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Chapter 12 - Solution Manual

Recognition of the asset is constrained by the more

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Recognition of the asset is constrained by the more likely than not criterion that may limit the amount of deferred tax assets in the balance sheet by a valuation allowance. According to SFAS No. 109, the resulting deferred tax assets meet the definition of assets found in SFAC No. 6. They embody future benefit to the entity resulting from prior transactions or events (the occurrence of the temporary difference or the presence of the NOL carryforward or unused tax credit). b. The asset/liability method of interperiod tax allocation is balance sheet oriented. The intent is to accrue and report the total tax benefit or taxes payable that will actually be realized or assessed on temporary differences when they reverse. A temporary difference is viewed as giving rise to either a tax benefit that will result in a decrease in future payments, or a tax liability that will be paid in the future at the then-current tax rates. When using the asset/liability method, income tax expense is the sum (or difference between) the changes in deferred tax asset and liability balances, and the current provision for income taxes per the tax return. Under this approach, deferred taxes meet the conceptual definition of assets and liabilities established in SFAC No. 6. The deferred method of income tax allocation is an income statement approach. It is based on the concept that income tax expense is related to the period in which income is recognized. The tax effect of a temporary difference is the difference between income taxes computed with and without the inclusion of temporary differences. The resulting difference between income tax expense and income taxes currently payable is an increase or decrease to the deferred tax account. Case 12-6 a. Proponents of no allocation of income taxes believe that income tax expense should be equal to the current year provision for taxes. The following are arguments defending this position. 1. Income taxes result from taxable income, not accounting income. Thus, attempts to match taxes with accounting income are irrelevant. 2. Income taxes are not like other expenses, therefore, they should not be allocated in a manner similar to other expenses. Other expenses are costs of generating revenue. Income taxes
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261 generate no revenue. They are not incurred in anticipation of future benefit, nor are they expirations of cost incurred to provide facilities that generate revenue. 3. Income taxes are levied on total taxable income, not individual items of revenue or expense. Hence, there are no temporary differences between taxable income and accounting income. 4. Tax allocation hides economic differences between a company that employs tax savings strategies from one that does not. 5. Reporting tax expense equal to taxes paid provides a better predictor of future cash flows because many deferred taxes will never be paid.
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