenses Provisions of the tax laws, in some other instances, dictate that the amount of a revenue that is taxable or expense that is deductible permanently differs from the amount reported in the income statement Permanent differences are disregarded when determining both the tax payable currently and the deferred tax effect Question 16–6 Examples of nontemporary or “permanent” differences are: • Interest received from investments in bonds issued by state and municipal governments (not taxable) • Investment expenses incurred to obtain tax-exempt income (not tax deductible) • Life insurance proceeds upon the death of an insured executive (not taxable) • Premiums paid for life insurance policies (not tax deductible) • Compensation expense pertaining to some employee stock option plans (not tax deductible) • Expenses due to violations of the law (not tax deductible) • Portion of dividends received from U.S corporations that is not taxable due to the “dividends received deduction” • Tax deduction for depletion of natural resources (percentage depletion) that permanently exceeds the income statement depletion expense (cost depletion) Question 16–7 A deferred tax liability (or asset) is based on enacted tax rates and laws Hudson should use the 35% rate, the currently enacted tax rate that will be effective in the year(s) the temporary difference reverses Calculations are not based on anticipated legislation that would alter the company’s tax rate Question 16–8 When a change in a tax law or rate occurs, a deferred tax liability or asset must be adjusted to reflect the amount to be paid or recovered in the future If a deferred tax liability was established with the expectation that the future taxable amount would be taxed at 34%, it would now be adjusted to reflect taxation at 36% instead The usual practice of recalculating the desired balance in a deferred tax liability each period, and comparing that amount with any previously existing balance automatically takes into account tax rate changes The effect is reflected in operating income (adjustment to income tax expense) in the year of the enactment of the change in the tax law or rate © The McGraw-Hill Companies, Inc., 2013 16–4 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions (continued) Question 16–9 The income tax benefit of either an operating loss carryback or an operating loss carryforward is recognized for accounting purposes in the year the operating loss occurs The net after-tax operating loss reflects the reduction of past taxes from the loss carryback or future tax savings that the loss carryforward is expected to create An operating loss carryforward creates future deductible amounts, so a deferred tax asset is recognized for an operating loss carryforward The deferred tax asset is then reduced by a valuation allowance if it is “more likely than not” that some portion or all of the deferred tax asset will not be realized due to insufficient taxable income expected in the carryforward years Question 16–10 Deferred tax assets and deferred tax liabilities are not reported individually, but combined instead into a net current amount and a net noncurrent amount Each is reported as either an asset— if deferred tax assets exceed deferred tax liabilities—or as a liability—if deferred tax liabilities exceed deferred tax assets Deferred tax assets and deferred tax liabilities are classified as either current or noncurrent according to how the related assets or liabilities are classified for financial reporting For instance, a deferred tax liability arising from estimated warranty expenses would be classified as current if the warranty liability is classified as current A deferred tax asset or liability that is not related to a specific asset or liability should be classified according to when the underlying temporary difference is expected to reverse Question 16–11 Regarding deferred tax amounts reported in the balance sheet, disclosure notes should indicate (a) the total of all deferred tax liabilities, (b) the total of all deferred tax assets, (c) the total valuation allowance recognized for deferred tax assets, (d) the net change in the valuation allowance, and (e) the approximate tax effect of each type of temporary difference (and carryforward) Question 16–12 Pertaining to the income tax expense reported in the income statement, disclosure notes should indicate (a) the current portion of the tax expense (or tax benefit), (b) the deferred portion of the tax expense (or tax benefit), with separate disclosure of amounts attributable to (c) the portion that does not include the effect of the following separately disclosed amounts, (d) operating loss carryforwards, (e) adjustments due to changes in tax laws or rates, (f) adjustments to the beginningof-the-year valuation allowance due to revised estimates, and (g) investment tax credits Solutions Manual, Vol.2, Chapter 16 © The McGraw-Hill Companies, Inc., 2013 16–5 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Answers to Questions (concluded) Question 16–13 GAAP creates a higher standard that tax benefits must meet before they can be recognized in a company’s financial statements The identified tax position must have a "more-likely-than-not" likelihood—a more than 50 percent chance—of being sustained on examination The concept of "being sustained" means being capable of making it through the final level of appeal or litigation on the tax position's technical merits, assuming the examining jurisdictions have full knowledge of all facts and circumstances Once a company concludes that a particular tax position has a "more likely than not" chance of being sustained, it should deal with step two in the FASB's model by measuring the dollar amount of benefit to recognize Specifically, it should follow the Board's "cumulative probability" methodology under which companies will record in the financial statements the largest benefit that cumulatively is greater than 50 percent likely to be sustained Question 16–14 Intraperiod tax allocation means the total income tax obligation for a reporting period is allocated among the income statement items that gave rise to the income tax The following items should be reported net of their respective income tax effects: • Income (or loss) from continuing operations • Discontinued operations • Extraordinary items Question 16–15 Despite the similar approaches for accounting for taxation under IAS No 12, “Income Tax,” and U.S GAAP, differences in reported amounts for deferred taxes are among the most frequent between the two reporting approaches The reason is that a great many of the nontax differences between IFRS and U.S GAAP affect deferred taxes as well © The McGraw-Hill Companies, Inc., 2013 16–6 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com BRIEF EXERCISES Brief Exercise 16–1 Since taxable income is less than pretax accounting income, a future taxable amount will occur when the temporary difference reverses This means a deferred tax liability should be recorded to reflect the future tax consequences of the temporary difference: ($ in millions) Income tax expense (to balance) Deferred tax liability ([$10 – 7] x 40%) Income tax payable ($7 x 40%) Solutions Manual, Vol.2, Chapter 16 4.0 1.2 2.8 © The McGraw-Hill Companies, Inc., 2013 16–7 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 16–2 Since tax depreciation to date has been $100,000 more than depreciation for financial reporting purposes, a future taxable amount will occur when the temporary difference reverses This means a deferred tax liability should be reported to reflect the future tax consequences of the temporary difference At this point, that amount is $100,000 times 40%, or $40,000 If the balance was $32,000 last year, we need an increase of $8,000 The entry to record income taxes is: Income tax expense (to balance) Deferred tax liability ($40,000 – 32,000) Income tax payable ($4,000,000 x 40%) 1,608,000 8,000 1,600,000 Brief Exercise 16–3 Since taxable income is more than pretax accounting income, a future deductible amount will occur when the temporary difference reverses This means a deferred tax asset should be recorded to reflect the future tax savings from the temporary difference: ($ in millions) Income tax expense (to balance) Deferred tax asset ([$12 – 10] x 40%) Income tax payable ($12 x 40%) 4.0 4.8 Brief Exercise 16–4 ($ in millions) Income tax expense (to balance) Deferred tax asset ($50 x 40%) Income tax payable ($180 x 40%) © The McGraw-Hill Companies, Inc., 2013 16–8 52 20 72 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 16–5 ($ in millions) 84 Income tax expense (to balance) Deferred tax asset ([$20 – [$40 x 40%]) Income tax payable ($200 x 40%) 80 Brief Exercise 16–6 ($ in millions) Income tax expense (to balance) Deferred tax asset ($30 x 40%) Income tax payable ($35 x 40%) 12 14 Income tax expense Valuation allowance – deferred tax asset (1/4 x $12) 3 Brief Exercise 16–7 Deferred tax assets are recognized for all deductible temporary differences and operating loss carryforwards Deferred tax assets are then reduced by a valuation allowance if it is “more likely than not” that some portion or all of the deferred tax assets will not be realized That would be the case if management feels taxable income will not be sufficient in future years to permit gaining the benefit of reducing taxable income by the future deductible amounts This apparently is the case with Hypercom, which reported large losses in 2012 and years prior to 2012, perhaps indicative of insufficient taxable income in coming years to benefit from the tax savings Brief Exercise 16–8 Since taxable income to date has been $40 million less than pretax accounting income because of the temporary difference, a future taxable amount of $40 million will occur when the temporary difference reverses This means a deferred tax liability should be reported to reflect the future tax consequences of the temporary difference That amount is $40 million times 40%, or $16 million (The $18 million temporary difference shown for the current year already is included in the $40 million cumulative difference.) Solutions Manual, Vol.2, Chapter 16 © The McGraw-Hill Companies, Inc., 2013 16–9 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Brief Exercise 16–9 Current year Pretax accounting income Permanent difference: Municipal bond interest Temporary difference: Depreciation $ 900,000 Taxable income (tax return) $ 760,000 Enacted tax rate Tax payable currently 40% $ 304,000 (20,000) (120,000)* Deferred tax liability Journal entry Income tax expense (to balance) Deferred tax liability ($120,000 x 40%) Income tax payable (determined above) * tax depreciation: $800,000 x 40% straight-line depreciation: $800,000 ÷ years difference the first year © The McGraw-Hill Companies, Inc., 2013 16–10 Future taxable amount $120,000 40% $ 48,000 352,000 48,000 304,000 $320,000 200,000 $120,000 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Integrating Case 16–3 Requirement ($ in 000s) Fair value adjustment (to balance) Unrealized holding gain on investments (given) Deferred income tax liability (given) 209 126 83 Temporary differences between the reported amount of an asset (investments in this case) in the financial statements and its tax basis result in deferred taxes (deferred income tax liability in this case) This temporary difference creates a deferred tax liability because it results in taxable amounts in some future year(s) when the investment is sold (when the temporary difference reverses) © The McGraw-Hill Companies, Inc., 2013 16–88 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Integrating Case 16–4 a This is a correction of an error To correct the error: Prepaid insurance ($35,000 ÷ yrs x yrs: 2013–2015) Income tax payable ($21,000 x 40%) Retained earnings* 21,000 8,400 12,600 *($35,000 – [$35,000 ÷ years x years: 2011–2012]) less $8,400 tax 2013 adjusting entry: Insurance expense ($35,000 ÷ years) Prepaid insurance 7,000 7,000 The financial statements that were incorrect as a result of the error would be retrospectively restated to report the prepaid insurance acquired and reflect the correct amount of insurance expense when those statements are reported again for comparative purposes in the current annual report A “prior period adjustment” to retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on each year’s net income, income before extraordinary items, and earnings per share b This is a correction of an error To correct the error: Retained earnings (net effect) Refund—Income tax ($25,000 x 40%) Inventory 15,000 10,000 25,000 The financial statements that were incorrect as a result of the error would be retrospectively restated to report the correct inventory amounts, cost of goods sold, and retained earnings when those statements are reported again for comparative purposes in the current annual report A “prior period adjustment” to retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on each year’s net income, income before extraordinary items, and earnings per share Solutions Manual, Vol.2, Chapter 16 © The McGraw-Hill Companies, Inc., 2013 16–89 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 16–4 (continued) c This is a change in accounting principle and is reported retrospectively To record the change: Inventory (given) Deferred tax liability ($960,000 x 40%) Retained earnings (net effect) 960,000 384,000 576,000 Most changes in accounting principle are accounted for retrospectively Prior years' financial statements are recast to reflect the use of the new accounting method The company should increase retained earnings to the balance it would have had if the FIFO method had been used previously; that is, by the cumulative net income difference between the LIFO and FIFO methods Simultaneously, inventory is increased to the balance it would have had if the FIFO method had always been used A disclosure note should justify that the change is preferable and describe the effect of the change on any financial statement line items and per share amounts affected for all periods reported For financial reporting purposes, but not for tax, the company is retrospectively increasing pretax accounting income, but not taxable income This creates a temporary difference between the two that will reverse over time as the unsold inventory becomes cost of goods sold When that happens, taxable income will be higher than pretax accounting income When taxable income will be higher than pretax accounting income as a temporary difference reverses, we have a “future taxable amount” and record a deferred tax liability © The McGraw-Hill Companies, Inc., 2013 16–90 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 16–4 (continued) d This is a correction of an error To correct the error: Retained earnings (net effect) Refund—Income tax ($15,500 x 40%) Compensation expense 9,300 6,200 15,500 The 2012 financial statements that were incorrect as a result of the error would be retrospectively restated to report the correct compensation expense, net income, and retained earnings when those statements are reported again for comparative purposes in the current annual report A “prior period adjustment” to retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on each year’s net income, income before extraordinary items, and earnings per share e This is a change in estimate resulting from a change in accounting principle and is accounted for prospectively No entry is needed to record the change 2013 adjusting entry: Depreciation expense (calculated below) Accumulated depreciation 57,600 57,600 A change in depreciation method is considered a change in accounting estimate resulting from a change in accounting principle Accordingly, Williams-Santana reports the change prospectively; previous financial statements are not revised Instead, the company simply employs the straight-line method from now on The undepreciated cost remaining