1 Accounting for Income Taxes

Intermediate Accounting
14th Edition

Kieso, Weygandt, and Warfield

19-1
 Learning
Learning Objectives
Objectives
1. Identify differences between pretax financial income and taxable income.

2. Describe a temporary difference that results in future taxable amounts.

3. Describe a temporary difference that results in future deductible amounts.

4. Explain the purpose of a deferred tax asset valuation allowance.

5. Describe the presentation of income tax expense in the income statement.

6. Describe various temporary and permanent differences.

7. Describe the presentation of deferred income taxes in financial statements

19-2
 Accounting
Accounting for
for Income
Income Taxes
Taxes

Fundamentals of Financial
Accounting for Statement
Income Taxes Presentation

Future taxable
Balance sheet
amounts and
deferred taxes Income
statement
Future deductible
amounts and Uncertain tax
deferred taxes positions
Income
statement
presentation
Specific
differences

19-3
Fundamentals
Fundamentals of
of Accounting
Accounting for
for Income
Income Taxes
Taxes

Corporations must file income tax returns following the

guidelines developed by the Internal Revenue Service (IRS),
thus they:

 calculate taxes payable based upon IRS code,

 calculate income tax expense based upon IFRS.

Amount reported as tax expense will often differ from the

amount of taxes payable to the IRS.

19-4 LO 1 Identify differences between pretax financial income and taxable income.
Fundamentals
Fundamentals of
of Accounting
Accounting for
for Income
Income Taxes
Taxes
Illustration 19-1

Financial Statements Tax Return

vs.

Exchanges

Investors and Creditors

Pretax Financial Income  Taxable Income

IFRS Tax Code
Income Tax Expense  Income Tax Payable

19-5 LO 1 Identify differences between pretax financial income and taxable income.
Fundamentals
Fundamentals of
of Accounting
Accounting for
for Income
Income Taxes
Taxes

Illustration: Chelsea, Inc. reported revenues of $130,000

and expenses of $60,000 in each of its first three years of
operations. For tax purposes, Chelsea reported the same
expenses to the IRS in each of the years. Chelsea reported
taxable revenues of $100,000 in 2012, $150,000 in 2013,
and $140,000 in 2014. What is the effect on the accounts of
reporting different amounts of revenue for IFRS versus tax?

19-6 LO 1 Identify differences between pretax financial income and taxable income.
 Book
Book vs.
vs. Tax
Tax Difference
Difference
Illustration 19-2
IFRS
IFRSReporting
Reporting 2012 2013 2014 Total

Revenues $130,000 $130,000 $130,000 $390,000

Expenses 60,000 60,000 60,000 180,000
Pretax financial income $70,000 $70,000 $70,000 $210,000

Income tax expense (40%) $28,000 $28,000 $28,000 $84,000

Illustration 19-3
Tax
TaxReporting
Reporting 2012 2013 2014 Total

Revenues $100,000 $150,000 $140,000 $390,000

Expenses 60,000 60,000 60,000 180,000
Pretax financial income $40,000 $90,000 $80,000 $210,000

Income tax payable (40%) $16,000 $36,000 $32,000 $84,000

19-7 LO 1 Identify differences between pretax financial income and taxable income.
 Book
Book vs.
vs. Tax
Tax Difference
Difference
Illustration 19-2
Comparison
Comparison 2012 2013 2014 Total

Income tax expense (IFRS) $28,000 $28,000 $28,000 $84,000

Income tax payable (IRS) 16,000 36,000 32,000 84,000
Difference $12,000 $(8,000) $(4,000) $0

Income tax expense (40%) $28,000 $28,000 $28,000 $84,000

Are the differences accounted for in the financial statements? Yes

Year Reporting Requirement

2012 Deferred tax liability account increased to $12,000

2013 Deferred tax liability account reduced by $8,000

2014 Deferred tax liability account reduced by $4,000

19-8 LO 1 Identify differences between pretax financial income and taxable income.
 Financial
Financial Reporting
Reporting for
for 2010
2010
Balance Sheet Income Statement
2012 2012
Assets:
Revenues:

Expenses:
Liabilities:
Deferred taxes 12,000
Income tax payable 16,000
Equity: Income tax expense 28,000

Net income (loss)

Where does the “deferred tax liability” get reported in the financial
statements?
19-9 LO 1 Identify differences between pretax financial income and taxable income.
 Temporary
Temporary Differences
Differences
A Temporary Difference is the 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.

