Taxable

Income

The amount on which

Income Tax Payable

is computed.

Computed using IRS rules.

Appears on the tax return.

Pretax

Accounting

Income

The income before taxes

under the accrual basis

of accounting.

Computed using GAAP.

Appears on Income Statement.

Temporary

Differences

1. result of differences between taxable income (IRS rules) and pretax accounting income (GAAP)

during a specific period.

2. are due to differences in the financial statement basis for assets and liabilities and the tax basis.

3. Result in deferred tax assets and deferred tax liabilities.

Future

Taxable

Difference

A temporary difference that will increase taxable income relative to accounting income in the future as a result of revenues/gains appearing on the tax return in a later period than income statement or expenses appearing on the tax return in an earlier period than income statement.

**This is a keyword for "Deferred Tax Liability"

Income

Taxes

Currently

Payable

Current

Income

Tax

Expense

Deferred

Income

Tax

Expense (Benefit)

the net change in

Deferred

Tax Assets and Liabilities

1. Balance Sheet accounts; must be classified 'current' or 'noncurrent'

2. Not based on when the temporary difference reverses; based on the classification of the related asset or liability on the balance sheet

3. If temporary difference is NOT related to an asset or liability on the balance sheet then it is classified as 'current' or 'noncurrent' based on when the difference reverses.

Temporary Differences Between

Financial Reporting and Income Tax Laws

Installment sales

Financial Reporting

Reported as revenue when the sale is made. (Receivable is recorded on the books.)

Income Tax Laws

Reported as revenue when collected. (No receivable on the books.)

Temporary Differences Between

Financial Reporting and Income Tax Laws

Warranty Costs

Financial Reporting:

Expense is recorded when product is sold. (Warranty liability on the books.)

Income Tax Laws:

Expense is deducted when cash paid. (No liability on tax books.)

Temporary Differences Between

Financial Reporting and Income Tax Laws

Litigation Liability

Financial Reporting:

Recorded when it is probable that a loss has occurred. (Liability on the books.)

Income Tax Laws:

Deducted when paid.

(No liability on tax books.

Temporary Differences Between

Financial Reporting and Income Tax Laws

Bad Debt Expense

Financial Reporting:

Recognized using the allowance method.

(Book value of AR = AR - allowance)

Income Tax Laws:

Recognized using direct-write-off method.

(No allowance recorded.)

Temporary Differences Between

Financial Reporting and Income Tax Laws

Revenue received in advance

Financial Reporting:

Recorded as revenue when earned.

(Liability on the books.)

Income Tax Laws:

Recorded as revenue when cash received.

(No liability on the books.0

Temporary Differences Between

Financial Reporting and Income Tax Laws

Depreciation Expense

Financial Reporting:

Use of straight-line method.

(Asset book value based on SL method.)

Income Tax Laws:

Use of MACRS (accelerated method).

(Asset tax book value based on MACRS.)

Temporary Differences Between

Financial Reporting and Income Tax Laws

Prepaid Expenses

Financial Reporting:

Expense is recorded when asset expires.

(Asset on books.)

Income Tax Laws:

Expense is deducted when cash paid.

(No asset on tax books.)

Temporary Differences Between

Financial Reporting and Income Tax Laws

Unrealized Gain

Financial Reporting:

From recording investments at fair value.

Gain is recognized in the period it occurs.

Income Tax Laws:

Gain is recognized when securities are sold.

Temporary Differences Between

Financial Reporting and Income Tax Laws

Unrealized Loss

Financial Reporting:

From recording investments at fair value (includes any, other than temporary loss) or inventory at LCM.

Loss is deducted when it occurs.

Income Tax Laws:

Loss is deducted when asset is sold.

PERMANENT DIFFERENCES

between Financial Reporting and Income Tax Laws

Items Recognized for Financial Reporting, but not for Tax Purposes

(Note: There are 5 of them)

1. Interest received on state & municipal obligations

2. Expenses incurred in obtaining tax exempt income

3. Proceeds from life insurance carried by the company on key officers or employees

4. Premiums paid for life insurance carried by the company on key officers or employees (company is the beneficiary)

5. Fines and expenses resulting from a violation of the law.

PERMANENT DIFFERENCES

between Financial Reporting & Income Tax Laws

Items Recognized for Income Tax, but not for Financial Reporting Purposes

(Note: There are 2 of them)

1. Deduction for dividends received from U.S. corporations (generally 70-80%)

2. Goodwill amortized for tax purposes, but not for books.

1. The amount on which the income tax currently payble (due or owed) is computed.

2. reported on the tax return

3. computed using IRS rules

4. consists of revenues, expenses, gains & losses as measured to the regulations of the appropriate taxing authority

Pretax

Financial

Income

A financial accounting term (often referred to as income before taxes, income for financial reporting purposes, or income for book purposes).

It is determined using GAAP.

A difference between pretax accounting income and taxable income.

