Chapter 19 Accounting for Income Taxes

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Chapter 19 Accounting for Income Taxes

QUESTIONS

1. Explain the difference between pretax financial income and taxable income.
2.
What are the two objectives of accounting for income taxes?
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.
4.
Explain the meaning of a temporary difference as it relates to deferred tax computations, and give three examples.
5.
Differentiate between an originating temporary difference and a reversing difference.
6.
The book basis of depreciable assets for Erwin Co. is $900,000, and the tax basis is $700,000 at the end of 2013. The enacted tax rate is 34% for all periods. Determine the amount of deferred taxes to be reported on the balance sheet at the end of 2013.
7.
Roth Inc. has a deferred tax liability of $68,000 at the beginning of 2013. At the end of 2013, it reports accounts receivable on the books at $90,000 and the tax basis at zero (its only temporary difference). If the enacted tax rate is 34% for all periods, and income taxes payable for the period is $230,000, determine the amount of total income tax expense to report for 2013.
8.
What is the difference between a future taxable amount and a future deductible amount? When is it appropriate to record a valuation account for a deferred tax asset?
9.
Pretax financial income for Lake Inc. is $300,000, and its taxable income is $100,000 for 2013. Its only temporary difference at the end of the period relates to a $70,000 difference due to excess depreciation for tax purposes. If the tax rate is 40% for all periods, compute the amount of income tax expense to report in 2013. No deferred income taxes existed at the beginning of the year.
10.
How are deferred tax assets and deferred tax liabilities reported on the balance sheet?
11.
Describe the procedures involved in segregating various deferred tax amounts into current and noncurrent categories.
12.
How is it determined whether deferred tax amounts are considered to be “related” to specific asset or liability amounts?
13.
At the end of the year, Falabella Co. has pretax financial income of $550,000. Included in the $550,000 is $70,000 interest income on municipal bonds, $25,000 fine for dumping hazardous waste, and depreciation of $60,000. Depreciation for tax purposes is $45,000. Compute income taxes payable, assuming the tax rate is 30% for all periods.
14.
Addison Co. has one temporary difference at the beginning of 2012 of $500,000. The deferred tax liability established for this amount is $150,000, based on a tax rate of 30%. The temporary difference will provide the following taxable amounts: $100,000 in 2013, $200,000 in 2014, and $200,000 in 2015. If a new tax rate for 2015 of 20% is enacted into law at the end of 2012, what is the journal entry necessary in 2012 (if any) to adjust deferred taxes?
15.
What are some of the reasons that the components of income tax expense should be disclosed and a reconciliation between the effective tax rate and the statutory tax rate be provided?
16.
Differentiate between “loss carryback” and “loss carryforward.” Which can be accounted for with the greater certainty when it arises? Why?
17.
What are the possible treatments for tax purposes of a net operating loss? What are the circumstances that determine the option to be applied? What is the proper treatment of a net operating loss for financial reporting purposes?
18.
What controversy relates to the accounting for net operating loss carryforwards?
19.
What is an uncertain tax position, and what are the general guidelines for accounting for uncertain tax positions? BRI E F EXERCI S E S
BE19-1
In 2012, Amirante Corporation had pretax financial income of $168,000 and taxable income of $120,000. The difference is due to the use of different depreciation methods for tax and accounting purposes. The effective tax rate is 40%. Compute the amount to be reported as income taxes payable at December 31, 2012.
BE19-2
Oxford Corporation began operations in 2012 and reported pretax financial income of $225,000 for the year. Oxford’s tax depreciation exceeded its book depreciation by $40,000. Oxford’s tax rate for 2012 and years thereafter is 30%. In its December 31, 2012, balance sheet, what amount of deferred tax liability should be reported?
BE19-3
Using the information from
BE19-2, assume this is the only difference between Oxford’s pretax financial income and taxable income. Prepare the journal entry to record the income tax expense, deferred income taxes, and income taxes payable, and show how the deferred tax liability will be classified on the December 31, 2012, balance sheet.

BE19-4
At December 31, 2012, Appaloosa Corporation had a deferred tax liability of $25,000. At December 31, 2013, the deferred tax liability is $42,000. The corporation’s 2013 current tax expense is $48,000. What amount should Appaloosa report as total 2013 income tax expense?
