ABOUT THIS CHAPTER!

BE ALERT! WE ARE GOING TO BE BUSY AND

Accounting for Income Taxes MOVING FAST. THIS IS NOT THEORY AND IS
BEST TAUGHT WITH A LOT OF EXAMPLES.

YOUR BRAIN WILL STRAIN BUT KEEP WITH ME,

IT WILL BE WORTH IT!
Chapter
19

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19-1 19-2
Bob Anderson- UCSB Bob Anderson- UCSB

The jist of it Quick & simple illustration

CORPORATE TAX RATE: 35%

GAAP income is not always the same as tax. Sales

BOOK/ GAAP
100,000
TAX/ IRC
100,000
DIFFERENCE
-

Accordingly there is a difference between the amount COS

SG&A
75,000
8,000
75,000
8,000
-
-
of “net income” in the financial statements and Depreciation
INCOME BEFORE INCOME TAX
10,000
7,000
12,000
5,000
(2,000)
2,000
“taxable income” in the tax return. Income tax rate
Income tax provision
35%
have to solve
35%
1,750
35%
700

– These items usually “reverse” over time. NET INCOME need to know tax provision N/A N/A
The depreciation difference will "reverse" over time, but we need to do something about it right now! Since this is a

– Until they reverse an asset or liability must be balance sheet approach, we first find the balance sheet amounts then solve for the tax expense to record. We are
Liability
getting more of a deduction for dep. than we expense (this year) for GAAP. This creates a deferred tax liability

recorded on the financial statements in order for because we will be recording more expense in the future. We compute the deferred tax asset as follows:

the tax entries to balance. The balance sheet

Book/Tax difference 2,000
Effective rate 35%
Liability
account used to do this is called deferred tax
DEFERRED TAX ASSET 700
We owe Uncle Sam 1,750
asset/ liability. ENTRY:
Deferred tax liability 700
Income tax payable 1,750

This is called the “balance sheet” approach and is

Income tax provision 2,450
NOTE that the income tax expense of $2,450, which was a plug for us, works out to be 35% of the GAAP

required by FAS 109.

income before income tax!! For those math folks out there, this is because the income tax rate used for
computing the "deferreds" is 35% and is the same as that used in computing the tax amount owed
(consequently ends up with the same effective tax rate).
PS Good way to check your computation is to look at the end of it all and see if the effective tax
rate you come up with makes sense!
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19-3 19-4
Bob Anderson- UCSB Bob Anderson- UCSB
 Book vs. Tax Difference Book vs. Tax Difference

GAAP Reporting 2000 2001 2002 Total Comparison 2000 2001 2002 Total

Revenues $130,000 $130,000 $130,000 $390,000 Income tax expense (GAAP) $40,000 $40,000 $40,000 $120,000
Expenses (S/L depreciation) 30,000 30,000 30,000 90,000 Income tax payable (IRS) 36,000 40,000 44,000 120,000
Pretax financial income $100,000 $100,000 $100,000 $300,000 Difference $4,000 $0 $(4,000) $0

Income tax expense (40%) $40,000 $40,000 $40,000 $120,000

Are the differences accounted for in the financial statements? Yes

Tax Reporting 2000 2001 2002 Total Year Reporting Requirement

Revenues $130,000 $130,000 $130,000 $390,000 2000 Deferred tax liability account increased to $4,000
Expenses (MACRS depreciation) 40,000 30,000 20,000 90,000 2001 No change in deferred tax liability account
Pretax financial income $90,000 $100,000 $110,000 $300,000
2002 Deferred tax liability account reduced by $4,000
Income tax payable (40%) $36,000 $40,000 $44,000 $120,000

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19-5 19-6
Bob Anderson- UCSB Bob Anderson- UCSB

Difference Reporting in F/S Difference Reporting in F/S

Balance Sheet Income Statement Balance Sheet Income Statement
2000 2000 2001 2001
Assets: Assets:
Revenues: Revenues:
Cash (36,000)

Expenses: Expenses:
Liabilities: Liabilities:
Deferred taxes (4,000) Deferred taxes (4,000)
Income tax payable (36,000) Income tax payable (40,000)
Equity: Income tax expense 40,000 Equity: Income tax expense 40,000

Retained earnings 40,000 Net income (loss) (40,000) Retained earnings 80,000 Net income (loss) (40,000)

Where does the “deferred tax liability” get reported in the Where does the “deferred tax liability” get reported in the
financial statements? financial statements?
Assumes the 2000 taxes paid in 2001
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19-7 19-8
Bob Anderson- UCSB Bob Anderson- UCSB
 Difference Reporting in F/S Difference Reporting in F/S
Balance Sheet Income Statement Balance Sheet Income Statement
2002 2002 2003 2003
Assets: Assets:
Revenues: Revenues:
Cash (76,000) Cash (120,000)