Types of temporary differences:

1. Deferred Tax Assets

2. Deferred Tax Liabilities

AKA "Deferred Tax Liability"

A future tax liability or asset, resulting from temporary differences or timing differences between the accounting value of assets and liabilities and their value for tax purposes.

What is a

deferred tax liability?

What is a

future deductible amount?

AKA "Deferred Tax Asset"

A temporary difference that will decrease taxable income relative to accounting income in the future as a result of revenuesd/gains appearing on the tax return in an earlier period than income statement or expenses appearing on the tax return in a later period than income statement.

Permanent Differences

How many can you name?

1. Club Dues

2. Dividends received deduction

3. Goodwill - nondeductible lease inclusion amts

4. Meals & Entertainment

5. Municipal interest income

6. Officers' life insurance premiums/proceeds (when paid by company)

7. Organization & start-up costs

8. Penalties & fines

9. Percentage depletion

10. Wages & salaris eligible for jobs credit

If change in a tax law or rate occurs, any existing tax liability or asset must be adjusted to reflect the amount to be paid or recovered in the future. When is the effect of the adjustment shown in net income?

(Note: The book says 'operating income' but income taxes are not part of operating income.)

Net Operating Loss

What is it?

A negative taxable income;

occurs when tax-deductible expenses exceed taxable revenues

Net operating losses (NOL) can be offset against taxable income in other years.

1. How many years can the NOL be carried back?

2. How many years can the NOL be carried forward?

(NOTE: the # of years changes periodically w/changes in the tax code.)

1. A NOL can be carried back for 2 years.

2. A NOL can be carried forward for up to 20 years.

However, the length of time can change periodically w/changes to the tax code.

In a classified balance sheet,

how are deferred tax assets and liabilities determined to be current or noncurrent?

Income Tax Terminology

DEFERRED TAX ASSET

Income Tax Terminology

Deferred Tax Benefit

Credits to the Income Tax Expense account.

Results from the increase in the deferred tax asset (or decrease in the deferred tax liability) from the beginning to the end of the accounting period.

Income Tax Terminology

Deferred Tax Expense

Income Tax Terminology

Deferred Tax Liability

Income Tax Terminology

Effective Tax Rate

Total income tax expense

divided by

Pretax financial income

Income Tax Terminology

Future deductible amounts

The future tax consequence of a temporary difference will be to decrease taxable income relative to accounting income.

Amounts which will decrease taxable income in the future.

Income Tax Terminology

Future Taxable Amounts

The future tax consequence of a temporary difference will be to increase taxable income relative to accounting income.

Amounts which will increase taxable income in the future.

Income Tax Terminology

Permanent Differences

1. Items that enter into pretax financial income but never into taxable income; or enter into taxable income but never into pretax financial income.

2. Differences between pretax accounting income and taxable income that will never reverse.

3. Result from transactions and events that under existing tax law will never affect taxable income or taxes payable.

4. There are no deferred tax consequences related to these items.

Income Tax Terminology

Pretax Financial Income

A financial accounting term often referred to as income before taxes, income for financial reporting purposes, or income for book purposes.

Determined using GAAP rules.

Income Tax Terminology

Taxable Income

A tax accounting term used to indicate teh amount upon which a company's income tax (currently) payable is computed.

Comprises revenues, expenses, gains and losses as measured according to the regulations of the appropriate taxing authorities.

Income Tax Terminology

Temporary Difference

Income Tax Terminology

Valuation Allowance

Permanent Difference or Temporary Difference

The company paid for a 3-year fire insurance policy. This amount will be recognized as an expense over the 3-year period for financial reporting purposes. This amount is deductible in the year paid.

Temporary difference that will result in

1. future taxable amounts

and

2. a deferred tax liability

Permanent Difference or Temporary Difference

The tax return reports a deduction for 80% if the dividends received from U.S. corporations. The cost method is used for the related investments for financial repiorting purposes. Under the cost method, dividends received are reported as revenue.

PERMANENT

DIFFERENCE

Permanent Difference or Temporary Difference

Proceeds are received from a life insurance company because of the death of a key office. The company carries a policy on key officers.

PERMANENT

DIFFERENCE

Permanent Difference or Temporary Difference

Estimated losses on pending lawsuits and claims are accrued for books. These losses are tax deductible in the period(s) when the related liabilities are settled.

Temporary Difference

will result in the following:

1. future deductible amounts

2. deferred tax asset

Permanent Difference or Temporary Difference

A landlord collects some rents in advance.

These amounts are taxable when collected.

Temporary Difference

will result in the following:

1. future deductible amounts

2. deferred tax asset

Permanent Difference or Temporary Difference

For some assets, straight-line depreciation is used for both financial reporting purposes and tax purposes, but the assets' lives are shorter for tax purposes.

Temporary Difference

which will result in the following:

1. future taxable amounts

2. future tax liability

Permanent Difference or Temporary Difference

Interest is received on an investment in tax-exempt municipal bonds.

PERMANENT

DIFFERENCE

Permanent Difference or Temporary Difference

Installment sales of inventories are accounted for by the accrual method for financial reporting purposes and the installment method for tax purposes.