Future Taxable Amounts Future Deductible Amounts

Deferred Tax Liability represents Deferred Tax Asset represents the
the increase in taxes payable in increase in taxes refundable (or
future years as a result of taxable saved) in future years as a result of
temporary differences existing at deductible temporary differences
the end of the current year. existing at the end of the current
year.

Illustration 19-22 Examples of Temporary Differences

19-10 LO 2 Describe a temporary difference that results in future taxable amounts.

 Future
Future Taxable
Taxable Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Illustration: In Chelsea’s situation, the only difference

between the book basis and tax basis of the assets and
liabilities relates to accounts receivable that arose from revenue
recognized for book purposes. Chelsea reports accounts
receivable at $30,000 in the December 31, 2012, IFRS-basis
balance sheet. However, the receivables have a zero tax
basis.
Illustration 19-5

19-11 LO 2 Describe a temporary difference that results in future taxable amounts.

 Future
Future Taxable
Taxable Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Illustration: Reversal of Temporary Difference, Chelsea Inc.

Illustration 19-6

Chelsea assumes that it will collect the accounts receivable and report
the $30,000 collection as taxable revenues in future tax returns.
Chelsea does this by recording a deferred tax liability.

19-12 LO 2 Describe a temporary difference that results in future taxable amounts.

 Future
Future Taxable
Taxable Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Liability

A deferred tax liability represents the increase in taxes payable
in future years as a result of taxable temporary differences
existing at the end of the current year.

Illustration 19-4

2012 2013 2014 Total

Income tax expense (IFRS) $28,000 $28,000 $28,000 $84,000

Income tax payable (IRS) 16,000 36,000 32,000 84,000
Difference $12,000 $(8,000) $(4,000) $0

19-13 LO 2 Describe a temporary difference that results in future taxable amounts.

 Future
Future Taxable
Taxable Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Liability

Illustration: Because it is the first year of operations for
Chelsea, there is no deferred tax liability at the beginning of the
year. Chelsea computes the income tax expense for 2012 as
follows:
Illustration 19-9

19-14 LO 2 Describe a temporary difference that results in future taxable amounts.

 Future
Future Taxable
Taxable Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Liability

Illustration: Chelsea makes the following entry at the end of
2012 to record income taxes.

Income Tax Expense 28,000

Income Tax Payable 16,000
Deferred Tax Liability 12,000

19-15 LO 2 Describe a temporary difference that results in future taxable amounts.

 Future
Future Taxable
Taxable Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Liability

Illustration: Computation of Income Tax Expense for 2013.
Illustration 19-10

19-16 LO 2 Describe a temporary difference that results in future taxable amounts.

 Future
Future Taxable
Taxable Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Liability

Illustration: Chelsea makes the following entry at the end of
2013 to record income taxes.

Income Tax Expense 28,000

Deferred Tax Liability 8,000
Income Tax Payable 36,000

19-17 LO 2 Describe a temporary difference that results in future taxable amounts.

 Future
Future Taxable
Taxable Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Liability

Illustration: The entry to record income taxes at the end of
2014 reduces the Deferred Tax Liability by $4,000. The Deferred
Tax Liability account appears as follows at the end of 2014.
Illustration 19-11

19-18 LO 2 Describe a temporary difference that results in future taxable amounts.