Expenses: Expenses:
Liabilities: Liabilities:
Deferred taxes 0!!! Deferred taxes 0!!!
Income tax payable (44,000) Income tax payable paid
Equity: Income tax expense 40,000 Equity:
Retained earnings 120,000 Net income (loss) (40,000) Retained earnings 120,000 Net income (loss)

Where does the “deferred tax liability” get reported in the Where does the “deferred tax liability” get reported in the
financial statements? financial statements?
Assumes the 2001 taxes paid in 2002 Assumes the 2002 taxes paid in 2003
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19-9 19-10
Bob Anderson- UCSB Bob Anderson- UCSB

Temporary Difference Examples Permanent Difference

A Temporary Difference is the difference between the tax basis Permanent differences are caused by items that (1) enter into
of an asset or liability and its reported (carrying or book) amount pretax financial income but never into taxable income or (2) enter
in the financial statements that will result in taxable amounts or into taxable income but never into pretax financial income.
deductible amounts in future years.

Future Taxable Amounts Future Deductible Amounts Congress has enacted a variety of Permanent differences affect only
Deferred Tax Liability represents Deferred Tax Asset represents the tax law provisions in an effort to the period in which they occur, they
the increase in taxes payable in increase in taxes refundable (or attain certain political, economic, NEVER reverse!
future years as a result of taxable saved) in future years as a result of and social objectives. They are RARELY seen.
temporary differences existing at deductible temporary differences There are no deferred tax
the end of the current year. existing at the end of the current consequences to be recognized.
year.

Illustration 19-24 Examples of Permanent Differences

Illustration 19-22 Examples of Temporary Differences (Text page 975)
(Text page 974)

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19-11 19-12
Bob Anderson- UCSB Bob Anderson- UCSB
 Future Taxable or Deductible Amounts Future Taxable or Deductible Amounts
Do the following generate: Do the following generate:
Future Deductible Amount = Deferred Tax Asset Future Deductible Amount = Deferred Tax Asset
Future Taxable Amount = Deferred Tax Liability Future Taxable Amount = Deferred Tax Liability
A Permanent Difference A Permanent Difference

1. The MACRS depreciation system is used for tax purposes, Future 5. Sales of investments are accounted for by the accrual Future
and the straight-line depreciation method is used for financial Taxable Taxable
method for financial reporting purposes and the installment
reporting purposes. Amount Amount
method for tax purposes.
2. A landlord collects some rents in advance. Rents received Future 6. Proceeds are received from a life insurance company A
are taxable in the period when they are received. Deductible Permanent
because of the death of a key officer (the company carries a
Amount Difference
policy on key officers).
3. Expenses are incurred in obtaining tax-exempt income. Permanent 7. Estimated losses on pending lawsuits and claims are accrued Future
Difference Deductible
for books. These losses are tax deductible in the period(s)
when the related liabilities are settled.. Amount
4. Costs of guarantees and warranties are estimated and Future
accrued for financial reporting purposes. Deductible
Amount

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19-13 19-14
Bob Anderson- UCSB Bob Anderson- UCSB

Exercise 19-1 Exercise 19-1, requirement “c”

E20-1 South Carolina Corporation has one temporary difference at the end Balance Sheet Income Statement
of 1999 that will reverse and cause taxable amounts of $55,000 in 2000,
$60,000 in 2001, and $65,000 in 2002. South Carolina’s pretax financial 1999 1999
Assets:
income for 1999 is $300,000 and the tax rate is 30% for all years. There Revenues:
are no deferred taxes at the beginning of 1999.
Instructions
a. Compute taxable income and income taxes payable for 1999. Expenses:
b. Prepare the journal entry to record income tax expense, deferred Liabilities:
income taxes, and income taxes payable for 1999. Income tax payable 36,000
c. Illustrate how the journal entry is reflected on the financial Deferred tax liability 54,000 Income before tax 300,000
statements for 1999.
Equity: Income tax expense 90,000
ACCOUNTING ENTRY:
Deferred tax liability 54,000 Retained earnings 210,000 Net income (loss) 210,000