BE19-5
At December 31, 2012, Suffolk Corporation had an estimated warranty liability of $105,000 for accounting purposes and $0 for tax purposes. (The warranty costs are not deductible until paid.) The effective tax rate is 40%. Compute the amount Suffolk should report as a deferred tax asset at December 31, 2012.
BE19-6
At December 31, 2012, Percheron Inc. had a deferred tax asset of $30,000. At December 31, 2013, the deferred tax asset is $59,000. The corporation’s 2013 current tax expense is $61,000. What amount should Percheron report as total 2013 income tax expense?
BE19-7
At December 31, 2012, Hillyard Corporation has a deferred tax asset of $200,000. After a careful review of all available evidence, it is determined that it is more likely than not that $60,000 of this deferred tax asset will not be realized. Prepare the necessary journal entry.
BE19-8
Mitchell Corporation had income before income taxes of $195,000 in 2012. Mitchell’s current income tax expense is $48,000, and deferred income tax expense is $30,000. Prepare Mitchell’s 2012 income statement, beginning with Income before income taxes.
BE19-9
Shetland Inc. had pretax financial income of $154,000 in 2012. Included in the computation of that amount is insurance expense of $4,000 which is not deductible for tax purposes. In addition, depreciation for tax purposes exceeds accounting depreciation by $10,000. Prepare Shetland’s journal entry to record 2012 taxes, assuming a tax rate of 45%.
BE19-10
Clydesdale Corporation has a cumulative temporary difference related to depreciation of $580,000 at December 31, 2012. This difference will reverse as follows: 2013, $42,000; 2014, $244,000; and 2015, 1 2 1 2 9 2 5 1 3 2 3 4 5 2 3 5 $294,000. Enacted tax rates are 34% for 2013 and 2014, and 40% for 2015. Compute the amount Clydesdale should report as a deferred tax liability at December 31, 2012.
BE19-11
At December 31, 2012, Fell Corporation had a deferred tax liability of $680,000, resulting from future taxable amounts of $2,000,000 and an enacted tax rate of 34%. In May 2013, a new income tax act is signed into law that raises the tax rate to 40% for 2013 and future years. Prepare the journal entry for Fell to adjust the deferred tax liability.
BE19-12
Conlin Corporation had the following tax information. Exercises 1183 In 2013, Conlin suffered a net operating loss of $480,000, which it elected to carry back. The 2013 enacted tax rate is 29%. Prepare Conlin’s entry to record the effect of the loss carryback.
BE19-13
Rode Inc. incurred a net operating loss of $500,000 in 2012. Combined income for 2010 and 2011 was $350,000. The tax rate for all years is 40%. Rode elects the carryback option. Prepare the journal entries to record the benefits of the loss carryback and the loss carryforward.
BE19-14
Use the information for Rode Inc. given in
BE19-13. Assume that it is more likely than not that the entire net operating loss carryforward will not be realized in future years. Prepare all the journal entries necessary at the end of 2012.

BE19-15
Youngman Corporation has temporary differences at December 31, 2012, that result in the following deferred taxes. Deferred tax liability—current $38,000 Deferred tax asset—current $(62,000) Deferred tax liability—noncurrent $96,000 Deferred tax asset—noncurrent $(27,000) Indicate how these balances would be presented in Youngman’s December 31, 2012, balance sheet. Year Taxable Income Tax Rate Taxes Paid 2010 $300,000 35% $105,000 2011 $325,000 30% $ 97,500 2012 $400,000 30% $120,000 7 8 8 4 8 9 EXERCI S E S
E19-1 (One Temporary Difference, Future Taxable Amounts, One Rate, No Beginning Deferred Taxes)
Starfleet Corporation has one temporary difference at the end of 2012 that will reverse and cause taxable amounts of $55,000 in 2013, $60,000 in 2014, and $75,000 in 2015. Starfleet’s pretax financial income for 2012 is $400,000, and the tax rate is 30% for all years. There are no deferred taxes at the beginning of 2012.