 Future
Future Taxable
Taxable Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

E19-1: Starfleet Corporation has one temporary difference at

the end of 2012 that will reverse and cause taxable amounts of
$55,000 in 2013, $60,000 in 2014, and $75,000 in 2015.
Starfleet’s pretax financial income for 2012 is $400,000, and the
tax rate is 30% for all years. There are no deferred taxes at the
beginning of 2012.

Instructions
a) Compute taxable income and income taxes payable for
2012.
b) Prepare the journal entry to record income tax expense,
deferred income taxes, and income taxes payable for 2012.

19-19 LO 2 Describe a temporary difference that results in future taxable amounts.

 Future
Future Taxable
Taxable Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes
Ex. 19-1: Current Yr.
INCOME: 2012 2013 2014 2015
Financialincome
income(IFRS)
(GAAP) 400,000
Temporary Diff. (190,000) 55,000 60,000 75,000
Taxable income (IRS) a. 210,000 55,000 60,000 75,000
Tax rate 30% 30% 30% 30%
Income tax a. 63,000 16,500 18,000 22,500

b. Income tax expense (plug) 120,000

Income tax payable 63,000
Deferred tax liability 57,000

19-20 LO 2 Describe a temporary difference that results in future taxable amounts.

 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Illustration: During 2012, Cunningham Inc. estimated its

warranty costs related to the sale of microwave ovens to be
$500,000, paid evenly over the next two years. For book
purposes, in 2012 Cunningham reported warranty expense and
a related estimated liability for warranties of $500,000 in its
financial statements. For tax purposes, the warranty tax
deduction is not allowed until paid.
Illustration 19-12

19-21 LO 3 Describe a temporary difference that results in future deductible amounts.

 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Illustration: Reversal of Temporary Difference.

Illustration 19-13

When Cunningham pays the warranty liability, it reports an expense

(deductible amount) for tax purposes. Cunningham reports this future
tax benefit in the December 31, 2012, balance sheet as a deferred tax
asset.
19-22 LO 3 Describe a temporary difference that results in future deductible amounts.
 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Asset

A deferred tax asset represents the increase in taxes
refundable (or saved) in future years as a result of deductible
temporary differences existing at the end of the current year.

19-23 LO 3 Describe a temporary difference that results in future deductible amounts.

 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Asset

Illustration: Hunt Co. accrues a loss and a related liability of
$50,000 in 2012 for financial reporting purposes because of
pending litigation. Hunt cannot deduct this amount for tax
purposes until the period it pays the liability, expected in 2013.
Illustration 19-14

19-24 LO 3 Describe a temporary difference that results in future deductible amounts.

 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Asset

Illustration: Assuming that 2012 is Hunt’s first year of
operations, and income tax payable is $100,000, Hunt computes
its income tax expense as follows.
Illustration 19-16

19-25 LO 3 Describe a temporary difference that results in future deductible amounts.

 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Asset

Illustration: Hunt makes the following entry at the end of 2012
to record income taxes.

Income Tax Expense 80,000

Deferred Tax Asset 20,000
Income Tax Payable 100,000

19-26 LO 3 Describe a temporary difference that results in future deductible amounts.

 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Asset

Illustration: Computation of Income Tax Expense for 2013.
Illustration 19-17

19-27 LO 3 Describe a temporary difference that results in future deductible amounts.

 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Asset

Illustration: Hunt makes the following entry at the end of 2013
to record income taxes.

Income Tax Expense 160,000

Deferred Tax Asset 20,000
Income Tax Payable 140,000

19-28 LO 3 Describe a temporary difference that results in future deductible amounts.

 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Asset

Illustration: The entry to record income taxes at the end of
2013 reduces the Deferred Tax Asset by $20,000.

Illustration 19-18

19-29 LO 3 Describe a temporary difference that results in future deductible amounts.