at the time of the change is depreciated straight-line over the remaining useful life Undepreciated cost, Jan 1, 2013 (given) Estimated residual value To be depreciated over remaining years Annual straight-line depreciation 2013–2018 Solutions Manual, Vol.2, Chapter 16 $460,800 (0) $460,800 $ 57,600 years © The McGraw-Hill Companies, Inc., 2013 16–91 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 16–4 (concluded) f This is a correction of an error To correct the error: Equipment (cost) 1,000,000 Accumulated depreciation ([$1,000,000 ÷ 10] x years) 300,000 Deferred tax liability ([$1,000,000 – 300,000] x 40%) 280,000 Retained earnings ($1,000,000 – [$100,000 x years]) less $280,000 tax 420,000 2013 adjusting entry: Depreciation expense ($1,000,000 ÷ 10) Accumulated depreciation 100,000 100,000 The financial statements that were incorrect as a result of the error would be retrospectively restated to report the correct depreciation, assets, and retained earnings when those statements are reported again for comparative purposes in the current annual report A “prior period adjustment” to retained earnings would be reported, and a disclosure note should describe the nature of the error and the impact of its correction on each year’s net income, income before extraordinary items, and earnings per share © The McGraw-Hill Companies, Inc., 2013 16–92 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Communication Case 16–5 To: From: Re: Mr Randy Patey Accounting for income taxes Below is a brief overview of accounting for income taxes and its application to our situation The objectives of accounting for income taxes are to recognize the amount of taxes payable (or refundable) for the current year and deferred tax liabilities and assets for the estimated future tax consequences of temporary differences and carryforwards Temporary differences are differences between the tax basis of assets or liabilities and their reported amounts in the financial statements that will result in taxable or deductible amounts in future years The reported amount in the financial statements for our building is $5,600,000, which is its $6,000,000 cost reduced by two years’ straight-line depreciation of $200,000 per year ($6,000,000 ÷ 30 years) The tax basis is $5,200,000, so there is a $400,000 temporary difference The deferred tax liability is that amount times the tax rate when the future taxable amounts are taxable That rate is the currently enacted rate, 40%, even though it’s likely that rate might change The measurement of deferred tax assets is reduced if necessary, by a valuation allowance to reflect the net asset amount that is “more likely than not” to be realized Nontemporary or “permanent” differences are caused by transactions and events that under existing tax law will never affect taxable income or taxes payable Some provisions of the tax laws exempt certain revenues from taxation and prohibit the deduction of certain expenses One such deduction is the insurance premium we pay each year on the CEO’s life insurance policy Nontemporary or “permanent” differences are disregarded when determining both the tax payable currently and the deferred tax effect Please let me know if you have any questions or concerns Solutions Manual, Vol.2, Chapter 16 © The McGraw-Hill Companies, Inc., 2013 16–93 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Real World Case 16–6 Deferred tax assets and deferred tax liabilities are classified as either current or noncurrent according to how the related assets or liabilities are classified for financial reporting A deferred tax asset or deferred tax liability is considered to be related to an asset or liability if reduction (including amortization) of that asset or liability will cause the temporary difference to reverse Deferred tax assets and deferred tax liabilities are not reported separately Instead, they are offset, and a net current amount and a net noncurrent amount are reported as either an asset or a liability Because it reports a noncurrent liability, “Deferred income taxes” of $6,682 million, while the “net deferred tax liability” reported in the disclosure note is only $1,695 million, Walmart apparently has a net current asset, that is, current deferred tax assets in excess of current deferred tax liabilities The apparent amount of the net current asset is $6,682 million – 1,695 million, or $4,987 million This is reported as a current asset in the balance sheet The company reports noncurrent deferred tax liabilities in excess of noncurrent deferred tax assets, a $6,682 million net noncurrent liability as a long-term liability in the balance sheet (Walmart includes this amount as part of deferred income taxes and other.) The journal entry that summarizes the entries Walmart used to record fiscal yearend 2011 income taxes can be reconstructed from the information provided in the note: ($ in millions) Income tax expense (given) Deferred tax asset ($7,540 – 6,872) Valuation allowance ($2,899 – 2,167) Deferred tax liability ($6,336 – 5,596) Income tax payable (to balance) © The McGraw-Hill Companies, Inc., 2013 16–94 7,579 668 732 740 6,775 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Research Case 16–7 An objective of this case is to acquaint the student with information provided by the Treasury