Temporary Difference

which will result in the following:

1. future taxable amount

2. deferred tax liability

Permanent Difference or Temporary Difference

The company recognized a loss on its inventory due to obsolescence for financial reporting purposes. This loss is deductible for income tax purposes when the inventory is sold.

Temporary Difference

which will result in the following:

1. future deductible amounts

2. deferred tax asset

Permanent Difference or Temporary Difference

Expenses are incurred in obtaining tax-exempt income.

PERMANENT

DIFFERENCE

Permanent Difference or Temporary Difference

The company incurred expenses due to violations of the Clean Air Act.

PERMANENT

DIFFERENCE

Permanent Difference or Temporary Difference

The company amortizes goodwill over a 15-year period for tax purposes. Goodwill is not amortized for financial reporting purposes.

PERMANENT

DIFFERENCE

Permanent Difference or Temporary Difference

The company recognized an unrealized gain on trading securities for financial reporting purposes. The gain is not taxable until the securities are sold.

Temporary Difference

which will result in the following:

1. future taxable amounts

2. deferred tax liability

Permanent Difference or Temporary Difference

Costs of guarantees and warranties are estimated and accrued for financial reporting purposes.

Temporary Difference

which will result in the following:

1. future deductible amounts

2. deferred tax asset

Permanent Difference or Temporary Difference

The MACRS depreciation system is used for tax purposes, and the straight-line depreciation method is used for financial reporting purposes for some PP&E.

Temporary Difference

which will result in the following:

1. future taxable amounts

2. deferred tax liability

If the company is paying less taxes now, but will pay more in the future as money is collected.

Future taxable difference

or

Future deductible difference

Future Taxable Difference

(Financial Income > Taxable Income)

Income Tax Expense

(formula)

Income Tax Expense = Income Taxes Payable (currently)

+ increase in Deferred Tax Liability (income earned currently but not taxed yet)

- decrease in Deferred Tax Liability (income earned earlier and is now being taxed)

- increase in Deferred Tax Asset (income taxed now and will be earned later)

+ decrease in Deferred Tax Asset (income taxed earlier and is now earned)

1. Installment sales of property (installment method for taxes)

2. Revenue reported in the income statement now, but on the tax return later

Deferred Tax Liability

1. Unrealized gain from recording investements at fair value (taxable when asset is sold).

2. Gain reported in the income statement now, but on the tax return later.

Deferred Tax Liability

1. Accelerated depreication on teh tax return in excess of straight-line depreciation in the income statement.

2. Expense (or loss) reported on teh tax return now, but in the income statement later.

Deferred Tax Liability

1. Prepaid expenses (tax-deductible when paid)

2. Expense (or loss) reported on the tax return now, but in the income statement later.

Deferred Tax Liability

1. Rent collected in advance

2. Revenue reported on the tax return now, but in the income statement later.

Deferred Tax Asset

1. Subscriptions collected in advance.

2. Reported on the tax return now, but in the income statement later.

Deferred Tax Asset

1. Other revenue collected in advance

2. Reported on the tax return now, but in the income statement later.

Deferred Tax Asset

1. Estimated expenses and losses (tax-deductible when paid).

2. Reported in the income statement now, but on the tax return later.

Deferred Tax Asset

1. Unrealized loss from recording investments at fair value or inventory at LCM (tax-deductible when asset is sold).

2. Reported in the income statement now, b ut on the tax return later

Deferred Tax Asset

Revenues or gains reported in the income statement now, but on the tax return later.

Deferred Tax Liability

Revenues or gains reported on the tax return now, but in the income statement later

Deferred Tax Asset

Expenses or losses reported in the income statement now, but on the tax return later.

Deferred Tax Asset

Expenses or losses reported on the tax return now, but in the income statement later

Deferred Tax Liability

Suttle Corp hasd one temporary difference at the end of 2011 due to using the installment sales method for income tax purposes and the accrual method for financial reporting purposes. The company had installment sales revenue of $700,000 and collected $100,000 during the year. Suttle's pretax financial income for 2011 was $1,000,000 and the tax rate is 35% for all years.

Compute taxable income & income taxes payable for 2011.

Pretax financial income                                                   $1,000,000

Deduct: Revenue not taxable in 2011 (not collected in 2011)  (600,000)

Taxable income                                                              $  400,000

Tax Rate                                                                              35%

Income Taxes Currently Payable                                        $ 140,000

Suttle Corp hasd one temporary difference at the end of 2011 due to using the installment sales method for income tax purposes and the accrual method for financial reporting purposes. The company had installment sales revenue of $700,000 and collected $100,000 during the year. Suttle's pretax financial income for 2011 was $1,000,000 and the tax rate is 35% for all years.

Compute the amt of deferred tax asset/liability needed at December 31, 2011.

Cumulative taxable difference                         $ 600,000

Tax Rate                                                            35%

Deferred Tax Liability, 12/31/2011                    $ 210,000