Accounting for Income Taxes
After careful study of this chapter, you will be able to: 1. 2. 3. 4. 5. 6. 7. 8. 9. Understand permanent and temporary differences. Explain the conceptual issues regarding interperiod tax allocation. Record and report deferred tax liabilities. Record and report deferred tax assets. Explain an operating loss carryback and carryforward. Account for an operating loss carryback. Account for an operating loss carryforward. Apply intraperiod tax allocation. Classify deferred tax liabilities and assets.
Overview and Definitions 1. Significant differences normally exist between a company's pretax financial income and taxable income because generally accepted accounting principles are used to measure pretax financial income while the Internal Revenue Code and state tax laws are used to determine taxable income for purposes of paying income taxes. These differences stem from the different objectives of generally accepted accounting principles and of tax laws. The objective of generally accepted accounting principles is to provide information useful to present and potential users in making rational investment, credit, or similar decisions. However, the objectives of the Internal Revenue Code are to raise revenue to operate the government and to assist the government in achieving social or economic goals.
Interperiod Income Tax Allocation: Basic Issues 2. Differences between a corporation's pretax financial income and taxable income are a result of either permanent or temporary differences. The three types of permanent differences are: (a) revenues that are recognized for financial reporting purposes but are never taxable, such as interest received by a corporation on an investment in municipal bonds and proceeds received from life insurance policies on key officers; (b) expenses that are recognized for financial reporting purposes but are never deductible in calculating taxable income, such as premium payments on officers' life insurance and fines related to the violation of a law; and (c) deductions that are allowed for taxable income but are not allowed as expenses under generally accepted accounting principles, such as percentage depletion in excess of cost depletion, and certain dividend exclusions for investments in equity securities. Interperiod tax allocation procedures are not applicable to permanent differences between a corporation's taxable income and pretax financial income. Permanent differences do not have deferred tax consequences, and, therefore, affect either a corporation's reported pretax financial income or its taxable income, but not both. A temporary (timing) difference is a difference in a corporation's pretax financial income and taxable income resulting from reporting revenues and expenses in one period for income tax purposes and in another period for financial reporting purposes. The temporary differences normally originate in one or more years and reverse in later years. Temporary differences in the year of origination may result in either future pretax financial income exceeding future taxable income or future taxable income exceeding future pretax financial income in the year of reversal. Examples of various types of temporary differences in these two situations are presented in items (5) and (6). These temporary differences create the need for interperiod tax allocation.
Chapter 19 Accounting for Income Taxes
The following selected examples result in temporary differences that generate a deferred tax liability (future taxable amounts) because a corporation's pretax financial income is greater than taxable income in the year in which the temporary difference originates. As a result, its future taxable income will be greater than future pretax financial income when the item reverses in future years. Method Used for Book Purposes Profits on installment sales are recognized at date of sale...