Lecture Intermediate accounting (IFRS/e) - Chapter 16: Accounting for income taxes

Chapter 16

ACCOUNTING FOR INCOME
TAXES

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Slide 2

Deferred Tax Assets and Deferred Tax
Liabilities
Tax
Taxlaws
lawsform
formthe
the
set
setthe
therules
rulesfor
for
preparing
preparingtax
tax
returns.
returns.

IFRS
IFRSprovides
providesthe

the
basis
basisfor
forpreparing
preparing
financial
financial
statements.
statements.
Results in . . .

Usually. . .

Financial
Financial statement
statement
income
incometax
taxexpense.
expense.

Income
Incometaxes
taxes
payable.
payable.

The
Theobjective
objectiveof

ofaccounting
accountingfor
forincome
incometaxes
taxesis
isto
to
recognize
recognizeaa deferred
deferredtax
taxliability
liability or
or deferred
deferred tax
taxasset
asset
for
for the
thetax
taxconsequences
consequencesof
of amounts
amounts that
thatwill
willbecome
become
taxable
taxableor
or deductible
deductiblein

in future
futureyears
yearsas
as aaresult
result of
of
transactions
transactionsor
orevents
eventsthat
that already
alreadyhave
haveoccurred.
occurred.


Slide 3

Temporary Differences
Often,
Often, the
the difference
difference between
between pre-tax
pre-tax
accounting
accounting income
income and
and taxable
taxable income

income
results
results from
from items
items entering
entering the
the income
income
tax
tax computations
computations at
at different
different times.
times.

These are called
temporary
differences.
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Slide 4

Temporary Differences

Temporary
Temporary differences
differences will
will reverse
reverse out

out in
in
one
one or
or more
more future
future periods.
periods.
Accounting Income>Taxable Income

Accounting Income
Future Taxable Amounts

Future Deductible Amounts

Deferred Tax Liability

Deferred Tax Asset

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Slide 5

Tax Base

Note: If an item is non-taxable, the tax base of that asset is
equivalent to the carrying amount, thereby creating no
temporary differences.

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Temporary Differences
Revenues (or gains)
Installment sales of
property (installment
method for taxes)

Items
reported on
the tax return
AFTER the
Unrealized gain from
income
recording investments at
statement
fair value (taxable when
asset is sold)
Items
reported on
the tax return
BEFORE the
income
statement

Rent or subscriptions
collected in advance
Other revenue collected
in advance

(Item s above are taxable on
receipt)

Deferred tax assets result
in deductible amounts in
the future.

Slide 6

Expenses (or losses)
Estimated expenses and
losses (tax deductible
when paid)
Unrealized loss from
recording investments at
fair value or inventory at
LCM (tax deductible when
asset is sold)
Accelerated depreciation
on tax return (straight-line
on income statement)
Prepaid expenses (tax
deductible when paid)

Deferred tax liabilities
result in taxable amounts in
the future.


Slide 7

Deferred Tax Liabilities
In
In 2012,
2012, Baxter
Baxter reports
reports $300,000
$300,000 of
of pretax
pretax income.
income. Included
Included in
in this
this
amount
amount is
is $100,000
$100,000 resulting
resulting from
from interest
interest revenue
revenue earned
earned but
but not
not
received.
received. The
The revenue
revenue will
will be

be taxed
taxed as
as the
the interest
interest is
is collected
collected in
in
2013
2013 and
and 2014.
2014. Baxter
Baxter expects
expects to
to collect
collect $70,000
$70,000 in
in 2013
2013 and
and the
the
remaining
remaining $30,000
$30,000 in
in 2014.
2014. In
In 2013
2013 and
and 2014,
2014, Baxter

Baxter reports
reports $200,000
$200,000
of
of pretax
pretax income.
income. The
The company
company is
is subject
subject to
to aa 20%
20% tax
tax rate.
rate.
There
There are
are no
no other
other temporary
temporary differences.
differences.