Instructions
(a) Compute taxable income and income taxes payable for 2012. (b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012. (c) Prepare the income tax expense section of the income statement for 2012, beginning with the line “Income before income taxes.”
E19-2 (Two Differences, No Beginning Deferred Taxes, Tracked through 2 Years)
The following information is available for McKee Corporation for 2012. 1. Excess of tax depreciation over book depreciation, $40,000. This $40,000 difference will reverse equally over the years 2013–2016. 2. Deferral, for book purposes, of $25,000 of rent received in advance. The rent will be earned in 2013. 3. Pretax financial income, $350,000. 4. Tax rate for all years, 40%.
Instructions
(a) Compute taxable income for 2012. (b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012. (c) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2013, assuming taxable income of $325,000.
E19-3 (One Temporary Difference, Future Taxable Amounts, One Rate, Beginning Deferred Taxes)
Brennan Corporation began 2012 with a $90,000 balance in the Deferred Tax Liability account. At the end of 2012, the related cumulative temporary difference amounts to $350,000, and it will reverse evenly over the next 2 years. Pretax accounting income for 2012 is $525,000, the tax rate for all years is 40%, and taxable income for 2012 is $400,000.
Instructions
(a) Compute income taxes payable for 2012. (b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012. (c) Prepare the income tax expense section of the income statement for 2012, beginning with the line “Income before income taxes.”
E19-4 (Three Differences, Compute Taxable Income, Entry for Taxes)
Havaci Company reports pretax financial income of $80,000 for 2012. The following items cause taxable income to be different than pretax financial income. 1. Depreciation on the tax return is greater than depreciation on the income statement by $16,000. 2. Rent collected on the tax return is greater than rent earned on the income statement by $27,000. 3. Fines for pollution appear as an expense of $11,000 on the income statement. Havaci’s tax rate is 30% for all years, and the company expects to report taxable income in all future years. There are no deferred taxes at the beginning of 2012.
Instructions
(a) Compute taxable income and income taxes payable for 2012. (b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012. (c) Prepare the income tax expense section of the income statement for 2012, beginning with the line “Income before income taxes.” (d) Compute the effective income tax rate for 2012.
E19-5 (Two Temporary Differences, One Rate, Beginning Deferred Taxes)
The following facts relate to Alschuler Corporation. 1. Deferred tax liability, January 1, 2012, $40,000. 2. Deferred tax asset, January 1, 2012, $0. 3. Taxable income for 2012, $115,000. 4. Pretax financial income for 2012, $200,000. 5. Cumulative temporary difference at December 31, 2012, giving rise to future taxable amounts, $220,000. 6. Cumulative temporary difference at December 31, 2012, giving rise to future deductible amounts, $35,000. 7. Tax rate for all years, 40%. 8. The company is expected to operate profitably in the future.
Instructions
(a) Compute income taxes payable for 2012. (b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012. (c) Prepare the income tax expense section of the income statement for 2012, beginning with the line “Income before income taxes.”
E19-6 (Identify Temporary or Permanent Differences)
Listed below are items that are commonly accounted for differently for financial reporting purposes than they are for tax purposes.
Instructions
For each item below, indicate whether it involves: (1) A temporary difference that will result in future deductible amounts and, therefore, will usually give rise to a deferred income tax asset. (2) A temporary difference that will result in future taxable amounts and, therefore, will usually give rise to a deferred income tax liability. (3) A permanent difference. 2 5 2 3 5 6 2 3 5 6 Use the appropriate number to indicate your answer for each. (a) ______ The MACRS depreciation system is used for tax purposes, and the straight-line depreciation method is used for financial reporting purposes for some plant assets. (b) ______ A landlord collects some rents in advance. Rents received are taxable in the period when they are received. (c) ______ Expenses are incurred in obtaining tax-exempt income. (d) ______ Costs of guarantees and warranties are estimated and accrued for financial reporting purposes. (e) ______ Installment sales of investments are accounted for by the accrual method for financial reporting purposes and the installment-sales method for tax purposes. (f) ______ Interest is received on an investment in tax-exempt municipal obligations. (g) ______ 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. (h) ______ Proceeds are received from a life insurance company because of the death of a key officer. (The company carries a policy on key officers.) (i) ______ The tax return reports a deduction for 80% of the dividends received from U.S. corporations. The cost method is used in accounting for the related investments for financial reporting purposes. (j) ______ Estimated losses on pending lawsuits and claims are accrued for books. These losses are taxdeductible in the period(s) when the related liabilities are settled. (k) ______ Expenses on stock options are accrued for financial reporting purposes.