 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Illustration: Columbia Corporation has one temporary difference

at the end of 2012 that will reverse and cause deductible amounts
of $50,000 in 2013, $65,000 in 2014, and $40,000 in 2015.
Columbia’s pretax financial income for 2012 is $200,000 and the
tax rate is 34% for all years. There are no deferred taxes at the
beginning of 2012. Columbia expects to be profitable in the future.
Instructions
a) Compute taxable income and income taxes payable for 2012.
b) Prepare the journal entry to record income tax expense,
deferred income taxes, and income taxes payable for 2012.

19-30 LO 3 Describe a temporary difference that results in future deductible amounts.

 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Illustration Current Yr.

INCOME: 2012 2013 2014 2015
Financialincome
income(IFRS)
(GAAP) 200,000
Temporary Diff. 155,000 (50,000) (65,000) (40,000)
Taxable income (IRS) a. 355,000 (50,000) (65,000) (40,000)
Tax rate 34% 34% 34% 34%
Income tax a. 120,700 (17,000) (22,100) (13,600)

b. Income tax expense 68,000

Deferred tax asset 52,700
Income tax payable 120,700

19-31 LO 3 Describe a temporary difference that results in future deductible amounts.

 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Asset—Valuation Allowance

A company should reduce a deferred tax asset by a valuation
allowance if it is more likely than not that it will not realize
some portion or all of the deferred tax asset.
“More likely than not” means a level of likelihood of at least
slightly more than 50 percent.

19-32 LO 4 Explain the purpose of a deferred tax asset valuation allowance.

 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

E19-14: Callaway Corp. has a deferred tax asset balance of

$150,000 at the end of 2012 due to a single cumulative
temporary difference of $375,000. At the end of 2013 this same
temporary difference has increased to a cumulative amount of
$500,000. Taxable income for 2013 is $850,000. The tax rate is
40% for all years. No valuation account is in existence at the end
of 2012.
Instructions
Assuming that it is more likely than not that $30,000 of the
deferred tax asset will not be realized, prepare the journal entries
required for 2013.

19-33 LO 4 Explain the purpose of a deferred tax asset valuation allowance.

 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes
E19-14: Current Yr.
INCOME: 2012 2013 Comulative
Financialincome
income(IFRS)
(GAAP) 725,000
Temporary difference 375,000 125,000 (500,000)
Taxable income (IRS) 375,000 850,000 (500,000) -
Tax rate 40% 40% 40% 40%
Income tax 150,000 340,000 (200,000) -

Income tax expense 290,000

Deferred tax asset 50,000
Income tax payable 340,000

Income tax expense 30,000

Allowance for deferred tax asset 30,000
19-34 LO 4 Explain the purpose of a deferred tax asset valuation allowance.
 Future
Future Deductible
Deductible Amounts
Amounts and
and Deferred
Deferred Taxes
Taxes

Deferred Tax Asset—Valuation Allowance

E19-14 Balance Sheet Presentation

Assets: 2013
Deferred tax asset $ 200,000
Allowance for deferred tax (30,000)
Deferred tax asset, net 170,000

19-35 LO 4 Explain the purpose of a deferred tax asset valuation allowance.

 Income
Income Statement
Statement Presentation
Presentation

Formula to Compute Income Tax Expense Illustration 19-20

Income tax Change in Income tax

payable or + deferred income = expense or
-
refundable tax benefit

In the income statement or in the notes to the financial

statements, a company should disclose the significant
components of income tax expense (current and deferred).

19-36 LO 5 Describe the presentation of income tax expense in the income statement.
 Income
Income Statement
Statement Presentation
Presentation

Given the previous information related to Chelsea Inc.,

Chelsea reports its income statement as follows.
Illustration 19-21

19-37 LO 5 Describe the presentation of income tax expense in the income statement.
 Specific
Specific Differences
Differences

Temporary Differences
 Taxable temporary differences - Deferred tax
liability
 Deductible temporary differences - Deferred tax
Asset

Text Illustration 19-22 Examples of Temporary Differences

19-38 LO 6 Describe various temporary and permanent differences.

