CHAPTER 19 Accounting for Income Taxes ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Brief Questions Exercises Topics Exercises Concepts Problems for Analysis Reconcile pretax financial income with taxable income 1, 13 1, 2, 3, 4, 5, 12, 18, 20, 21 1, 2, 3, 4, Identify temporary and permanent differences 3, 4, 4, 5, 6, 2, 3, 3, 4, Determine deferred income 6, 7, 13 taxes and related items—single tax rate 1, 2, 3, 4, 5, 6, 7, 1, 3, 4, 5, 7, 8, 3, 4, 8, 12, 14, 15, 19, 21 Classification of deferred taxes 10, 11, 12 15 7, 11, 16, 18, 19, 20, 21, 22 3, 2, 3, 5 Determine deferred income taxes and related items— multiple tax rates, expected future income 10 2, 13, 16, 17, 18, 20, 22 1, 2, 6, 1, 6, Determine deferred taxes, multiple rates, expected future losses 10 Carryback and carryforward of NOL 16, 17, 18, 12, 13, 14 9, 10, 23, 24, 25 Change in enacted future tax rate 14 11 16 2, 8, 17 2, Tracking temporary differences through reversal 10 Income statement presentation 11 Conceptual issues—tax allocation 1, 2, 8, 19 12 Valuation allowance—deferred 8, 19 tax asset 13 Disclosure and other issues Copyright © 2011 John Wiley & Sons, Inc 1, 2, 3, 4, 5, 7, 1, 2, 3, 5, 10, 12, 16, 19, 7, 8, 23, 24, 25 7 5, 1, 2, 7, 14, 15, 23, 24, 25 15 Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 19-1 ASSIGNMENT CLASSIFICATION TABLE (BY LEARNING OBJECTIVE) Brief Exercises Learning Objectives Exercises Problems Identify differences between pretax financial income and taxable income 1, 2, Describe a temporary difference that results in future taxable amounts 1, 2, 4, 9, 10 1, 2, 3, 4, 5, 7, 8, 11, 12, 13, 16, 17, 18, 19, 20, 21, 22 1, 3, 4, 6, 7, 8, Describe a temporary difference that results in future deductible amounts 5, 6, 4, 5, 7, 8, 11, 12, 14, 15, 17, 18, 19, 20, 21, 22 1, 2, 4, 6, 8, Explain the purpose of a deferred tax asset valuation allowance 7, 14 7, 14, 15, 23, 24, 25 Describe the presentation of income tax expense in the income statement 4, 6, 1, 3, 4, 5, 8, 12, 15, 16 1, 2, 3, 4, 5, 7, 8, Describe various temporary and permanent differences 4, 6, 2, 3, Explain the effect of various tax rates and tax rate changes on deferred income taxes 11 13, 16, 17, 18, 21, 23, 24, 25 5, Apply accounting procedures for a loss carryback and a loss carryforward 12, 13, 14 9, 10, 23, 24, 25 Describe the presentation of deferred income taxes in financial statements 3, 15 8, 11, 16, 19, 20, 21, 22 3, 5, 6, 8, 19-2 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) ASSIGNMENT CHARACTERISTICS TABLE Level of Difficulty Time (minutes) Item Description E19-1 One temporary difference, future taxable amounts, one rate, no beginning deferred taxes Simple 15–20 E19-2 Two differences, no beginning deferred taxes, tracked through years Simple 15–20 E19-3 One temporary difference, future taxable amounts, one rate, beginning deferred taxes Simple 15–20 E19-4 Three differences, compute taxable income, entry for taxes Simple 15–20 E19-5 Two temporary differences, one rate, beginning deferred taxes Simple 15–20 E19-6 Identify temporary or permanent differences Simple 10–15 E19-7 Terminology, relationships, computations, entries Simple 10–15 E19-8 Two temporary differences, one rate, years Simple 10–15 E19-9 Carryback and carryforward of NOL, no valuation account, no temporary differences Simple 15–20 E19-10 Two NOLs, no temporary differences, no valuation account, entries and income statement Moderate 20–25 E19-11 Three differences, classify deferred taxes Simple 10–15 E19-12 Two temporary differences, one rate, beginning deferred taxes, compute pretax financial income Complex 20–25 E19-13 One difference, multiple rates, effect of beginning balance versus no beginning deferred taxes Simple 20–25 E19-14 Deferred tax asset with and without valuation account Moderate 20–25 E19-15 Deferred tax asset with previous valuation account Complex 20–25 E19-16 Deferred tax liability, change in tax rate, prepare section of income statement Complex 15–20 E19-17 Two temporary differences, tracked through years, multiple rates Moderate 30–35 E19-18 Three differences, multiple rates, future taxable income Moderate 20–25 E19-19 Two differences, one rate, beginning deferred balance, compute pretax financial income Complex 25–30 E19-20 Two differences, no beginning deferred taxes, multiple rates Moderate 15–20 E19-21 Two temporary differences, multiple rates, future taxable income Moderate 20–25 E19-22 Two differences, one rate, first year Simple 15–20 E19-23 NOL carryback and carryforward, valuation account versus no valuation account Complex 30–35 E19-24 NOL carryback and carryforward, valuation account needed Complex 30–35 E19-25 NOL carryback and carryforward, valuation account needed Moderate 15–20 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 19-3 ASSIGNMENT CHARACTERISTICS TABLE (Continued) Item Description Level of Difficulty P19-1 Three differences, no beginning deferred taxes, multiple rates Complex 40–45 P19-2 One temporary difference, tracked for years, one permanent difference, change in rate Complex 50–60 P19-3 Second year of depreciation difference, two differences, single rate, extraordinary item