Deferred Tax Illustration

ILLUSTRATION 20-1
DEFERRED TAX LIABILITY
EXAMPLE
Assume that Sales Company recognizes $15,000 gross profit from installment
sales for financial accounting in 1997. The gross profit will be taxable at
$3,000 each year for the next five years. The company earns$10,000
additional income each year and the tax rate is 40%. The following schedule
shows taxable income, income tax payable, financial income, and income tax
expense for the five year period.
Income Income
Taxable Tax Financial Tax
Year Income Payable Income Expense
1997 $13,000 $ 5,200 $25,000 $10,000

1998 13,000 5,200 10,000 4,000
1999 13,000 5,200 10,000 4,000
2000 13,000 5,200 10,000 4,000
2001 13,000 5,200 10,000 4,000
Totals $65,000 $26,000 $65,000 $26,000
1. Calculation of Deferred Tax Liability.

Book basis of unearned revenue $ –0–
Tax basis of unearned revenue 12,000
Cumulative temporary difference 12,000
Tax rate 40%
Deferred tax liability at end of 1997 $ 4,800
Alternative Method—Scheduling
1998 1999 2000 2001
Future taxable amounts:

Installment sales revenue $3,000 $3,000 $3,000 $3,000
Tax rate 40% 40% 40% 40%
Deferred tax liability at end of 1997
is $4,800 $1,200 + $1,200 + $1,200 + $1,200
Copyright © 1998 John Wiley & Sons, Inc. Kieso/Intermediate 9e 139

ILLUSTRATION 20-1 (continued)
2. Income Tax Expense

1997 1998 1999 2000 2001
Deferred tax liability at
end of year $ 4,800 $3,600 $2,400 $1.200 $ –0–
Deferred tax liability at
beginning of year –0– 4,800 3,600 2,400 1,200
Deferred tax expense for
current year 4,800 (1,200) (1,200) (1,200) (1,200)
Current tax expense (income
tax payable) 5,200 5,200 5,200 5,200 5,200
Income tax expense for the year $10,000 $4,000 $4,000 $4,000 $4,000
3. Journal Entry in 1997 to Recognize Deferred Tax Liability.

Income Tax Expense…………………………………. 10,000
Deferred Tax Liability……………………………... 4,800 (Originating)
Income Tax Payable……………………………… 5,200
Journal Entries 1998 through 2001.

Deferred Tax Liability………………………………… 1,200 (Reversing)

ILLUSTRATION 20-2
DEFERRED TAX ASSET
EXAMPLE
Financial Magazine Company received $15,000 of subscriptions in advance
for 1997. Subscription revenue will be recognized equally in 1998, 1999, and
2000, for financial accounting purposes but all of the $15,000 will be recognized
in 1997 for tax purposes. There is additional income of $50,000 each year
and the tax rate is 40%.
1. Calculation of Deferred Tax Asset.

Book basis of unearned subscription revenue $ 15,000
Tax basis of unearned subscription revenue –0–
Cumulative temporary difference 15,000
Tax rate 40%
Deferred tax asset at end of 1997 $6,000
Alternative Method—Scheduling
1998 1999 2000
Future deductible amounts:

Subscription revenue $5,000 $5,000 $5,000
Tax rate 40% 40% 40%
Deferred tax asset at end of 1997
is $6,000 $2,000 + $2,000 + $2,000
2. Income Tax Expense

1997 1998 1999 2000
Deferred tax asset at end

of year $6,000 $4,000 $2,000 $ –0–
Deferred tax asset at beginning
of year –0– 6,000 4,000 2,000
Deferred tax expense for

current year (6,000) $2,000 $2,000 $2,000
Current tax expense (income

tax payable) 26,000 20,000 20,000 20.000
Income tax expense for

the year $20,000 $22,000 $22,000 $22,000
.
3. Journal Entry in 1997 to Recognize Deferred Tax Asset.

Deferred Tax Asset………………………………..….. 6,000 (Originating)
Journal Entries 1998, 1999, and 2000.

Deferred Tax Asset……………………………….. 2,000 (Reversing)
4. Valuation Allowance.
If after careful review of all available evidence in 1997, it is determined that it is more
likely than not that $2,000 of the deferred tax asset will not be realized, the entry to
record this reduction would be:
Allowance to Reduce Deferred Tax Asset
To Expected Realizable Value…………………… 2,000
The valuation allowance would be evaluated each year for adjustment.

3. Journal Entry in 1997 to Recognize Deferred Tax Asset.

Deferred Tax Asset………………………………..….. 6,000 (Originating)
Journal Entries 1998, 1999, and 2000.

