Fall 2010 Class 7

Fall 2010 Class 7 - CHAPTER 18 Accounting for Income Taxes...

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Unformatted text preview: CHAPTER 18 Accounting for Income Taxes Questions We Need to Answer Questions We Need to Answer 1. What is the difference between accounting income and taxable income? taxable 2. What are timing, temporary, and permanent differences. 3. What is a taxable (deductible) temporary difference and 3. why is a future tax liability (asset) recognized? why 4. How does change of tax rate affect future income taxes 5. What are the accounting procedures for loss carry-back 5. and carry-forward. Skills We Will Learn 1.Adjust accounting income to taxable income 1.Adjust 2. Prepare journal entries to record income tax 2. expenses when there are multiple temporary differences. differences. 3. Adjust future income tax accounts in response 3. to a tax rate change. 3. Apply accounting procedures for a tax loss carry-back and a tax loss carry-forward carry-back Role of Accountants and Objectives of Role of Accountants and Objectives of Tax Accounting Tax Collector, by Marinus van Reymerswale, 1552. Source: www.wga.hu Accounting Income Accounting Income vs. Taxable income Accounting income (based on GAAP) ≠ Taxable Accounting income (based on Income Tax Act) income To determine income taxes payable: Accounting income ± differences . = Taxable income Taxable Taxable income × tax rate = Tax Payable Timing Difference Timing Difference vs. Permanent Difference 1. Permanent difference: -caused by different definitions of income -caused different -e.g. fines and penalties, dividends 2. Timing difference: -caused by different timing of recognizing different income income -e.g. installment sale, warranty expense, -e.g. unearned revenue, prepaid rent unearned - Timing difference will reverse in subsequent Timing years years Future Tax Expenses / Benefits Future Tax Expenses / Benefits Books Income before Warr. Exp. & Inst. Sales Warranty expense deducted, 2005 deducted, Installment Sales recognized,2005 recognized,2005 Income reported Income in 2005 in Tax rate = 40% Income tax exp. Income tax pay. Future income benefits: Future benefits Tax 1,200,000 1,200,000 -500,000 -500,000 0 +300,000 +300,000 +100,000 1,000,000 ×40% 400,000 400,000 1,300,000 ×40% . Total Income Tax Expense Current Income Tax Expense 520,000 520,000 120,000 120,000 Current Income Tax Expenses­Total Income Tax Expenses=Future Income Tax Benefits Recording Future Tax Recording Future Tax Expenses/Benefits Journal Entry: Current Income Tax Expense Current Income Tax Payable Future Income Tax Asset Future Income Tax Benefit 520,000 520,000 520,000 520,000 120,000 120,000 Recording Future Tax Recording Future Tax Expenses/Benefits Or you can use one journal entry for future tax expenses Or and another for future tax benefit: Future Income Tax Asset 200,000* Future Future Income Tax Benefit 200,000 *200,000=500,000*40% (The timing difference related to warranty) Future Income Tax Expense 80,000 Future Income Tax Liability 80,000 *80,000=(300,000-100,000)*40% (The timing difference related to *80,000=(300,000-100,000)*40% installment sales) Disclosure on I/S Disclosure on I/S Income before income tax expense Less: Income tax expense Current income tax expenses Future income tax expense (benefits) (120,000) (120,000) Net income $1,000,000 520,000 520,000 $600,000 Impact on B/S and Temporary Impact on B/S and Temporary Difference • Temporary Difference Temporary = difference between book value of an asset or liability and its tax basis asset = accumulated timing differences • It could be either a deductible temporary It difference, creating a future tax asset, OR difference creating future • …a taxable temporary difference, creating a taxable creating future tax liability. future Deductible Temporary Difference & Deductible Future Tax Asset Entry for recording warranty liability and associated tax Entry asset: asset: Warranty Expense 500,000 500,000 Estimated Warranty Liabilities 500,000 Estimated Future Income Tax Asset (500,000*40%) Future Income Tax Benefit 200,000 200,000 • Tax basis of this liability item is $0. The temporary difference is Tax 500,000. 500,000. • When the liability is settled in the future, it result in deductible When expenses. • So we recognize a tax asset for this future tax benefit: Calculation of Future Tax Assets Calculation of Future Tax Assets Acct. 2005 2006 2007 Tax 2005 2006 2007 Income Before Warranty Exp. 1,000,000 1,000,000 1,000,000 Taxable Income before Warranty Exp. 1,000,000 1,000,000 1,000,000 0 250,000 250,000 1,000,000 750,000 750,000 500,000 0 0 Warranty Total tax saving in the future Deductible = 100,000+100,000 Taxable Income 500,000 1,000,000 1,000,000 Before Income Income =250,000*40%+250,000*40% Taxes Warranty Exp. Tax Rate 40% 40% 40% Tax Rate 40% 40% 40% Income Tax Expenses (Total) 200,000 400,000 400,000 Tax Payable 400,000 300,000 300,000 +200,000 -100,000 -100,000 Difference Decreasing Tax Asset in the Future Decreasing Tax Asset in the Future In subsequent years, tax asset will reduced as a result In of reversing timing difference: of - warranty exp. of 500,000 deducted for tax, but not for warranty books books - Income taxes payable reduced by 500,000 × 40% = Income 200,000 200,000 - Entry in future (Reversal of temporary difference), Entry therefore: therefore: Future Income tax expense Future income tax asset Future $ 200,000 $ 200,000 200,000 Taxable Temporary Difference & Future Taxable Tax Liability Entry for recording installment sales and associated liability: Account Receivable Sales Sales Cash Account Receivable Account 300,000 300,000 300,000 100,000 100,000 100,000 Future Income Tax Expense [(300k-100k)*40%] 80,000 Future Income Tax Liability 80,000 Future • • • The balance of the A/R is $200k, but tax basis of this asset item is $0. The The temporary difference is 200k. temporary When the asset is recovered in the future, it result in taxable income. When So we recognize a tax liability for this future tax amount: Calculation of Future Tax Calculation of Future Tax Liabilities Acct. 2005 2006 2007 Tax 2005 2006 2007 Income Before Installment Sales 500,000 500,000 500,000 Taxable Income before Installment Sales 500,000 500,000 500,000 100,000 150,000 50,000 600,000 650,000 550,000 300,000 0 0 Taxable Total “extra” tax in the future Revenue = 60,000+20,000 Taxable Income 800,000 500,000 500,000 Before Income Income =150,000*40%+50,000*40% Taxes Installment Sales Tax Rate 40% 40% 40% Tax Rate 40% 40% 40% Income Tax Expenses (Total) 320,000 200,000 200,000 Tax Payable 240,000 260,000 220,000 -80,000 +60,000 +20,000 Difference Decreasing Tax Liability in the Future Decreasing Tax Liability in the Future In subsequent years, tax liability will be reduced as a In result of reversing timing difference: result - Installment sales 200,000 is taxable when cash is Installment received, but not for books received, - Income taxes payable increased by 200,000 × 40% = Income 80,000 80,000 - Entry in future (Reversal of temporary difference), Entry therefore: therefore: Future Income tax liability $ 80,000 Future income tax benefits $ 80,000 80,000 Different Future Tax Rates Different Future Tax Rates • Assume the firm collected $150,000 account Assume receivable in 2006 and $50,000 in 2007, and receivable • The tax rate is 40% for 2006 and 35% for 2007. The The journal entry to recognized tax liability in 2005 will 2005 change to: Future Income Tax Expense Future Income Tax Liability Future 77,500* 77,500 77,500 *77.5k=150k*40%+50k*35%=60k+17.5k Calculation of Future Tax Calculation of Future Tax Liabilities Acct. 2005 2006 2007 Tax 2005 2006 2007 Income Before Installment Sales 500,000 500,000 500,000 Taxable Income before Installment Sales 500,000 500,000 500,000 100,000 150,000 50,000 600,000 650,000 550,000 300,000 0 0 Taxable Total “extra” taxin the future Revenue = 60,000+17,500 Taxable Income 800,000 500,000 500,000 Before Income Income =150,000*40%+50,000*35% Taxes Installment Sales Tax Rate 40% 40% 35% Tax Rate 40% 40% 35% Income Tax Expenses (Total) 320,000 200,000 175,000 Tax Payable 240,000 260,000 192,500 -80,000 +60,000 +17,500 Difference Revision of Future Tax Rates Revision of Future Tax Rates • Assume that before the end of 2005, a new income Assume tax rate is enacted: the tax rate is reduced to 30%, effective January 1, 2007. • The journal entry to adjust tax liability in 2005 will be: The 2005 Future Income Tax Liability Future Income Tax Benefit Future * 2,500=50k*(35%-30%) 2,500 2,500* 2,500 Loss Carryover Benefits Loss Carryover Benefits • A tax loss of one year can be used to offset tax taxable income of immediately preceding 3 years or taxable income of the next 20 years. years next Example of Loss Carryback Example of Loss Carryback Year 2001 2002 2003 2004 2005 Taxable Income / Loss Tax Rate Tax Paid 75,000 30% $22,500 50,000 35% $17,500 100,000 30% $30,000 200,000 40% $80,000 -500,000 $0 The firm decided to file amended tax returns for 2002, 2003, and 2004, and received refund for taxes paid in these year: Total refund=17.5k+30k+80k=127.5k Journal Entry / Disclosure for Loss Journal Entry / Disclosure for Loss Carryback • The journal entry to recognize the tax benefits in The 2005: 2005 Income Tax Refund Receivable Income Current Income Tax Benefit 127.5k 127.5k Income Statement Presentation: Loss before income taxes Income tax benefit Current benefit due to loss carryback Current Net loss $(500,000) 127,500 127,500 $(372,500) Loss Carryforward (1) Loss Carryforward (1) • Assume that in previous example, the firm Assume wants to carryforward the $150,000 tax loss wants • Future tax rate is 40% Future Income Tax Asset Future Income Tax Benefit *60k=150k*40% *60k=150k*40% 60,000* 60,000 Loss Carryforward (2) Loss Carryforward (2) • Assume that in 2006, the firm has taxable Assume income of $200,000, the firm wants to use the $150,000 tax loss: Future Income Tax Expense 60,000* 60,000* Future Income Tax Asset 60,000 *60k=150k*40% *60k=150k*40% Loss Carryforward (3) Loss Carryforward (3) If the firm believe that it is unlikely that the firm will have If sufficient income in the future to use the loss, a tax asset is not recognized in 2005. The loss is only note disclosed. In subsequent years, if the firm does generate taxable income and uses the unrecognized losses to reduce taxable income: taxable Income Tax Payable xx Current Income Tax Benefit* xx * Due to realization of unrecognized loss carryforward Summary of Accounting for Summary of Accounting for Income Tax • • • • Current tax liability or asset is based on current year’s taxes payable (or refundable) and is recognized in the current year recognized A future tax liability or asset is recognized for future tax effects of temporary differences and carryforwards carryforwards Measurement of current and future tax liabilities and Measurement assets is based on the tax rate expected at the time the liability will be settled or asset realized the Future tax asset is reduced by any tax benefits not Future expected to be realized expected ...
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