E19-7 (Terminology, Relationships, Computations, Entries)

Instructions
Complete the following statements by filling in the blanks. (a) In a period in which a taxable temporary difference reverses, the reversal will cause taxable income to be _______ (less than, greater than) pretax financial income. (b) If a $68,000 balance in Deferred Tax Asset was computed by use of a 40% rate, the underlying cumulative temporary difference amounts to $_______. (c) Deferred taxes ________ (are, are not) recorded to account for permanent differences. (d) If a taxable temporary difference originates in 2013, it will cause taxable income for 2013 to be ____ ____ (less than, greater than) pretax financial income for 2013. (e) If total tax expense is $50,000 and deferred tax expense is $65,000, then the current portion of the expense computation is referred to as current tax _______ (expense, benefit) of $_______. (f) If a corporation’s tax return shows taxable income of $105,000 for Year 2 and a tax rate of 40%, how much will appear on the December 31, Year 2, balance sheet for “Income taxes payable” if the company has made estimated tax payments of $36,500 for Year 2? $________. (g) An increase in the Deferred Tax Liability account on the balance sheet is recorded by a _______ (debit, credit) to the Income Tax Expense account. (h) An income statement that reports current tax expense of $82,000 and deferred tax benefit of $23,000 will report total income tax expense of $________. (i) A valuation account is needed whenever it is judged to be _______ that a portion of a deferred tax asset _______ (will be, will not be) realized. (j) If the tax return shows total taxes due for the period of $75,000 but the income statement shows total income tax expense of $55,000, the difference of $20,000 is referred to as deferred tax _______ (expense, benefit).
E19-8 (Two Temporary Differences, One Rate, 3 Years)
Gordon Company has two temporary differences between its pretax financial income and taxable income. The information is shown below. The income tax rate for all years is 40%.
Instructions
(a) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012, 2013, and 2014. 2012 2013 2014 Pretax fi nancial income $840,000 $910,000 $945,000 Excess depreciation expense on tax return (30,000) (40,000) (20,000) Excess warranty expense in fi nancial income 20,000 10,000 8,000 Taxable income $830,000 $880,000 $933,000 2 3 4 6 2 3 5 9 Exercises 1185 (b) Assuming there were no temporary differences prior to 2012, indicate how deferred taxes will be reported on the 2014 balance sheet. Gordon’s product warranty is for 12 months. (c) Prepare the income tax expense section of the income statement for 2014, beginning with the line “Pretax financial income.”
E19-9 (Carryback and Carryforward of NOL, No Valuation Account, No Temporary Differences)
The pretax financial income (or loss) figures for Synergetics Company are as follows. 2008 $160,000 2009 250,000 2010 90,000 2011 (160,000) 2012 (350,000) 2013 120,000 2014 100,000 Pretax financial income (or loss) and taxable income (loss) were the same for all years involved. Assume a 45% tax rate for 2008 and 2009 and a 40% tax rate for the remaining years.
Instructions
Prepare the journal entries for the years 2010 to 2014 to record income tax expense and the effects of the net operating loss carrybacks, and carryforwards, assuming Synergetics Company uses the carryback provision. All income and losses relate to normal operations. (In recording the benefits of a loss carryforward, assume that no valuation account is deemed necessary.)
E19-10 (Two NOLs, No Temporary Differences, No Valuation Account, Entries and Income Statement)
Lanier Corporation has pretax financial income (or loss) equal to taxable income (or loss) from 2005 through 2013 as follows. Income (Loss) Tax Rate 2005 $29,000 30% 2006 40,000 30% 2007 22,000 35% 2008 48,000 50% 2009 (150,000) 40% 2010 90,000 40% 2011 30,000 40% 2012 105,000 40% 2013 (50,000) 45% Pretax financial income (loss) and taxable income (loss) were the same for all years since Lanier has been in business. Assume the carryback provision is employed for net operating losses. In recording the benefits of a loss carryforward, assume that it is more likely than not that the related benefits will be realized.