Complex 40–45 P19-4 P19-5 Permanent and temporary differences, one rate Moderate Simple 20–25 20–25 Moderate 20–25 P19-6 NOL without valuation account Two differences, two rates, future income expected Time (minutes) P19-7 One temporary difference, tracked years, change in rates, income statement presentation Complex 45–50 P19-8 Two differences, years, compute taxable income and pretax financial income Complex 40–50 P19-9 Five differences, compute taxable income and deferred taxes, draft income statement Complex 40–50 CA19-1 Objectives and principles for accounting for income taxes Simple 15–20 CA19-2 Basic accounting for temporary differences Moderate 20–25 CA19-3 Identify temporary differences and classification criteria Complex 20–25 CA19-4 Accounting and classification of deferred income taxes Moderate 20–25 CA19-5 Explain computation of deferred tax liability for multiple tax rates Complex 20–25 CA19-6 Explain future taxable and deductible amounts, how carryback and carryforward affects deferred taxes Complex 20–25 CA19-7 Deferred taxes, income effects Moderate 20–25 19-4 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) SOLUTIONS TO CODIFICATION EXERCISES CE19-1 Master Glossary (a) The deferred tax consequences attributable to deductible temporary differences and carryforwards A deferred tax asset is measured using the applicable enacted tax rate and provisions of the enacted tax law A deferred tax asset is reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized (b) The excess of taxable revenues over tax deductible expenses and exemptions for the year as defined by the governmental taxing authority (c) The portion of a deferred tax asset for which it is more likely than not that a tax benefit will not be realized (d) The deferred tax consequences attributable to taxable temporary differences A deferred tax liability is measured using the applicable enacted tax rate and provisions of the enacted tax law CE19-2 According to FASB ASC 740-10-30-2 (Income Taxes—Initial Measurement): The following basic requirements are applied to the measurement of current and deferred income taxes at the date of the financial statements: (a) The measurement of current and deferred tax liabilities and assets is based on provisions of the enacted tax law; the effects of future changes in tax laws or rates are not anticipated (b) The measurement of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized CE19-3 According to FASB ASC 740-10-S99-2 (Income Taxes—SEC Materials): Yes In such an event, a note must (1) disclose the aggregate dollar and per share effects of the tax holiday and (2) briefly describe the factual circumstances including the date on which the special tax status will terminate Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 19-5 CE19-4 According to FASB ASC 740-10-25-6 (Income Taxes—Recognition): An entity shall initially recognize the financial statement effects of a tax position when it is more likely than not, based on the technical merits, that the position will be sustained upon examination The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any For example, if an entity determines that it is certain that the entire cost of an acquired asset is fully deductible, the more-likely-than-not recognition threshold has been met The more-likely-than-not recognition threshold is a positive assertion that an entity believes it is entitled to the economic benefits associated with a tax position The determination of whether or not a tax position has met the more-likely-than-not recognition threshold shall consider the facts, circumstances, and information available at the reporting date The level of evidence that is necessary and appropriate to support an entity’s assessment of the technical merits of a tax position is a matter of judgment that depends on all available information 19-6 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) ANSWERS TO QUESTIONS Pretax financial income is reported on the income statement and is often referred to as income before income taxes Taxable income is reported on the tax return and is the amount upon which a company’s income taxes payable are computed One objective of accounting for income taxes is to recognize the amount of taxes payable or refundable for the current year A second is to recognize deferred tax liabilities and assets for the future tax consequences of events that have already been recognized in the financial statements or tax returns A permanent difference is a difference between taxable income and pretax financial income that, under existing applicable tax laws and regulations, will not be offset by corresponding differences or “turn around” in other periods Therefore, a permanent difference is caused by an item that: (1) is included in pretax financial income but never in taxable income, or (2) is included in taxable income but never in pretax financial income Examples of permanent differences are: (1) interest received on municipal obligations (such interest is included in pretax financial income but is not included in taxable income), (2) premiums paid on officers’ life insurance policies in which the