 Specific
Specific Differences
Differences
Permanent differences are caused by items that (1) enter into
pretax financial income but never into taxable income or (2)
enter into taxable income but never into pretax financial
income.

Permanent differences affect only the period in which they

occur. They do not give rise to future taxable or deductible
amounts. There are no deferred tax consequences to be
recognized.

Text Illustration 19-24 Examples of Permanent Differences

19-39 LO 6 Describe various temporary and permanent differences.

 Specific
Specific Differences
Differences
Do the following generate:
 Future Deductible Amount = Deferred Tax Asset
 Future Taxable Amount = Deferred Tax Liability E19-6
 Permanent Difference

1. The Accelarated depreciation system is used for tax Future

purposes, and the straight-line depreciation method is used Taxable
Amount
for financial reporting purposes.
2. A landlord collects some rents in advance. Rents received Future
are taxable in the period when they are received. Deductible
Amount

3. Expenses are incurred in obtaining tax-exempt income. Permanent

Difference

4. Costs of guarantees and warranties are estimated and Future

accrued for financial reporting purposes. Deductible
Amount

19-40 LO 6 Describe various temporary and permanent differences.

 Specific
Specific Differences
Differences
Do the following generate:
 Future Deductible Amount = Deferred Tax Asset
 Future Taxable Amount = Deferred Tax Liability E19-6
 Permanent Difference

5. Installment sales of investments are accounted for by the Future

accrual method for financial reporting purposes and the Taxable
Amount
installment-sales method for tax purposes.

6. Proceeds are received from a life insurance company

Permanent
because of the death of a key officer (the company carries a Difference
policy on key officers).

7. Estimated losses on pending lawsuits and claims are accrued Future

for books. These losses are tax deductible in the period(s) Deductible
Amount
when the related liabilities are settled.

19-41 LO 6 Describe various temporary and permanent differences.

 Permanent
Permanent Differences
Differences
E19-4: Havaci Company reports pretax financial income of $80,000
for 2012. The following items cause taxable income to be different
than pretax financial income.
1. Depreciation on the tax return is greater than depreciation on
the income statement by $16,000.
2. Rent collected on the tax return is greater than rent earned on
the income statement by $27,000.
3. Fines for pollution appear as an expense of $11,000 on the
income statement.
Havaci’s tax rate is 30% for all years, and the company expects to
report taxable income in all future years. There are no deferred
taxes at the beginning of 2012.

19-42 LO 6 Describe various temporary and permanent differences.

 Permanent
Permanent Differences
Differences
E19-4: Current Yr. Deferred Deferred
INCOME: 2012 Asset Liability
Financialincome
income(IFRS)
(GAAP) $ 80,000
Excess tax depreciation (16,000) $ 16,000
Excess rent collected 27,000 $ (27,000)
Fines (permanent) 11,000
Taxable income (IRS) 102,000 (27,000) 16,000 -
Tax rate 30% 30% 30%
Income tax $ 30,600 $ (8,100) $ 4,800 -

Income tax expense 27,300

Deferred tax asset 8,100
Deferred tax liability 4,800
Income tax payable 30,600

19-43 LO 6 Describe various temporary and permanent differences.

 Financial
Financial Statement
Statement Presentation
Presentation

Balance Sheet Presentation

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.

Companies should classify deferred tax accounts on the

balance sheet in two categories:
 one for the net current amount, and
 one for the net noncurrent amount.

LO 6 Describe the presentation of deferred

19-44 income taxes in financial statements.
 Financial
Financial Statement
Statement Presentation
Presentation

Income Statement Presentation

Companies should allocate income tax expense (or benefit)
to continuing operations, discontinued operations,
extraordinary items, and prior period adjustments.

Companies should disclose the significant components of

income tax expense attributable to continuing operations
(current tax expense, deferred tax expense, etc.).

LO 9 Describe the presentation of deferred

19-45 income taxes in financial statements.
End of Chapter
One