Income tax payable 36,000

Income tax provision (plug) 90,000 c. Illustrate how the journal entry is reflected on the financial statements
for 1999.
NOTE: 90,000 is 30% of the FINANCIAL income of $300,000.
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19-15 19-16
Bob Anderson- UCSB Bob Anderson- UCSB
 ANOTHER EXERCISE Exercise, requirement “c”
Columbia Corporation has one temporary difference at the end of 1999 that
Balance Sheet Income Statement
will reverse and cause deductible amounts of $50,000 in 2000, $65,000 in
2001, and $40,000 in 2002. Columbia’s pretax financial income for 1999 is 1999 1999
$200,000 and the tax rate is 34% for all years. There are no deferred taxes Assets:
Revenues:
at the beginning of 1999. Columbia expects profitable operations to continue
Deferred tax asset 52,700
in the future.
Instructions
Expenses:
a. Compute taxable income and income taxes payable for 1999.
b. Prepare the journal entry to record income tax expense, deferred
Liabilities:
Income tax payable 120,700
income taxes, and income taxes payable for 1999.
Income before tax 200,000
c. Illustrate how the journal entry is reflected on the financial statements
for 1999. Equity: Income tax expense 68,000
ACCOUNTING ENTRY: Retained earnings 132,000 Net income (loss) 132,000
Deferred tax ASSET 52,700
Income tax payable 120,700
Income tax provision (plug) 68,000 c. Illustrate how the journal entry is reflected on the financial statements
NOTE: 68,000 is 34% of the FINANCIAL income of $200,000. for 1999.

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19-17 19-18
Bob Anderson- UCSB Bob Anderson- UCSB

Exercise 19-3 Exercise 19-3, requirement “c”

E19-3 Bandung Corporation began 2004 with a $92,000 balance in the Balance Sheet Income Statement
Deferred Tax Liability account. At the end of 2004, the related cumulative 2004 2004
temporary difference amounts to $350,000, and it will reverse evenly over Assets:
Revenues:
the next two years. Pretax accounting income for 2004 is $525,000, the
tax rate for all years is 40%, and taxable income for 2004 is $405,000.
Instructions
Expenses:
a. Compute taxable income and income taxes payable for 1999.
b. Prepare the journal entry to record income tax expense, deferred Liabilities:
income taxes, and income taxes payable for 1999. Income tax payable 162,000
c. Illustrate how the journal entry is reflected on the financial Deferred tax liability 48,000 Income before tax 525,000
statements for 1999. Equity: Income tax expense 210,000

ACCOUNTING ENTRY: Retained earnings 315,000 Net income (loss) 315,000

Deferred tax liability 48,000
Income tax payable 162,000
Income tax provision (plug) 210,000 c. Illustrate how the journal entry is reflected on the financial statements
for 2004.
NOTE: 210,000 is 40% of the FINANCIAL income of $525,000.
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19-19 19-20
Bob Anderson- UCSB Bob Anderson- UCSB
 Exercise 19-4 COMPUTATION
E19-4 Zurich Company reports pretax financial income of $70,000 for 2004. The GAAP income 70,000
following items cause taxable income to be different than pretax financial income: Temporary diff's
Depreciation (16,000)
Rent 22,000
6,000
1. Depreciation on the tax return is greater than depreciation on the income Permanent Diff's 11,000
statement by $16,000. Comined diff's 17,000
Rate TAX
2. Rent collected on the tax return is greater than rent earned on the Taxable income 87,000 30% 26,100
income statement by $22,000. HINT/ CRUTCH: DEDUCTIONS FROM BOOK=LIABILITY OR REDUCTION OF ASSET, ADD'S=ASSET OR REDUX OF LIAB
3. Fines for pollution appear as an expense of $11,000 on the income
statement. Cumulative items causing DTA's @ BOY
Cy addition
-
22,000
NOTE, OUR EFFECTIVE RATE:
Tax provision 24,300
Zurich’s tax rate is 30% for all years and the company expects to report taxable 22,000 GAAP income 70,000
income in all future years. There are no deferred taxes at the beginning of 2004. Rate 30% Effective rate 34.71% NOT 30%, WHY?
Deferred tax asset @ EOY 6,600 PERMANENT DIFFERENCE
Instructions YOU CAN STILL CHECK!
a. Compute taxable income and income taxes payable for 2004. Cumulative items causing DTL's @ BOY
Cy addition
-
16,000
Tax provision
Permanent item
24,300
(3,300) =11,000*30%
b. Prepare the journal entry to record income tax expense, deferred 16,000 Net of perm item 21,000
income taxes, and income taxes payable for 2004. Rate
Deferred tax liability @ EOY
30%
4,800
GAAP income
Effective rate
70,000
30% VOILA
c. Illustrate how the journal entry is reflected on the financial ENTRY
statements for 2004. Deferred tax asset 6,600
Deferred tax liability 4,800
Income tax payable 26,100
Income tax provision (PLUG) 24,300
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19-21 19-22
Bob Anderson- UCSB Bob Anderson- UCSB