company is the beneficiary (such premiums are not allowable expenses for determining taxable income but are expenses for determining pretax financial income), and (3) fines and expenses resulting from a violation of law Item (3), like item (2), is an expense which is not deductible for tax purposes A temporary difference is a difference between the tax basis of an asset or liability and its reported (carrying or book) amount in the financial statements that will result in taxable amounts or deductible amounts in future years when the reported amount of the asset is recovered or when the reported amount of the liability is settled The temporary differences discussed in this chapter all result from differences between taxable income and pretax financial income which will reverse and result in taxable or deductible amounts in future periods Examples of temporary differences are: (1) Gross profit or gain on installment sales reported for financial reporting purposes at the date of sale and reported in tax returns when later collected (2) Depreciation for financial reporting purposes is less than that deducted in tax returns in early years of assets’ lives because of using an accelerated depreciation method for tax purposes (3) Rent and royalties taxed when collected, but deferred for financial reporting purposes and recognized as revenue when earned in later periods (4) Unrealized gains or losses recognized in income for financial reporting purposes but deferred for tax purposes An originating temporary difference is the initial difference between the book basis and the tax basis of an asset or liability A reversing difference occurs when a temporary difference that originated in prior periods is eliminated and the related tax effect is removed from the tax account Book basis of assets Tax basis of assets Future taxable amounts Tax rate Deferred tax liability (end of 2013) Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) $900,000 700,000 200,000 34% $ 68,000 19-7 Questions Chapter 19 (Continued) Book basis of asset $90,000 Tax basis of asset $ 30,600 Deferred tax liability (beginning of 2013) Future taxable amounts Deferred tax liability (end of 2013) 90,000 Deferred tax benefit for 2013 Tax rate X 34% Income taxes payable for 2013 Deferred tax liability (end of 2013) $30,600 Total income tax expense for 2013 68,000 (37,400) 230,000 $192,600 A future taxable amount will increase taxable income relative to pretax financial income in future periods due to temporary differences existing at the balance sheet date A future deductible amount will decrease taxable income relative to pretax financial income in future periods due to existing temporary differences A deferred tax asset is recognized for all deductible temporary differences However, a deferred tax asset should be reduced by a valuation account if, based on all available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized More likely than not means a level of likelihood that is slightly more than 50% Taxable income $100,000 Future taxable amounts $70,000 Tax rate X Tax rate X 40% Income taxes payable $ 40,000 Deferred tax liability (end of 2013) $28,000 Deferred tax liability (end of 2013) $ 28,000 Current tax expense $40,000 Deferred tax liability (beginning of 2013) ( Deferred tax expense (28,000) Deferred tax expense for 2013 $ 28,000 Income tax expense for 2013 $68,000 40% 0) 10 Deferred tax accounts are reported on the balance sheet as assets and liabilities They should be classified in a net current and a net noncurrent amount An individual deferred tax liability or asset is classified as current or noncurrent based on the classification of the related asset or liability for financial reporting purposes A deferred tax asset or liability is considered to be related to an asset or liability if reduction of the asset or liability will cause the temporary difference to reverse or turn around A deferred tax liability or asset that is not related to an asset or liability for financial reporting purposes, including deferred tax assets related to loss carryforwards, shall be classified according to the expected reversal date of the temporary difference 11 The balances in the deferred tax accounts should be analyzed and classified on the balance sheet in two categories: one for the net current amount, and one for the net noncurrent amount This procedure is summarized as indicated below (1) Classify the amounts as current or noncurrent If an amount is related to a specific asset or liability, it should be classified in the same manner as the related asset or liability If not so related, it should be classified on the basis of the expected reversal date (2) Determine the net current amount by summing the various deferred tax assets and liabilities classified as current If the net result is an asset, report on the balance sheet as a current asset; if it is a liability, report as a current liability (3) Determine the net noncurrent amount by summing the various deferred tax assets and liabilities classified as noncurrent If the net result is an asset, report on the balance sheet as a noncurrent asset (“other assets” section); if