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Unformatted text preview: CHAPTER 19 Accounting for Income Taxes ANSWERS TO QUESTIONS 1. Pretax financial income is reported on the income statement and is often referred to as income before income taxes. Taxable income is reported on the tax return and is the amount upon which a company’s income tax payable is computed. 2. One objective of accounting for income taxes is to recognize the amount of taxes payable or refundable for the current year. A second is to recognize deferred tax liabilities and assets for the future tax consequences of events that have already been recognized in the financial statements or tax returns. 3. A permanent difference is a difference between taxable income and pretax financial income that, under existing applicable tax laws and regulations, will not be offset by corresponding differences or “turn around” in other periods. Therefore, a permanent difference is caused by an item that: (1) is included in pretax financial income but never in taxable income, or (2) is included in taxable income but never in pretax financial income. Examples of permanent differences are: (1) interest received on municipal obligations (such interest is included in pretax financial income but is not included in taxable income), (2) premiums paid on officers’ life insurance policies in which the company is the beneficiary (such premiums are not allowable expenses for determining taxable income but are expenses for determining pretax financial income), and (3) fines and expenses resulting from a violation of law. Item (3), like item (2), is an expense which is not deductible for tax purposes. 4. A temporary difference is a 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 when the reported amount of the asset is recovered or when the reported amount of the liability is settled. The temporary differences discussed in this chapter all result from differences between taxable income and pretax financial income which will reverse and result in taxable or deductible amounts in future periods. Examples of temporary differences are: (1) Gross profit or gain on installment sales reported for financial reporting purposes at the date of sale and reported in tax returns when later collected. (2) Depreciation for financial reporting purposes is less than that deducted in tax returns in early years of assets’ lives because of using an accelerated method of depreciation for tax purposes. (3) Rent and royalties taxed when collected, but deferred for financial reporting purposes and recognized as revenue when earned in later periods....
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