Instructions
(a) What entry(ies) for income taxes should be recorded for 2009? (b) Indicate what the income tax expense portion of the income statement for 2009 should look like. Assume all income (loss) relates to continuing operations. (c) What entry for income taxes should be recorded in 2010? (d) How should the income tax expense section of the income statement for 2010 appear? (e) What entry for income taxes should be recorded in 2013? (f) How should the income tax expense section of the income statement for 2013 appear?
E19-11 (Three Differences, Classify Deferred Taxes)
At December 31, 2012, Cascade Company had a net deferred tax liability of $450,000. An explanation of the items that compose this balance is as follows. Resulting Balances Temporary Differences in Deferred Taxes 1. Excess of tax depreciation over book depreciation $200,000 2. Accrual, for book purposes, of estimated loss contingency from pending lawsuit that is expected to be settled in 2013. The loss will be deducted on the tax return when paid. (50,000) 3. Accrual method used for book purposes and installment-sales method used for tax purposes for an isolated installment sale of an investment. 300,000 $450,000 In analyzing the temporary differences, you find that $30,000 of the depreciation temporary difference will reverse in 2013, and $120,000 of the temporary difference due to the installment sale will reverse in 2013. The tax rate for all years is 40%.
Instructions
Indicate the manner in which deferred taxes should be presented on Cascade Company’s December 31, 2012, balance sheet.
E19-12 (Two Temporary Differences, One Rate, Beginning Deferred Taxes, Compute Pretax Financial Income)
The following facts relate to McKane Corporation. 1. Deferred tax liability, January 1, 2012, $60,000. 2. Deferred tax asset, January 1, 2012, $20,000. 3. Taxable income for 2012, $115,000. 4. Cumulative temporary difference at December 31, 2012, giving rise to future taxable amounts, $210,000. 5. Cumulative temporary difference at December 31, 2012, giving rise to future deductible amounts, $95,000. 6. Tax rate for all years, 40%. No permanent differences exist. 7. The company is expected to operate profitably in the future.
Instructions
(a) Compute the amount of pretax financial income for 2012. (b) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012. (c) Prepare the income tax expense section of the income statement for 2012, beginning with the line “Income before income taxes.” (d) Compute the effective tax rate for 2012.
E19-13 (One Difference, Multiple Rates, Effect of Beginning Balance versus No Beginning Deferred Taxes)
At the end of 2012, Wasicsko Company has $180,000 of cumulative temporary differences that will result in reporting future taxable amounts as follows. Exercises 1187 Tax rates enacted as of the beginning of 2011 are: 2011 and 2012 40% 2013 and 2014 30% 2015 and later 25% Wasicsko’s taxable income for 2012 is $340,000. Taxable income is expected in all future years.
Instructions
(a) Prepare the journal entry for Wasicsko to record income taxes payable, deferred income taxes, and income tax expense for 2012, assuming that there were no deferred taxes at the end of 2011. (b) Prepare the journal entry for Wasicsko to record income taxes payable, deferred income taxes, and income tax expense for 2012, assuming that there was a balance of $22,000 in a Deferred Tax Liability account at the end of 2011.
E19-14 (Deferred Tax Asset with and without Valuation Account)
Callaway Corp. has a deferred tax asset account with a balance of $150,000 at the end of 2012 due to a single cumulative temporary difference of $375,000. At the end of 2013, this same temporary difference has increased to a cumulative amount of $500,000. Taxable income for 2013 is $850,000. The tax rate is 40% for all years. No valuation allowance related to the deferred tax asset is in existence at the end of 2012.
Instructions
(a) Record income tax expense, deferred income taxes, and income taxes payable for 2013, assuming that it is more likely than not that the deferred tax asset will be realized. (b) Assuming that it is more likely than not that $30,000 of the deferred tax asset will not be realized, prepare the journal entry at the end of 2013 to record the valuation account.