it is a liability, report as a long-term liability 12 19-8 A deferred tax asset or liability is considered to be related to an asset or liability if reduction of the asset or liability will cause the temporary difference to reverse or turn around Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) Questions Chapter 19 (Continued) 13 Pretax financial income Interest income on municipal bonds Hazardous waste fine Depreciation ($60,000 – $45,000) Taxable income Tax rate Income taxes payable 14 $200,000 (2015 taxable amount) 10% (30% – 20%) $ 20,000 Decrease in deferred tax liability at the end of 2012 Deferred Tax Liability Income Tax Expense $550,000 (70,000) 25,000 15,000 520,000 X 30% $156,000 20,000 20,000 15 Some of the reasons for requiring income tax component disclosures are: (a) Assessment of the quality of earnings Many investors seeking to assess the quality of a company’s earnings are interested in the reconciliation of pretax financial income to taxable income Earnings that are enhanced by a favorable tax effect should be examined carefully, particularly if the tax effect is nonrecurring (b) Better prediction of future cash flows Examination of the deferred portion of income tax expense provides information as to whether taxes payable are likely to be higher or lower in the future 16 The loss carryback provision permits a company to carry a net operating loss back two years and receive refunds for income taxes paid in those years The loss must be applied to the second preceding year first and then to the preceding year The loss carryforward provision permits a company to carry forward a net operating loss twenty years, offsetting future taxable income The loss carryback can be accounted for with more certainty because the company knows whether it had taxable income in the past; such is not the case with income in the future 17 The company may choose to carry the net operating loss forward, or carry it back and then forward for tax purposes To forego the two-year carryback might be advantageous where a taxpayer had tax credit carryovers that might be wiped out and lost because of the carryback of the net operating loss In addition, tax rates in the future might be higher, and therefore on a present value basis, it is advantageous to carry forward rather than carry back For financial reporting purposes, the benefits of a net operating loss carryback are recognized in the loss year The benefits of an operating loss carryforward are recognized as a deferred tax asset in the loss year If it is more likely than not that the asset will be realized, the tax benefit of the loss is also recognized by a credit to Income Tax Expense on the income statement Conversely, if it is more likely than not that the loss carryforward will not be realized in future years, then an allowance account is established in the loss year and no tax benefit is recognized on the income statement of the loss year 18 Many believe that future deductible amounts arising from net operating loss carryforwards are different from future deductible amounts arising from normal operations One rationale provided is that a deferred tax asset arising from normal operations results in a tax prepayment—a prepaid tax asset In the case of loss carryforwards, no tax prepayment has been made Others argue that realization of a loss carryforward is less likely—and thus should require a more severe test—than for a net deductible amount arising from normal operations Some have suggested that the test be changed from “more likely than not” to “probable” realization Others have indicated that because of the nature of net operating losses, deferred tax assets should never be established for these items Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 19-9 Questions Chapter 19 (Continued) 19 Uncertain tax positions are tax positions for which the tax authorities may disallow a deduction in whole or in part Uncertain tax positions often arise when a company takes an aggressive approach in its tax planning, such as instances in which the tax law is unclear or the company may believe that the risk of audit is low Such positions give rise to tax benefits by either reducing income tax expense or related payables or by increasing an income tax refund receivable or deferred tax asset In assessing whether an uncertain tax position should be recognized, companies must determine whether a tax position will be sustained upon audit If the probability is more than 50 percent, the company may reduce its liability or increase its assets If the probability is less that 50 percent, companies may not record the tax benefit In determining “more likely than not,” companies must assume that they will be audited by the tax authorities If the recognition threshold is passed, companies must then estimate the amount to record as an adjustment to its tax assets and liabilities 19-10 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) FINANCIAL STATEMENT ANALYSIS CASE (a) Of the total provision for income taxes (reported in the income statement) the “current taxes” portion represents the taxes payable in cash while the “deferred taxes” represent