Department and the IRS on the Internet, and in particular the ability to download forms Another goal is to provide perspective on various topics (e.g., deductions, temporary differences, net operating losses) discussed in the chapter Specific deductions are listed that are deductible from “total income” to arrive at “taxable income.” On the 2011 Form 1120 these are items 12 (compensation of officers) through 29 (net operating loss deduction) Each of these items is a deduction that might not also be included among expenses in the income statement In addition, the amounts for the items might be different on the two statements A “net operating loss deduction” would be reported if a company reported a net operating loss in a previous period that was not “carried back” to a prior period and hasn’t yet been deducted as an operating loss carryforward The deduction reduces taxable income and therefore taxes payable Temporary differences between taxable income and pretax accounting income in the income statement are created when the amounts for various deductions differ from corresponding expenses in the income statement—if the differences will eventually be in the opposite direction, that is, if the differences will “reverse.” Differences in revenue items on the two reports might also create temporary differences Solutions Manual, Vol.2, Chapter 16 © The McGraw-Hill Companies, Inc., 2013 16–95 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Analysis Case 16–8 Deferred tax assets and deferred tax liabilities are classified as either current or noncurrent depending on how the related assets or liabilities are classified for financial reporting The several deferred tax assets and liabilities should be combined into two summary amounts Current deferred tax assets and liabilities should be netted together, with the net current amount reported as either a current asset, if deferred tax assets exceed deferred tax liabilities, or current liability, if deferred tax liabilities exceed deferred tax assets A single net noncurrent amount, too, should be reported as a net noncurrent asset or a net noncurrent liability Google reports deferred income taxes as both a current and a noncurrent asset in 2010 because, apparently, the net current amount is a current asset and the net noncurrent amount also is an asset In 2009, both the net current amount and the net noncurrent amount are assets as well Note 15 in the disclosure notes indicates that deferred tax assets are $1,221 million in 2010 and deferred tax liabilities are $405 million The reason these amounts differ from the two amounts reported in the balance sheet relates to the answer to requirement Both the $1,221 million deferred tax assets and the $405 million of deferred tax liabilities are separated into current and long-term classifications The current portions of each are combined to produce a $259 million current asset and the noncurrent portions of each are combined to produce a long-term asset of $265 million A valuation allowance is needed if it is “more likely than not” that some portion or all of a deferred tax asset will not be realized Google did record a valuation allowance for its deferred tax assets in both 2009 and in 2010 © The McGraw-Hill Companies, Inc., 2013 16–96 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Analysis Case 16–9 Kroger's January 29, 2011, income statement reports the income tax expense for the year as $601 million The current portion is $697 + 95 = $792 million The deferred portion of the expense is $(136) + (55) = $(191) Because the deferred portion is negative, Kroger had a combination of increases to deferred tax assets and decreases to deferred tax liabilities totaling $191: Income tax expense 601 Deferred tax assets/liabilities 191 Income tax payable 792 Deferred tax assets and deferred tax liabilities are classified as either current or noncurrent according to how the related assets or liabilities are classified for financial reporting A deferred tax asset or deferred tax liability is considered to be related to an asset or liability if reduction (including amortization) of that asset or liability will cause the temporary difference to reverse Deferred tax assets and deferred tax liabilities are not necessarily reported separately Instead, they are offset, and a net current amount and a net noncurrent amount are reported as either an asset or a liability In the balance sheet, Kroger reports current deferred tax liabilities ($387 million) in excess of current deferred tax assets ($167 million), a $220 million net current liability This is reported as part of current liabilities in the balance sheet The company reports noncurrent deferred tax liabilities ($1,515 million) in excess of net noncurrent deferred tax assets ($765 million), a $750 million net noncurrent liability This is reported separately as a long-term liability in the balance sheet Solutions Manual, Vol.2, Chapter 16 © The McGraw-Hill Companies, Inc., 2013 16–97 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Judgment Case 16–10 Requirement Increasing debt increases risk Financial risk often is measured by the debt to equity ratio: total liabilities/shareholders’ equity The higher the debt to equity ratio, other things being equal, the higher the risk Analysts sometimes maintain that deferred