E19-15 (Deferred Tax Asset with Previous Valuation Account)
Assume the same information as
E19-14, except that at the end of 2012, Callaway Corp. had a valuation account related to its deferred tax asset of $40,000.
2 3 5 2 7 3 4 3 4 5 2013 $ 70,000 2014 50,000 2015 40,000 2016 20,000 $180,000
Instructions
(a) Record income tax expense, deferred income taxes, and income taxes payable for 2013, assuming that it is more likely than not that the deferred tax asset will be realized in full. (b) Record income tax expense, deferred income taxes, and income taxes payable for 2013, assuming that it is more likely than not that none of the deferred tax asset will be realized.
E19-16 (Deferred Tax Liability, Change in Tax Rate, Prepare Section of Income Statement)
Sharrer Inc.’s only temporary difference at the beginning and end of 2012 is caused by a $2 million deferred gain for tax purposes for an installment sale of a plant asset, and the related receivable (only one-half of which is classified as a current asset) is due in equal installments in 2013 and 2014. The related deferred tax liability at the beginning of the year is $800,000. In the third quarter of 2012, a new tax rate of 34% is enacted into law and is scheduled to become effective for 2014. Taxable income for 2012 is $5,000,000, and taxable income is expected in all future years.
Instructions
(a) Determine the amount reported as a deferred tax liability at the end of 2012. Indicate proper classification(s). (b) Prepare the journal entry (if any) necessary to adjust the deferred tax liability when the new tax rate is enacted into law. (c) Draft the income tax expense portion of the income statement for 2012. Begin with the line “Income before income taxes.” Assume no permanent differences exist.
E19-17 (Two Temporary Differences, Tracked through 3 Years, Multiple Rates)
Taxable income and pretax financial income would be identical for Jones Co. except for its treatments of gross profit on installment sales and estimated costs of warranties. The following income computations have been prepared. The tax rates in effect are: 2012, 45%; 2013 and 2014, 40%. All tax rates were enacted into law on January 1, 2012. No deferred income taxes existed at the beginning of 2012. Taxable income is expected in all future years.
Instructions
Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012, 2013, and 2014.
E19-18 (Three Differences, Multiple Rates, Future Taxable Income)
During 2012, Graham Co.’s first year of operations, the company reports pretax financial income of $250,000. Graham’s enacted tax rate is 40% for 2012 and 35% for all later years. Graham expects to have taxable income in each of the next 5 years. The effects on future tax returns of temporary differences existing at December 31, 2012, are summarized below. Taxable income 2012 2013 2014 Excess of revenues over expenses (excluding two temporary differences) $160,000 $210,000 $90,000 Installment income collected 8,000 8,000 8,000 Expenditures for warranties (5,000) (5,000) (5,000) Taxable income $163,000 $213,000 $93,000 Pretax fi nancial income 2012 2013 2014 Excess of revenues over expenses (excluding two temporary differences) $160,000 $210,000 $90,000 Installment gross profi t earned 24,000 –0– –0– Estimated cost of warranties (15,000) –0– –0– Income before taxes $169,000 $210,000 $90,000 Future Years 2013 2014 2015 2016 2017 Total Future taxable (deductible) amounts: Installment sales $32,000 $32,000 $32,000 $ 96,000 Depreciation 6,000 6,000 6,000 $6,000 $6,000 30,000 Unearned rent (50,000) (50,000) (100,000)
Instructions
(a) Complete the schedule below to compute deferred taxes at December 31, 2012. (b) Compute taxable income for 2012. (c) Prepare the journal entry to record income taxes payable, deferred taxes, and income tax expense for 2012. Exercises 1189
E19-19 (Two Differences, One Rate, Beginning Deferred Balance, Compute Pretax Financial Income)
Shamess Co. establishes a $90 million liability at the end of 2012 for the estimated litigation settlement for manufacturing defects. All related costs will be paid and deducted on the tax return in 2013. Also, at the end of 2012, the company has $50 million of temporary differences due to excess depreciation for tax purposes, $7 million of which will reverse in 2013. The enacted tax rate for all years is 40%, and the company pays taxes of $64 million on $160 million of taxable income in 2012. Shamess expects to have taxable income in 2013.