the taxes payable in future years (although in this case, because the deferred taxes are a credit, they represent tax benefits receivable in future years) (b) Future taxable amounts increase taxable income relative to pretax financial income in the future due to temporary differences existing at the balance sheet date Future deductible amounts decrease taxable income relative to pretax financial income in the future due to existing temporary differences A deferred tax liability should be recorded for the deferred tax consequences attributable to the future taxable amounts scheduled and a deferred tax asset should be recorded for the deferred tax consequences attributable to the future deductible amounts scheduled (c) The carryback and carryforward provisions will affect the amounts to be reported for the resulting deferred tax asset and deferred tax liability In computing deferred tax account balances to be reported at a balance sheet date, the appropriate enacted tax rate is applied to future taxable and deductible amounts related to temporary differences existing at the balance sheet date In determining the appropriate tax rate, you must make assumptions about whether the entity will report taxable income or losses in the various future years expected to be affected by the existing temporary differences Thus, you calculate the taxes payable or refundable in the future due to existing temporary differences In making these calculations, you apply the provisions of the tax laws and enacted tax rates for the relevant periods For future taxable amounts: 19-82 If taxable income is expected in the year that a future taxable amount is scheduled, use the enacted rate for that future year to calculate the related deferred tax liability Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) FINANCIAL STATEMENT ANALYSIS CASE (Continued) If an NOL is expected in the year that a future taxable amount is scheduled, use the enacted rate of what would be the prior year the NOL would be carried back to or the enacted rate of the future year to which the carryforward would apply, whichever is appropriate, to calculate the related deferred tax liability For future deductible amounts: If taxable income is expected in the year that a future deductible amount is scheduled, use the enacted rate for that future year to calculate the related deferred tax asset If an NOL is expected in the year that a future deductible amount is scheduled, use the enacted rate of what would be the prior year the NOL would be carried back to or the enacted rate of the future year to which the carryforward would apply, whichever is appropriate, to calculate the related deferred tax asset Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 19-83 ACCOUNTING, ANALYSIS, AND PRINCIPLES Accounting Taxable income for 2012: Pretax financial income Permanent differences: Fines and penalties Tax-exempt interest Originating temporary differences: Excess installment gross profit per books ($560,000 – $112,000) Taxable income $500,000 26,000 (28,000) (448,000) $ 50,000 Income taxes payable for 2012: Taxable income 2012 Income tax rate Income taxes payable $ 50,000 X 50% $ 25,000 Allman has future taxable amounts arising from temporary differences as follows: 2013 Future taxable (deductible) amounts Enacted tax rate Deferred tax liability (asset) $112,000 X 40% $ 44,800 Future Years 2014 2015 $112,000 X 40% $ 44,800 $112,000 X 40% $ 44,800 2016 Total $112,000 X 40% $ 44,800 $448,000 $179,200 The $179,200 is a deferred tax liability because the temporary difference is from future taxable amounts The deferred tax liability needed = $179,200 Journal entry: Income Tax Expense 19-84 204,200 Income Taxes Payable 25,000 Deferred Tax Liability 179,200 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) ACCOUNTING, ANALYSIS, AND PRINCIPLES (Continued) Analysis The temporary difference in this case is due to the installment receivable Because the installment receivable would likely be classified as current (despite collection over four subsequent years; see Chapter 18), the $179,200 deferred tax liability would also be classified as current Income taxes payable would also be classified as current The income tax expense portion of the income statement would look as follows: Income before income taxes Income tax expense: Current Deferred Net Income $500,000 $ 25,000 179,200 204,200 $295,800 Allman’s 2012 effective tax rate is 40.84% ($204,200 ÷ $500,000) Principles We can use the conceptual framework to determine that deferred taxes should be reported as assets and liabilities The conceptual framework provides specific guidance as to how to define assets and liabilities Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 19-85 PROFESSIONAL RESEARCH (a) According to FASB ASC 740-10-30-18 (Income Taxes, Overall, Initial Measurement), future realization of the tax benefit of an existing deductible temporary difference or carryforward ultimately depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback, carryforward period available under the tax law (b) According to FASB ASC 740-10-30-18 (Income Taxes, Overall, Initial Measurement): The