Accounting income
Interest
income on the
income statement
Interest
income on the
tax return

Taxable income

Temporary Difference
Originates
Reverses
2012
2013
2014
$
300,000 $
200,000 $
200,000 $

(100,000)

$

200,000 $

Total
700,000

(100,000)

70,000
270,000 $

30,000
230,000 $

100,000
700,000


Slide 8

Deferred Tax Liabilities
Accounting income
Interest
income on the
income statement
Interest
income on the
tax return
Taxable income

Temporary Difference
Originates
Reverses
2012
2013
2014
$
300,000 $
200,000 $
200,000 $

(100,000)

$

200,000 $

Total
700,000

(100,000)

70,000
270,000 $

30,000
230,000 $

100,000
700,000

2012 Income tax payable = $200,000 × 20% = $40,000
2012 Deferred tax liability change = ($100,000 × 20%) - $0
General Journal= $20,000
Description
Income tax expense
Income tax payable
Deferred tax liability

Debit
60,000

Credit
40,000

20,000


Slide 9

Deferred Tax Liabilities
Deferred Tax Liability
20,000 2012
2013
Future taxable amounts

$

70,000

2014
$

30,000

Total
$

Enacted tax rate
Deferred tax liability

The Deferred Tax
Liability
represents the
future taxes Baxter

will pay in 2013
and 2014.

100,000
20%

$

General Journal
Description
Debit
Income tax expense
60,000
Income tax payable
Deferred tax liability

20,000

Credit
40,000
20,000

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Slide 10

Deferred Tax Liabilities
Recall this
information for

Baxter.
Accounting income
Interest
income on the
income statement
Interest
income on the
tax return
Taxable income

Temporary Difference
Originates
Reverses
2012
2013
2014
$
300,000 $
200,000 $
200,000 $

Total
700,000

(100,000)

$

200,000 $

(100,000)

70,000
270,000 $

30,000
230,000 $

100,000
700,000

2013 Income tax payable = $270,000 × 20% = $54,000
2013 Deferred tax liability change = ($30,000 × 20%) - $20,000
= - $14,000
General Journal
Description
Income tax expense
Deferred tax liability
Income tax payable

Debit
40,000
14,000

Credit

54,000


Slide 11

Deferred Tax Liabilities
The Deferred Tax Liability represents the future taxes
Baxter will pay in 2014.
Future
Taxable
Amount
Schedule

2014
Future taxable amounts

$

30,000

Total
$

Enacted tax rate
Deferred tax liability

30,000
20%

$

6,000

Deferred Tax Liability

2013
14,000
20,000 2012
6,000 Balance
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Slide 12

Deferred Tax Liabilities
Recall this
information for
Baxter.
Accounting income
Interest
income on the
income statement
Interest
income on the
tax return
Taxable income

Temporary Difference
Originates
Reverses
2012
2013
2014
$
300,000 $

200,000 $
200,000 $

(100,000)

$

200,000 $

Total
700,000

(100,000)

70,000
270,000 $

30,000
230,000 $

100,000
700,000

2014 Income tax payable = $230,000 × 20% = $46,000
2014 Deferred tax liability change = ($0 × 20%) - $6,000
= - $6,000
General Journal
Description
Income tax expense
Deferred tax liability

Income tax payable

Debit
40,000
6,000

Credit

46,000


Slide 13

Deferred Tax Liabilities
The Deferred Tax Liability represents the future taxes
Baxter will pay.
Future
Taxable
Amount
Schedule

2014
Future taxable amounts

$

-

Total
$

Enacted tax rate

20%

Deferred tax liability

$

-

Deferred Tax Liability
2013
14,000
20,000 2012
2014

6,000

6,000 Balance
0 Balance
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Slide 14

Deferred Tax Assets
RDP Networking reported pretax income in 2012,
2013, and 2014 of $70 million, $100 million, and $100
million, respectively.

The 2012 income statement includes a $30 million
warranty expense that is deducted for tax purposes
when paid in 2013 ($15 million) and 2014 ($15 million).
The income tax rate is 20% each year.

($ in thousands)
Accounting income
Warranty expense on
the income statement
Warranty expense
on the tax return
Taxable income

Temporary Difference
Originates
Reverses
2012
2013
2014
$
70,000 $
100,000 $ 100,000 $
30,000

$

100,000 $

Total
270,000

-

(15,000)
85,000 $

(15,000)
85,000 $

270,000


Slide 15

Deferred Tax Assets
($ in thousands)
Accounting income
Warranty expense on
the income statement
Warranty expense
on the tax return
Taxable income

Temporary Difference
Originates
Reverses
2012
2013
2014
$
70,000 $

100,000 $ 100,000 $

Total
270,000

30,000

$

(15,000)
85,000 $

100,000 $

(15,000)
85,000 $

270,000

This is the computation for the Deferred Tax Asset.
Calculation of Deferred Tax
Asset
Future deductible amount
Tax rate (20%)
Deferred tax asset

2012
$ (30,000)

$

$

$

6,000

2013
(15,000)
20%
3,000

2014
$

-

$

-

Now, let’s record the income tax entry for 2012.
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Slide 16

