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Revsine/Collins/Johnson/Mittelstaedt/Soffer: Chapter 13
Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution
without the prior written consent of McGraw-Hill Education
Learning objectives
1. The different objectives underlying income determination for
financial reporting (book) purposes versus tax purposes.
2. The distinction between temporary (timing) and permanent
differences, the items that cause these differences, and how each
affects book income versus taxable income.
3. The distortions created when the deferred tax effects of temporary
differences are ignored.
4. How tax expense is determined with interperiod tax allocation and
the relation between taxes payable, changes in deferred taxes
and tax expense.
5. Measuring and reporting valuation differences for deferred tax
assets.
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Learning objectives:
Concluded
Taxable Income:
Income computed for
tax compliance purposes
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Timing
differences:
Depreciation expense
Bad debt expense
Installment sales
Revenues received in advance
Permanent
differences
Taxable Income
A timing difference results when a revenue (gain) or expense (loss) enters book
income in one period but affects taxable income in a different (earlier or later)
period.
Timing differences give rise to deferred tax assets and deferred tax liabilities
because they are temporary (they eventually reverse):
Book
income
Current period
Later period
Taxable
income
$100
$0
$0
$100
Type
Originating
Reversing
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Taxable Income
Timing
differences:
Permanent
differences
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Mitchell Corporation buys new equipment for $10,000 on January 1, 2014. The
asset has a five-year life and no salvage value. It will be depreciated using the
straight-line method for book purposes, but for tax purposes the sum-of-theyears-digits method will be used. (Technically, firms are required to use
MACRS depreciation for tax purposes.)
Straight-line
SYD method
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Taxes
Due
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Depreciation Expense
Income
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If book income tax expense is set equal to actual taxes payable each
year, then:
Expense
increases with
taxes due
Book income
declines
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A When
financial
reporting
book income
tax expense distortion
is set equal to the actual taxes
payable each year, there is a mismatch:
Figure 13.2
MITCHELL
CORPORATION
Tax Expense
without
Interperiod Tax
Allocation
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$2,000
Book
depreciation
$1,333 of extra
depreciation
in year 1
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FASB ASC Topic 740, Income Taxes, requires that the journal
entry for income taxes reflect both:
Originating
Reversing
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13-14
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The FASB requires firms with deferred tax assets to assess the
likelihood that those assets may not be fully realized in future
periods.
Realization depends on whether or not the firm has future taxable
income.
More likely than not
0%
DTA carrying value is
reduced until the new
amount falls within this
range
50%
100%
Probability that
DTA will NOT
be realized
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Figure 13.6
Illustration of Tax
Loss Carryforward
Provision
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=$750,000 x
35%
If future pre-tax operating profits are expected to exceed $250,000, then the
carryforward entry would be :
$250,000
x 35%
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When tax rates change, the tax effects of reversals change as well.
Year 1
Year 2
$1,000
$1,000
350
350
at new 30%
300
300
Reversal
$700
The income tax expense number absorbs the full effect of the change
The relationship between that years tax expense and book income is
destroyed.
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= ($1,333 +
$667) x .35
$760
= ($1,333 +
$667) x .38
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13-23
Taxes due
GAAP tax
expense
Due to temporary differences in revenue and expense items reported on Deeres 2012
GAAP income statement versus what was reported on its 2012 tax return.
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GAAP
IFRS
No valuation account
Not required
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Summary
The rules for computing income for financial reporting purposes
book incomediffer from those for computing income for tax
purposes.
The differences between book income and taxable income are
caused by both permanent and temporary (timing) differences in
the revenue and expense items reported on a companys books
versus its tax return.
Temporary differences give rise to both deferred tax assets and
deferred tax liabilities.
Deferred tax accounting allows firms to report tax costs (or benefits)
on the income statement in the same period as the related revenue
or expense items are reported (matching principle).
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Summary concluded
The income tax foot provides useful information for understanding
how much tax is paid and how much is deferred each year. Tax
notes also help explain why effective tax rates may differ from the
statutory rate.
Tax notes provide useful information that can be exploited to
improve interfirm comparability and evaluate firms earnings
quality.
GAAP disclosures are useful in assessing a firms uncertain tax
positions and whether the firm is aggressive or conservative in
recognizing the benefits associated with these positions.
There are a number of differences between IFRS and U.S. GAAP
rules for accounting for income taxes that you should be aware of.
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