following four possible sources of taxable income may be available under the tax law to realize a tax benefit for deductible temporary differences and carryforwards: a Future reversals of existing taxable temporary differences b Future taxable income exclusive of reversing temporary differences and carryforwards c Taxable income in prior carryback year(s) if carryback is permitted under the tax law d Tax-planning strategies (see paragraph 740-10-30-19) that would, if necessary, be implemented to, for example: (1) Accelerate taxable amounts to utilize expiring carryforwards (2) Change the character of taxable or deductible amounts from ordinary income or loss to capital gain or loss (3) Switch from tax-exempt to taxable investments Evidence available about each of those possible sources of taxable income will vary for different tax jurisdictions and, possibly, from year to year To the extent evidence about one or more sources of taxable income is sufficient to support a conclusion that a valuation allowance is not necessary, other sources need not be considered Consideration of each source is required, however, to determine the amount of the valuation allowance that is recognized for deferred tax assets 19-86 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) PROFESSIONAL RESEARCH (Continued) (c) According to FASB ASC 740-10-30 (Income Taxes, Overall, Initial Measurement): 30-19 In some circumstances, there are actions (including elections for tax purposes) that: a Are prudent and feasible b An entity ordinarily might not take, but would take to prevent an operating loss or tax credit carryforward from expiring unused c Would result in realization of deferred tax assets This Subtopic refers to those actions as tax-planning strategies An entity shall consider tax-planning strategies in determining the amount of valuation allowance required Significant expenses to implement a tax-planning strategy or any significant losses that would be recognized if that strategy were implemented (net of any recognizable tax benefits associated with those expenses or losses) shall be included in the valuation allowance See paragraphs 740-10-55-39 through 55-48 for additional guidance Implementation of the tax-planning strategy shall be primarily within the control of management but need not be within the unilateral control of management 30-22 Examples (not prerequisites) of positive evidence that might support a conclusion that a valuation allowance is not needed when there is negative evidence include, but are not limited to, the following: a Existing contracts or firm sales backlog that will produce more than enough taxable income to realize the deferred tax asset based on existing sales prices and cost structures b An excess of appreciated asset value over the tax basis of the entity’s net assets in an amount sufficient to realize the deferred tax asset Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 19-87 PROFESSIONAL RESEARCH (Continued) c A strong earnings history exclusive of the loss that created the future deductible amount (tax loss carryforward or deductible temporary difference) coupled with evidence indicating that the loss (for example, an unusual, infrequent, or extraordinary item) is an aberration rather than a continuing condition 30-23 An entity shall use judgment in considering the relative impact of negative and positive evidence The weight given to the potential effect of negative and positive evidence shall be commensurate with the extent to which it can be objectively verified The more negative evidence that exists, the more positive evidence is necessary and the more difficult it is to support a conclusion that a valuation allowance is not needed for some portion or all of the deferred tax asset A cumulative loss in recent years is a significant piece of negative evidence that is difficult to overcome 30-24 Future realization of a tax benefit sometimes will be expected for a portion but not all of a deferred tax asset, and the dividing line between the two portions may be unclear In those circumstances, application of judgment based on a careful assessment of all available evidence is required to determine the portion of a deferred tax asset for which it is more likely than not a tax benefit will not be realized From the information given, it is not obvious whether a tax planning strategy could be employed More information is needed from the client 19-88 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) PROFESSIONAL SIMULATION Journal Entries Income Tax Expense Deferred Tax Asset Deferred Tax Liability Income Taxes Payable 40,840 1,200 20,000 22,040 Calculation of Deferred Taxes Temporary Difference Future Taxable (Deductible) Amounts Tax Rate Deferred Tax (Asset) Liability $ (3,000) $(1,200) 30,000 40% 40% Depreciation ( 20,000 40% Totals ($47,000 Warranty costs Construction profits *$12,000 * $(1,200) 8,000 *$20,000* *Because of a flat tax rate, these totals can be reconciled: $47,000 X 40% = $(1,200) + $20,000 Calculation of Taxable Income Pretax financial income Permanent differences Fine for pollution Tax-exempt interest Originating temporary