Deferred Tax Assets
($ in thousands)
Accounting income

Warranty expense on
the income statement
Warranty expense
on the tax return
Taxable income

Temporary Difference
Originates
Reverses
2012
2013
2014
$
70,000 $
100,000 $ 100,000 $

Total
270,000

30,000

$

100,000 $

(15,000)
85,000 $

(15,000)
85,000 $

270,000

2012 Income tax payable = $100,000 × 20% = $20,000
2012 Deferred tax asset change = [($30,000 × 20%] - $0
= $6,000
General Journal
Description
Income tax expense
Deferred tax asset
Income tax payable

Debit
14,000
6,000

Credit

20,000


Slide 17

Deferred Tax Assets
After posting the entry, the Deferred Tax Asset account
will have the desired ending balance of $6,000.
2012
Balance

Deferred Tax Asset

6,000
6,000

Calculation of Deferred Tax
Asset
Future deductible amount
Tax rate (20%)
Deferred tax asset

2012
$ (30,000)

$

$

$

Description
Income tax expense
Deferred tax asset
Income tax payable

6,000

2013
(15,000)
20%
3,000

Debit
14,000
6,000

2014
$

-

$

-

Credit

20,000


Slide 18

Deferred Tax Assets
($ in thousands)
Accounting income
Warranty expense on
the income statement
Warranty expense
on the tax return
Taxable income

Temporary Difference

Originates
Reverses
2012
2013
2014
$
70,000 $
100,000 $ 100,000 $

Total
270,000

30,000

$

100,000 $

(15,000)
85,000 $

(15,000)
85,000 $

270,000

2013 Income tax payable = $85,000 × 20% = $17,000
2013 Deferred tax asset change = [-$15,000 × 20%] – (-$6,000)
$3,000
General =Journal

Description
Income tax expense
Deferred tax asset
Income tax payable

Debit
20,000

Credit
3,000
17,000
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Slide 19

Deferred Tax Assets
In 2013, the balance in the Deferred Tax Asset should
decrease to $3,000.
Calculation of Deferred Tax
Asset
Future deductible amount
Tax rate (20%)
Deferred tax asset

2012
Balance

2012
$ (30,000)

$

$

$

6,000

2013
(15,000)
20%
3,000

2014
$

-

$

-

Deferred Tax Asset
6,000
3,000 2013
3,000

Can you prepare the entries for 2014?
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Slide 20

Deferred Tax Assets
This would be the entry for 2014.
General Journal
Description
Debit
Income tax expense
20,000
Deferred tax asset
Income tax payable

Credit
3,000
17,000

At the end of 2014, the balance in the Deferred
Tax Asset would be zero.
2012
Balance

Deferred Tax Asset
6,000
3,000 2013
3,000 2014
-

Slide 21

Deferred tax assets

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Slide 22

Deferred Tax Assets
For example, let’s say for RDP, management determines
that the company will make a loss in 2014 and it is unclear
what the profits will be after 2014. It’s not probable that
$15 million of the deductible temporary difference will
ultimately be utilized to offset future taxable income. The
deferred tax asset that is recognized on December 31,
2012 is thus $3 million [($30 million - $15 million) × 20%]
and not $6 million ($30 million × 20%)
General Journal
Description
Debit
Income tax expense
17,000
Deferred tax asset
3,000
Income tax payable

Credit

20,000

Slide 23

Nontemporary Differences
Created when an income item is
included in taxable income or
accounting income but will never be
included in the computation of the
other.
Example: Interest on tax-free government
bonds is included in accounting income
but is never included in taxable income.
• Nontemporary differences (or permanent differences) are
disregarded when determining both the tax payable
currently and the deferred tax effect.
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Slide 24

Nontemporary Differences
The term “permanent differences” does not
appear in IAS No. 12 but the concept applies
in the determination of tax expense. However,
IAS No. 12 specifically prohibits:
• The recognition of certain temporary differences
that arise on initial recognition when the
underlying transaction is not a business
combination and that “affects neither accounting

profit nor taxable profit (tax loss)” on initial
recognition.
• The recognition of a deferred tax liability on
goodwill.
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Slide 25

Tax Rate Considerations

Deferred
Deferred tax
tax assets
assets and
and

liabilities
liabilities should
should be
be
determined
determined using
using the
the current
current
tax
tax or
or “substantially
“substantially enacted”

enacted”
rates.
rates.

Tax
Code


The
The deferred
deferred tax
tax asset
asset or
or

liability
liability must
must be
be adjusted
adjusted ifif aa
change
change in
in aa tax
tax rate
rate occurs.
occurs.
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