taxes should be excluded, arguing that in many cases the deferred tax liability account remains the same (or continually grows larger) The reasoning is that no future tax payment will be required Requirement If we follow the argument above, we would reduce the numerator by the deferred tax: $15,101 – 1,245 Reducing liabilities would necessitate also increasing equity to keep everything in balance: $5,530 + 1,245 The reasoning behind adjusting both amounts is that we are in effect reversing the effect of recording the deferred tax liability over time which was: Income tax expense (reduces income and therefore equity [retained earnings]) 1,245 1,245 Deferred tax liability (increases liabilities) So, the revised ratio would be: ($15,101 – 1,245) ÷ ($5,530 + 1,245) = 2.0 This is a 26% reduction in the ratio Requirement The counterargument to this approach, though, is similar to other situations in which long-term borrowings tend to remain the same or continually grow larger Academic research suggests that investors view deferred tax liabilities as real liabilities and they appear to discount them according to the timing and likelihood of the liability’s settlement So, omitting deferred tax liabilities might distort the real debt-equity position © The McGraw-Hill Companies, Inc., 2013 16–98 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Trueblood Case 16–11 A solution and extensive discussion materials accompany each case in the Deloitte & Touche Trueblood Case Study Series These are available to instructors at: www.deloitte.com/ us/truebloodcases Solutions Manual, Vol.2, Chapter 16 © The McGraw-Hill Companies, Inc., 2013 16–99 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Judgment Case 16–12 Requirement ($ in millions, except per share amounts) RUSSELL-JAMES CORPORATION Income Statement For the year ended December 31, 2013 Revenues Cost of goods sold Gross profit Selling and administrative expenses Income from continuing operations before income taxes Income taxes Income from continuing operations Discontinued operations: Loss from operations of cosmetics division, less applicable income taxes of $40 Gain from disposal of cosmetics division, less applicable income taxes of $6 Income before extraordinary item Extraordinary loss from earthquake, less applicable income taxes of $4 Net income Per share of common stock (100 million shares): Income from continuing operations Loss from operations of cosmetics division, net of tax Gain from disposal of cosmetics division, net of tax Income before extraordinary item Extraordinary loss from earthquake, net of tax Net income © The McGraw-Hill Companies, Inc., 2013 16–100 $300 90 $210 (60) $150 60 $ 90 $(60) (51) $ 39 (6) $ 33 $.90 (.60) 09 $.39 (.06) $.33 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Case 16–12 (concluded) Requirement Income taxes on income from continuing operations Tax savings on loss from cosmetics division Tax on gain from disposal of cosmetics division Tax savings on loss from earthquake $60 (40) (4) Income taxes (total, unallocated) $22 Solutions Manual, Vol.2, Chapter 16 © The McGraw-Hill Companies, Inc., 2013 16–101 Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Air France–KLM Case Requirement AF reported €933 million of deferred taxes at March 31, 2011 as a noncurrent asset and €511 million of deferred taxes as a noncurrent liability In 2011, companies using IFRS reported total deferred tax assets and total liabilities as noncurrent amounts in their balance sheets in accordance with IAS No 12 A March 31, 2009, IASB exposure draft proposed to change the classification requirements to conform to those of U.S GAAP and have companies report deferred tax assets and liabilities as net current and net noncurrent amounts, based on the financial statement classification of the related nontax asset or liability As of 2011, the classification had not been changed Requirement This policy is not consistent with U.S GAAP, which requires that measurement be based on tax rates and laws that are enacted at the balance sheet date Using “substantively enacted” is not permissible A March 31, 2009, IASB exposure draft proposed to change the measurement requirements to conform to those of U.S GAAP Requirement This policy is not consistent with U.S GAAP, which requires that all deferred tax assets be recorded and then reduced by a valuation allowance when it is deemed “more likely than not” (the definition of probable under IFRS) that some or all of the benefits will not be realized due to insufficient taxable income to absorb the future deductible amounts and realize the tax savings A March 31, 2009, IASB exposure draft proposed to change the measurement requirements to conform to those of U.S GAAP © The McGraw-Hill Companies, Inc., 2013 16–102 Intermediate Accounting, 7e ... 16–6 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com BRIEF EXERCISES Brief Exercise 16–1 Since taxable income is less than pretax accounting. .. 16–14 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com EXERCISES Exercise 16–1 Requirement Since taxable income is less than pretax accounting. .. (18) $27 Intermediate Accounting, 7e Find more slides, ebooks, solution manual and testbank on www.downloadslide.com Exercise 16–3 ($ in millions) December 31 2013 Depreciable asset (net): Accounting