differences Excess warranty expense per books ($5,000 – $2,000) Excess construction profits per books ($92,000 – $62,000) Excess depreciation per tax return ($80,000 – $60,000) Taxable income (20,000) $ 55,100 Taxable income for 2012 Tax rate Income taxes payable for 2012 $ 55,100 40% $ 22,040 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual $100,000 3,500 (1,400) 3,000 (30,000) (For Instructor Use Only) 19-89 PROFESSIONAL SIMULATION (Continued) Deferred tax liability at the end of 2012 Deferred tax liability at the beginning of 2012 Deferred tax expense for 2012 $ 20,000 $ 20,000 Deferred tax asset at the end of 2012 Deferred tax asset at the beginning of 2012 Deferred tax benefit for 2012 $ 1,200 $ (1,200) Financial Statements Income before income taxes Income tax expense Current $22,040 Deferred 18,800 Net income 19-90 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual $100,000 40,840 $ 59,160 (For Instructor Use Only) IFRS CONCEPTS AND APPLICATION IFRS19-1 The accounting for income taxes in IFRS is covered in IAS 12 “Income Taxes” IFRS19-2 Both IFRS and GAAP use the asset and liability approach for recording deferred tax assets In general, the differences between IFRS and GAAP involve limited differences in the exceptions to the asset-liability approach, some minor differences in the recognition, measurement and disclosure criteria, and differences in implementation guidance Following are some key elements for comparison • Under IFRS, an affirmative judgment approach is used by which a deferred tax asset is recognized up to the amount that is probable to be realized GAAP uses an impairment approach In this situation, the deferred tax asset is recognized in full It is then reduced by a valuation account if it is more likely than not that all or a portion of the deferred tax asset will not be realized • IFRS uses the enacted tax rate or substantially enacted tax rate (Substantially enacted means virtually certain) For GAAP the enacted tax rate must be used • The tax effects related to certain items are reported in equity under IFRS That is not the case under GAAP, which charges or credits the tax effects to income • GAAP requires companies to assess the likelihood of uncertain tax positions being sustainable upon audit Potential liabilities must be accrued and disclosed if the position is “more likely than not” to be disallowed Under IFRS, all potential liabilities must be recognized With respect to measurement, IFRS uses an expected value approach to measure the tax liability which differs from GAAP • The classification of deferred taxes under IFRS is always non-current GAAP classifies deferred taxes based on the classification of the asset or liability to which it relates Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 19-91 IFRS19-3 The IASB and the FASB have been working to address some of the differences in the accounting for income taxes Some of the issues under discussion are the term “probable” under IFRS for recognition of a deferred tax asset, which might be interpreted to mean “more likely than not” If changed, the reporting for impairments of deferred tax assets will be essentially the same between GAAP and IFRS In addition, the IASB is considering adoption of the classification approach used in GAAP for deferred tax assets and liabilities Also, GAAP will likely continue to use the enacted tax rate in computing deferred taxes, except in situations where the U.S taxing jurisdiction is not involved In that case, companies should use IFRS which is based on enacted rates or substantially enacted tax rates Finally, the issue of allocation of deferred income taxes to equity for certain transactions under IFRS must be addressed in order to achieve convergence At the time of this printing, deliberations on the Income Tax project have been suspended indefinitely IFRS19-4 Deferred tax accounts are reported on the statement of financial position as assets and liabilities They should be classified in a net non-current amount IFRS19-5 Deferred tax assets and deferred tax liabilities are separately recognized and measured but are offset in the statement of financial position The net deferred tax asset or net deferred tax liability is reported in the non-current section of the statement of financial position IFRS19-6 Income Tax Expense Deferred Tax Asset 19-92 Copyright © 2011 John Wiley & Sons, Inc 60,000 Kieso, Intermediate Accounting, 14/e, Solutions Manual 60,000 (For Instructor Use Only) IFRS19-7 Income Tax Refund Receivable ($350,000 X 40) Benefit Due to Loss Carryback 140,000 Deferred Tax Asset ($500,000 – $350,000) X 40 Benefit Due to Loss Carryforward 60,000 140,000 60,000 IFRS19-8 Income Tax Refund Receivable ($350,000 X 40) Benefit Due to Loss Carryback 140,000 140,000 IFRS19-9 Non-current liabilities Deferred tax liability ($69,000 – $24,000) $45,000 IFRS19-10 Non-current liabilities Deferred tax liability $450,000 IFRS19-11 (a) Income Tax Expense Deferred Tax Asset Income Taxes Payable Taxable income Enacted tax rate Income taxes payable Cumulative Future Taxable Date (Deductible) Amounts 12/31/13 $(500,000) Copyright © 2011 John Wiley & Sons, Inc