Deferred Tax Asset……………………………….. 2,000 (Reversing)
4. Valuation Allowance.
If after careful review of all available evidence in 1997, it is determined that it is more
likely than not that $2,000 of the deferred tax asset will not be realized, the entry to
record this reduction would be:
Allowance to Reduce Deferred Tax Asset
To Expected Realizable Value…………………… 2,000
The valuation allowance would be evaluated each year for adjustment.

ILLUSTRATION 20-3
TEMPORARY AND PERMANENT DIFFERENCE
TEMPORARY DIFFERENCES
Resulting in Resulting in
DEDUCTIBLE AMOUNTS TAXABLE AMOUNTS
1. Product warranty liabilities 1. Difference between book

basis and tax basis for prepaid
insurance
2. Subscriptions received in 2. Excess tax depreciation over

in advance book depreciation
3. Unearned rent revenue 3. Installment sales contract

accounted for on cash basis
for tax purposes and on accrual
basis for book purposes
PERMANENT DIFFERENCES
1. Interest received on state municipal obligations
2. Premiums paid on officer's life insurance policy;

company is beneficiary
3. 70% or 80% dividends received deduction
4. Fines and expenses resulting from violation of law

ILLUSTRATION 20-4
PROCEDURES FOR COMPUTING DEFERRED INCOME TAXES
Annual Procedures
a. Identify (1) the types and amounts of existing temporary
differences and (2) the nature and amount of each
type of operating loss and tax credit carryforward and
the remaining length of the carryforward period.
b. Measure the total deferred tax liability for taxable
temporary differences using the applicable tax rate.
c. Measure the total deferred tax assert for deductible
temporary differences and operating loss carryforwards
using the applicable tax rate.
d. Measure deferred tax assets for each type of tax
credit carryforward.
e. Reduce deferred tax assets by a valuation allowance
if, based on the weight of available evidence, it is more
likely than not that some portion or all of the deferred
tax assets will not be realized. The valuation allowance
should be sufficient to reduce the deferred tax assets
to the amount that is more likely than not to be realized.

ILLUSTRATION 20-5
PROCEDURES FOR COMPUTING AND REPORTING
DEFERRED INCOME TAXES
Identify types and amounts of existing

temporary differences and carryforwards.
Measure deferred tax asset Measure deferred tax

for deductible temporary liability for taxable
differences and loss temporary differences
carryforwards (Use (Use enacted
enacted tax rate) tax rate)
Establish valuation allowance

account if more likely than not
that some portion or all of the
deferred tax asset will not
be realized.
On the balance sheet

Classify deferred taxes as current or
noncurrent based on asset or liability to
which they relate.
Report a net current and a net
noncurrent amount.
On the income statement
Report current tax expense (benefit) and
deferred tax expense (benefit) and total
income tax expense (benefit).
BACK TO RESOURCES

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ILLUSTRATION 20-1

DEFERRED TAX LIABILITY

1997 $13,000 $ 5,200 $25,000 $10,000

1. Calculation of Deferred Tax Liability.

Future taxable amounts:

Copyright © 1998 John Wiley & Sons, Inc. Kieso/Intermediate 9e 139

2. Income Tax Expense

3. Journal Entry in 1997 to Recognize Deferred Tax Liability.

Journal Entries 1998 through 2001.

Copyright © 1998 John Wiley & Sons, Inc. Kieso/Intermediate 9e 140

1. Calculation of Deferred Tax Asset.

Future deductible amounts:

2. Income Tax Expense

Deferred tax asset at end

Deferred tax expense for

Current tax expense (income

Income tax expense for

3. Journal Entry in 1997 to Recognize Deferred Tax Asset.

Journal Entries 1998, 1999, and 2000.

Copyright © 1998 John Wiley & Sons, Inc. Kieso/Intermediate 9e 142

3. Journal Entry in 1997 to Recognize Deferred Tax Asset.

Journal Entries 1998, 1999, and 2000.

Copyright © 1998 John Wiley & Sons, Inc. Kieso/Intermediate 9e 142

1. Product warranty liabilities 1. Difference between book

2. Subscriptions received in 2. Excess tax depreciation over

3. Unearned rent revenue 3. Installment sales contract

1. Interest received on state municipal obligations

2. Premiums paid on officer's life insurance policy;

3. 70% or 80% dividends received deduction

4. Fines and expenses resulting from violation of law

Copyright © 1998 John Wiley & Sons, Inc. Kieso/Intermediate 9e 143

Copyright © 1998 John Wiley & Sons, Inc. Kieso/Intermediate 9e 144

Identify types and amounts of existing

Measure deferred tax asset Measure deferred tax

Establish valuation allowance

On the balance sheet

Copyright © 1998 John Wiley & Sons, Inc. Kieso/Intermediate 9e 145

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