Exercise 19-4, requirement “c” IN-CLASS EXPANSION OF E19-4

Balance Sheet Income Statement Say that in 2005:
Assets:
2004 2004 – GAAP income is $100,000;
Revenues: – Tax depreciation is less than book by $4,000;
Deferred tax asset 6,600
– Rent collected on tax return exceeds book by
Expenses: $25,000;
Liabilities: – No other factors.
Income tax payable 26,100
Deferred tax liability 4,800 Income before tax 70,000
Equity: Income tax expense 24,300 Compute the tax provision and prepare the journal
Retained earnings 45,700 Net income (loss) 45,700 entry for 2005.

c. Illustrate how the journal entry is reflected on the financial statements

for 2004.

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19-23 19-24
Bob Anderson- UCSB Bob Anderson- UCSB
 COMPUATION/ SOLUTION TO E19-4 EXPANSION
GAAP income
Temporary diff's
100,000
Net Operating Losses (NOL)
Depreciation 4,000
Rent 25,000

Permanent Diff's
29,000
none
A net operating loss (NOL) occurs for tax purposes in a year
Comined diff's 29,000
Rate TAX
when tax-deductible expenses exceed taxable revenues.
Taxable income 129,000 30% 38,700
The federal tax laws permit taxpayers to use the losses of one
year to offset the profits of other years.
HINT/ CRUTCH: DEDUCTIONS FROM BOOK=LIABILITY OR REDUCTION OF ASSET, ADD'S=ASSET OR REDUX OF LIAB

Cumulative items causing DTA's @ BOY 22,000 NOTE, OUR EFFECTIVE RATE:
Cy addition 25,000 Tax provision 30,000

Loss Carryback Loss Carryforward

47,000 GAAP income 100,000
Rate 30% Effective rate 30.00% EQUALS 30%, WHY?
Deferred tax asset @ EOY 14,100 NO PERMANENT DIFFERENCE
Deferred tax asset on books
ADJUSTMENT
6,600
7,500
Carryback two years and receive Can elect to forgo the loss
Shortcut: Cy activity * rate= impact to this item: refunds for taxes paid. carryback and only use loss
Cumulative items causing DTL's @ BOY
Cy addition
16,000
(4,000)
Cy activity
Rate
25,000
30% Applied to earliest year first. carryforward option.
Rate
12,000
30%
Adjustment 7,500
Any remaining loss can be carried 20 years forward.
Deferred tax liability @ EOY
Deferred tax asset on books
3,600
4,800
Cy activity
Rate
(4,000)
0
forward 20 years.
ADJUSTMENT (1,200) Adjustment (1,200)
Journal Entry: Journal Entry:
ENTRY
Deferred tax asset 7,500 Tax receivable xxx Deferred tax asset xxx
Deferred tax liability 1,200
Income tax expense xxx Income tax expense xxx
Income tax payable 38,700
Income tax provision (PLUG) 30,000
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19-25 19-26
Bob Anderson- UCSB Bob Anderson- UCSB

E-19-9 ANSWER
Exercise 19-9
2002
Income Tax Refund Receivable 72,000
E20-9 The pretax financial income (or loss) figures for the Jenny ($160,000 X 45%-can go back 2 years and enough taxable income at 45% rate to cover entire loss)
Benefit Due to Loss Carryback 72,000
Spangler company are as follows: (Income Tax Expense)
1999 $160,000 2003 (380,000)
2003
2000 250,000 2004 120,000 Income Tax Refund Receivable 32,000
2001 80,000 2005 100,000 Benefit Due to Loss Carryback
(Income Tax Expense) 32,000
2002 (160,000) ($80,000 X 40%)
Pretax financial income (or loss) and taxable income (loss) were the same 2003-continuation
for all years involved. Assume a 45% tax rate for 1999 and 2000 and a Deferred Tax Asset (start carry-forward)
Benefit Due to Loss Carryforward
120,000

40% tax rate for the remaining years. (Income Tax Expense) 120,000
Instructions [40% X ($380,000 – $80,000)]

