Book cover for Intermediate Accounting

Intermediate Accounting

Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield

ISBN #9780470374948

13th Edition

695 Questions

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7,109 Students Helped

Homework Questions

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Summary
Learning Objectives
Key Concepts
Example Problems
Explanations
Common Mistakes

Summary

Chapter 19 delves into the complexities of accounting for income taxes, emphasizing the differences between pretax financial income and taxable income. It explains how temporary and permanent differences give rise to deferred tax liabilities and assets, and highlights the practical application of the asset-liability method using enacted tax rates. The chapter also covers the mechanisms of loss carryback and carryforward, and stresses the importance of establishing valuation allowances when future tax benefits are uncertain. The key takeaway is that accurate tax accounting requires careful analysis of timing differences and the realistic assessment of future tax realizations.

Learning Objectives

1

Explain the differences between pretax financial income and taxable income in accounting for income taxes.

2

Identify and differentiate between temporary and permanent differences, and understand their impact on deferred tax liabilities and assets.

3

Apply the asset-liability method for measuring deferred taxes using enacted tax rates.

4

Analyze the use of loss carryback and carryforward methods and evaluate the need for valuation allowances when deferred tax assets may not be realized.

Key Concepts

CONCEPT

DEFINITION

Pretax Financial Income

Income reported on the financial statements before income tax expense is deducted; it may differ from taxable income due to timing and recognition differences.

Taxable Income

Income calculated according to tax laws, which determines the tax liability for a period.

Temporary Differences

Differences between the book value of an asset or liability in the financial statements and its tax basis that will result in taxable or deductible amounts in future periods.

Permanent Differences

Differences that arise between pretax financial income and taxable income that do not reverse over time.

Deferred Tax Liability (DTL)

A tax obligation that is deferred to future periods due to temporary differences leading to future taxable amounts.

Deferred Tax Asset (DTA)

An asset that represents future tax benefits resulting from temporary differences that will result in deductible amounts in the future.

Asset-Liability Method

An accounting approach that measures deferred tax assets and liabilities based on the expected future tax consequences of existing temporary differences using enacted tax rates.

Loss Carryback and Carryforward

Methods that allow a company's net operating loss to be applied to tax periods other than the current one, either retrospectively (carryback) or prospectively (carryforward).

Valuation Allowance

A reserve established against deferred tax assets when it is uncertain that sufficient taxable income will be available to realize the tax benefit.

Enacted Tax Rate

The rate of tax that has been legally enacted and is used in the measurement of deferred tax assets and liabilities.

Example Problems

Example 1

Explain the difference between pretax financial income and taxable income.

Example 2

What are the two objectives of accounting for income taxes?

Example 3

Interest on municipal bonds is referred to as a permanent difference when determining the proper amount to report for deferred taxes. Explain the meaning of permanent differences, and give two other examples.

Example 4

Explain the meaning of a temporary difference as it relates to deferred tax computations, and give three examples.

Example 5

Differentiate between an originating temporary difference and a reversing difference.
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Step-by-Step Explanations

QUESTION

How is a deferred tax liability calculated when temporary differences arise?

STEP-BY-STEP ANSWER:

Step 1: Identify temporary differences between the book value and tax basis of assets and liabilities.
Step 2: Determine the amount of income that will be taxable in future periods due to these differences.
Step 3: Apply the enacted tax rate to the temporary difference amount.
Step 4: Record the calculated amount as a deferred tax liability, representing future tax obligations.
Final Answer: A deferred tax liability is calculated by multiplying the temporary difference by the enacted tax rate, reflecting future taxable income.

Deferred Tax Liability

QUESTION

How do you compute a deferred tax asset and decide if a valuation allowance is needed?

STEP-BY-STEP ANSWER:

Step 1: Identify temporary differences and any carryforward losses that could result in future deductible amounts.
Step 2: Apply the enacted tax rate to determine the potential future tax benefit.
Step 3: Assess the probability of realizing these benefits based on future taxable income projections.
Step 4: If future taxable income is uncertain, establish a valuation allowance to reduce the deferred tax asset to the amount expected to be realized.
Final Answer: A deferred tax asset is computed by multiplying potential future deductible differences by the enacted tax rate, with a valuation allowance applied when realization is uncertain.

Deferred Tax Asset

QUESTION

What are the steps for applying loss carryforward in accounting for income taxes?

STEP-BY-STEP ANSWER:

Step 1: Determine the net operating loss (NOL) for the current period.
Step 2: Identify the tax rules applicable for loss carryforward, including the number of future periods allowed.
Step 3: Calculate the potential tax benefit in each future period by applying the enacted tax rate to the loss amount.
Step 4: Recognize the deferred tax asset for the loss carryforward, and assess the need for a valuation allowance based on the likelihood of future taxable income.
Final Answer: Loss carryforward is applied by assessing the NOL, projecting future tax benefits using the enacted tax rate, and recording a deferred tax asset with adjustments for valuation allowance as necessary.

Loss Carryback and Carryforward

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Common Mistakes

  • Misclassifying temporary differences as permanent differences, leading to incorrect deferred tax calculations.
  • Failing to apply the correct enacted tax rate in the measurement of deferred tax assets and liabilities.
  • Neglecting to establish a valuation allowance when there is uncertainty over the realization of deferred tax assets.
  • Confusing the concepts of pretax financial income with taxable income, leading to errors in tax accounting entries.