module3slides.pdf[including; • Overview, permanent and temporary difference. • Deferred tax liability. • Deferred tax asset. • Deferred tax assets – Valuation Allowance • Comparing temporary and permanent difference • Tax rate changes • Accounting for losses – tax loss carryforward

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Intermediate Accounting ACCT 725 Dr. Yu Bai Module 3 Accounting for Income Taxes This slide deck contains animations. Please disable animations if they cause issues with your device. A list of ... topics covered in the videos • Overview, permanent and temporary difference. • Deferred tax liability. • Deferred tax asset. • Deferred tax assets – Valuation Allowance • Comparing temporary and permanent difference • Tax rate changes • Accounting for losses – tax loss carryforward lo-1 module3-02 lo-1 module3-03 Pre-tax Income (“book income”) Taxable Income x Effective tax rate x Statutory tax rate ___________________________ __________________ = Income Tax Expense = Income Tax Payable Conceptual Underpinning • The revenues and expenses (and gains and losses) included on the tax return may differ from those reported on the company’s income statement for the same year • Why? The objectives of financial reporting and those of taxing authorities are not the same –Financial accounting standards are established to provide useful information to investors and creditors –Congress establishes tax regulations to • Allow it to raise funds in a socially acceptable manner • Influence the behavior of taxpayers lo-1 module3-04 Conceptual Underpinning • The revenues and expenses (and gains and losses) included on the tax return may differ from those reported on the company’s income statement for the same year • You’ve probably come across instances where tax treatment differs from book treatment –Direct write-off of accounts receivable acceptable for tax purposes –Different methods of accounting for cost of goods sold –Accrual system of accounting gives rise to a lot of cases where revenues and expenditures are recorded without cash changing hands lo-1 module3-05 Permanent Differences lo-1 • Differences caused by transactions and events that under existing tax law will never affect taxable income or taxes payable • The tax-free income will never be reported on the tax return • Example: Interest received from investments in bonds issued by state and municipal governments is exempt from taxation – This interest revenue is reported as revenue on the recipient’s income statement but not on its tax return – There is a permanent difference between pretax accounting income and taxable income module3-6 Differences without Deferred Tax Consequences lo-1 • Interest received from investments in bonds issued by state and municipal governments (generally not taxable). • Investment expenses incurred to obtain tax-exempt income (not tax deductible). • Life insurance proceeds on the death of an insured executive (not taxable). • Premiums paid for life insurance policies when the payer is the beneficiary (not tax deductible). • Compensation expense pertaining to some employee stock option plans (not tax deductible). • Fines and penalties due to violations of the law (generally not tax deductible). • Difference in tax paid on foreign income permanently reinvested in the foreign country and the amount that would have been paid if taxed at U.S. rates. • Portion of dividends received from U.S. corporations that is not taxable due to the dividends received deduction. • Tax deduction for depletion of natural resources (percentage depletion) that is allowed in excess of an already full-depleted asset’s cost. module3-7 Permanent Differences (continued) • It’s easy to account for permanent differences • Taxes payable are calculated according to the tax law, and since permanent differences are never taxable, no deferred tax asset or liability is created. Plug tax expense, so tax expense = tax payable with respect to permanent differences. • Permanent differences affect the effective tax rate, because they affect the relationship between tax expense and pretax accounting income lo-1 Effective tax rate Tax expense Pretax accounting income module3-8 Temporary differences • Arise when tax rules and accounting rules recognize income in different periods. • The issue is not whether an amount is taxable or deductible, but when. • Originate in one period and reverse, or turn around, in one or more subsequent periods Examples • Sales accounted for on the accrual basis for financial reporting purposes and on the installment (cash) basis for tax purposes. • Contracts accounted for under the percentage-of-completion method for financial reporting purposes and a portion of related gross profit deferred for tax purposes. • Investments accounted for under the equity method for financial reporting purposes and under the cost method for tax purposes. • Gain on involuntary conversion of nonmonetary asset which is recognized for financial reporting purposes but deferred for tax purposes. • Unrealized holding gains for financial reporting purposes (including use of the fair value option), but deferred for tax purposes. lo-1 module3-09 Conceptual Underpinning - Example Watson Associates purchases $60 thousand of computer equipment in January of 2021. Watson estimates that the computer equipment will have an estimated useful life of three years. For financial reporting purposes, Watson records straight-line depreciation each year of $20 thousand. For tax purposes, Watson can deduct the entire $60 thousand cost of the equipment in 2021. lo-1 2021 2022 2023 Total Income before tax and depreciation $120 $120 $120 $360 Depreciation on the tax return (60) (0) (0) (60) Taxable income (tax return) $60 $120 $120 $300 Tax rate x 25% x 25% x 25% Tax payable $15 $30 $30 2021 2022 2023 Total Income before tax and depreciation $120 $120 $120 $360 Depreciation in the income statement (20) (20) (20) (60) Pretax accounting income $100 $100 $100 $300 Financial Reporting Tax Return module3-010 Conceptual Underpinning – Example (continued) • Pretax accounting income and taxable income both are $300 thousand over the threeyear depreciation period but, differ from each other in each of the three years • In 2021, tax depreciation ($60 thousand) is greater than accounting depreciation ($20 thousand), causing taxable income to be less than pretax accounting income by $40 thousand. • This difference is temporary and reverses in 2022 and 2023, when Watson recognizes depreciation expense in the income statement ($20 thousand in each 2022 and 2023) lo-1 2021 2022 2023 Total Income before tax and depreciation $120 $120 $120 $360 Depreciation on the tax return (60) (0) (0) (60) Taxable income (tax return) $60 $120 $120 $300 Tax rate x 25% x 25% x 25% Tax payable $15 $30 $30 2021 2022 2023 Total Income before tax and depreciation $120 $120 $120 $360 Depreciation in the inco [Show More]

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