Tax Rate 40% Kieso, Intermediate Accounting, 14/e, Solutions Manual 290,000 50,000 340,000 $850,000 X 40% $340,000 Deferred Tax (Asset) Liability $(200,000) (For Instructor Use Only) 19-93 IFRS19-11 (Continued) Deferred tax asset at the end of 2013 Deferred tax asset at the beginning of 2012 Deferred tax benefit for 2013 (increase in deferred tax asset) Current tax expense for 2013 (Income taxes payable) Income tax expense for 2013 $200,000 150,000 (50,000) 340,000 $290,000 (b) The journal entry at the end of 2013: Income Tax Expense Deferred Tax Asset 30,000 30,000 Note to instructor: Although not requested by the instructions, the pretax financial income can be computed by completing the following reconciliation: Pretax financial income for 2013 Originating difference which will result in future deductible amounts Taxable income for 2013 $ X a 125,000 $850,000 Solving for pretax financial income: X + $125,000 = $850,000 X = $725,000 = Pretax financial income a $500,000 – $375,000 = $125,000 IFRS19-12 (a) 19-94 According to IAS 12, paragraph 34, “A deferred tax asset shall be recognised for the carryforward of unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilised.” Thus, future taxable income is important because it will help increase the amount recognized in the deferred-tax asset balance Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) IFRS19-12 (Continued) (b) This question relates to the information found in paragraph 36, which states, “An entity considers the following criteria in assessing the probability that taxable profit will be available against which the unused tax losses or unused tax credits can be utilised: (1) whether the entity has sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity, which will result in taxable amounts against which the unused tax losses or unused tax credits can be utilised before they expire; (2) whether it is probable that the entity will have taxable profits before the unused tax losses or unused tax credits expire; (3) whether the unused tax losses result from identifiable causes which are unlikely to recur; and (4) whether tax planning opportunities (see paragraph 30) are available to the entity that will create taxable profit in the period in which the unused tax losses or unused tax credits can be utilised.” To the extent that it is not probable that taxable profit will be available against which the unused tax losses or unused tax credits can be utilised, the deferred tax asset is not recognised (c) Paragraph 30 discusses tax planning opportunities: “Tax planning opportunities are actions that the entity would take in order to create or increase taxable income in a particular period before the expiry of a tax loss or tax credit carryforward For example, in some jurisdictions, taxable profit may be created or increased by: (1) electing to have interest income taxed on either a received or receivable basis; (2) deferring the claim for certain deductions from taxable profit; (3) selling, and perhaps leasing back, assets that have appreciated but for which the tax base has not been adjusted to reflect such appreciation; and (4) selling an asset that generates non-taxable income (such as, in some jurisdictions, a government bond) in order to purchase another investment that generates taxable income.” Where tax planning opportunities advance taxable profit from a later period to an earlier period, the utilisation of a tax loss or tax credit carryforward still depends on the existence of future taxable profit from sources other than future originating temporary differences Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 19-95 IFRS19-13 (a) Per M&S’s 2010 consolidated income statement: Total income tax expense £179.7 million Per M&S’s April, 2010 statement of financial position: In non-current assets: Deferred tax assets £ 0.7 million In current liabilities: Current tax liabilities £129.2 million In non-current liabilities: Deferred tax liabilities £126.5 million Per M&S’s 2010 statement of cash flows: In cash flows provided by operating activities: Tax paid £120.7 million (b) M&S’s post-exceptional effective tax rates: 2010: (25.6%), 2009: (28.2%) (c) Income tax expense: Current Deferred Total £171.2 8.5 £179.7 (d) Significant components of M&S’s deferred tax assets and liabilities at April, 2010 were as follows: Deferred Tax Assets Pension temporary differences Deferred Tax Liabilities Fixed assets temporary differences Accelerated capital allowances Other short-term temporary differences Overseas deferred tax 19-96 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual £ 81.2 £ 74.3 123.7 3.2 5.8 £207.0 (For Instructor Use Only) ... © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 1 9- 5 CE1 9-4 According to FASB ASC 74 0-1 0-2 5-6 (Income Taxes—Recognition): An entity... 20–25 CA1 9-7 Deferred taxes, income effects Moderate 20–25 1 9- 4 Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) SOLUTIONS... Copyright © 2011 John Wiley & Sons, Inc Kieso, Intermediate Accounting, 14/e, Solutions Manual (For Instructor Use Only) 1 9- 9 Questions Chapter 19 (Continued) 19 Uncertain tax positions are tax positions