Prepare the journal entries for the years 2002 to 2005 to record income tax 2004
expense and the effects of the net operating loss carrybacks and carryforwards Income Tax Expense 48,000
assuming Jenny Spangler company uses the carryback provision. All income and Deferred Tax Asset (40% X $120,000) 48,000
losses relate to normal operations. (In recording the benefits of a loss
2005
carryforward, assume that no valuation account is deemed necessary.) Income Tax Expense 40,000
Deferred Tax Asset ($100,000 X 40%) 40,000
Note: Benefit Due to Loss Carryback and Benefit Due to Loss Carryforward
amounts are negative components of income tax expense.
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19-27 19-28
Bob Anderson- UCSB Bob Anderson- UCSB
 Valuation Allowance on Deferred Tax Asset VALUATION ALLOWANCE MECHANICS
You compute your tax activity just like you normally would. Then
Whether a deferred tax asset will be realized depends on you establish the valuation allowance. The allowance is a contra-
whether sufficient taxable income exists or will exist within the account to the deferred tax asset (just like the allowance for
carryback or carryforward period available under tax law. doubtful accounts is to a/r) and the expense is directly to the
There is no need for a valuation allowance if it is deemed “more tax provision. Remember to do it on a cumulative basis:
likely than not” that the deferred tax asset will be realized.

If the valuation allowance is $100,000 at BOY, and you

Taxable Income Sources determine that it should be $110,00 at EOY, the entry required
Future reversals of taxable temporary differences. is:
Future taxable income.
Income tax provision $10,000
Taxable income in carryback year(s).
Valuation allowance of DTA $10,000
Tax-planning strategies.

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19-29 19-30
Bob Anderson- UCSB Bob Anderson- UCSB

Exercise 19-14 E19-14 solution

Cumulative tax asset differences 450,000
E19-14 Jennifer Capriati Corp. has a deferred tax asset account with a
Tax rate 40%
balance of $150,000 at the end of 2003 due to a single cumulative
12/31/04 deferred tax asset 180,000
temporary difference of $375,000. At the end of 2004 this same
Already on books 150,000
temporary difference has increased to a cumulative amount of $450,000.
Adjustment 30,000
Taxable income for 2004 is $820,000. The tax rate is 40% for all years.
No valuation account related to the deferred tax asset is in existence at
the end of 2003. Taxable income 820,000
Tax rate 40%
Instructions
Income tax 328,000
(a) Record income tax expense, deferred income taxes, and income taxes
payable for 2004, assuming that it is more likely than not that the deferred tax
asset will be realized.
ENTRY EXCLUDING VALUATION ALLOWANCE:
Deferred tax asset 30,000
(b) Assuming that it is more likely than not that $30,000 of the deferred
tax asset will not be realized, prepare the journal entry at the end of 2004 to Income tax payable 328,000
record the valuation account. Income tax provision (plug) 298,000

ENTRY TO RECORD VALUATION ALLOWANCE:

Income tax provision 30,000
Valuation adjustment, DTA 30,000
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19-31 19-32
Bob Anderson- UCSB Bob Anderson- UCSB
 Exercise 19-14 Exercise 19-14
Balance Sheet Income Statement Balance Sheet Income Statement
1999 1999 1999 1999
Assets: Assets:
Revenues: Revenues:
Deferred tax asset 30,000 Deferred tax asset 30,000

Expenses: Expenses:
Liabilities: Liabilities:
Income tax payable 328,000 Income tax payable 328,000

Equity: Income tax expense 298,000 Equity: Income tax expense 298,000

Retained earnings 298,000 Net income (loss) (298,000) Retained earnings 298,000 Net income (loss) (298,000)

a. Illustrate how the journal entry is reflected on the financial statements b. Illustrate how the journal entry is reflected on the financial statements
for 1999. for 1999.

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19-33 19-34
Bob Anderson- UCSB Bob Anderson- UCSB

Exercise 20-14 Revenue

Revenue Recognition
Recognition
Chapter 19 Chapter 19

Balance Sheet Income Statement

Type of Sale of S ale of asset
Rendering a Permitting use
product from other tha n
Transaction service of an asset
inventory inventory

Revenue from Revenue from

1999 1999
Description Revenue from Gain or loss on
fees or interest, rents,
of Revenue sale s disposition

Assets:
service s and royalties

Revenues: Timing of
Revenue
Date of sale
(date of
Services
performed and
As time passes
or assets are
Date of sale
or trade-in

Deferred tax asset 180,000

Recognition d elive ry) billable use d

Illustration 19-1, pg. 1002 of text

Allowance Def’d tax (30,000) Slide

19-5
Copyright © 2000 by Coby Harmon

Expenses:
Liabilities:
Income tax payable 328,000

Equity: Income tax expense 328,000

Retained earnings (328,000) Net income (loss) (328,000)

b. Illustrate how the journal entry is reflected on the financial statements

for 1999.

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19-35 19-36
Bob Anderson- UCSB Bob Anderson- UCSB