Instructions
(a) Determine the deferred taxes to be reported at the end of 2012. (b) Indicate how the deferred taxes computed in (a) are to be reported on the balance sheet. (c) Assuming that the only deferred tax account at the beginning of 2012 was a deferred tax liability of $10,000,000, draft the income tax expense portion of the income statement for 2012, beginning with the line “Income before income taxes.” (Hint: You must first compute (1) the amount of temporary difference underlying the beginning $10,000,000 deferred tax liability, then (2) the amount of temporary differences originating or reversing during the year, then (3) the amount of pretax financial income.)
E19-20 (Two Differences, No Beginning Deferred Taxes, Multiple Rates)
Macinski Inc., in its first year of operations, has the following differences between the book basis and tax basis of its assets and liabilities at the end of 2012. Future Taxable December 31, 2012 (Deductible) Tax Deferred Tax Temporary Difference Amounts Rate (Asset) Liability Installment sales $ 96,000 Depreciation 30,000 Unearned rent (100,000) Totals $ It is estimated that the warranty liability will be settled in 2013. The difference in equipment (net) will result in taxable amounts of $20,000 in 2013, $30,000 in 2014, and $10,000 in 2015. The company has taxable income of $550,000 in 2012. As of the beginning of 2012, the enacted tax rate is 34% for 2012–2014, and 30% for 2015. Macinski expects to report taxable income through 2015.
Instructions
(a) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012. (b) Indicate how deferred income taxes will be reported on the balance sheet at the end of 2012.
E19-21 (Two Temporary Differences, Multiple Rates, Future Taxable Income)
Flynn Inc. has two temporary differences at the end of 2012. The first difference stems from installment sales, and the second one results from the accrual of a loss contingency. Flynn’s accounting department has developed a schedule of future taxable and deductible amounts related to these temporary differences as follows. Book Basis Tax Basis Equipment (net) $400,000 $340,000 Estimated warranty liability $150,000 $ –0– As of the beginning of 2012, the enacted tax rate is 34% for 2012 and 2013, and 38% for 2014–2017. At the beginning of 2012, the company had no deferred income taxes on its balance sheet. Taxable income for 2012 is $400,000. Taxable income is expected in all future years. 2013 2014 2015 2016 Taxable amounts $40,000 $50,000 $60,000 $90,000 Deductible amounts (15,000) (19,000) $40,000 $35,000 $41,000 $90,000 2 3 9 2 3 9 2 3 7 9
Instructions
(a) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012. (b) Indicate how deferred income taxes would be classified on the balance sheet at the end of 2012.
E19-22 (Two Differences, One Rate, First Year)
The differences between the book basis and tax basis of the assets and liabilities of Morgan Corporation at the end of 2012 are presented below. It is estimated that the litigation liability will be settled in 2013. The difference in accounts receivable will result in taxable amounts of $30,000 in 2013 and $20,000 in 2014. The company has taxable income of $300,000 in 2012 and is expected to have taxable income in each of the following 2 years. Its enacted tax rate is 34% for all years. This is the company’s first year of operations. The operating cycle of the business is 2 years.
Instructions
(a) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2012. (b) Indicate how deferred income taxes will be reported on the balance sheet at the end of 2012.
E19-23 (NOL Carryback and Carryforward, Valuation Account versus No Valuation Account)
Sondgeroth Inc. reports the following pretax income (loss) for both financial reporting purposes and tax purposes. (Assume the carryback provision is used for a net operating loss.) Book Basis Tax Basis Accounts receivable $50,000 $–0– Litigation liability 20,000 –0– The tax rates listed were all enacted by the beginning of 2011.
Instructions
(a) Prepare the journal entries for the years 2011–2014 to record income tax expense (benefit), income taxes payable (refundable), and the tax effects of the loss carryback and carryforward, assuming that at the end of 2013 the benefits of the loss carryforward are judged more likely than not to be realized in the future. (b) Using the assumption in (a), prepare the income tax section of the 2013 income statement, beginning with the line “Operating loss before income taxes.” (c) Prepare the journal entries for 2013 and 2014, assuming that based on the weight of available evidence, it is more likely than not that one-fourth of the benefits of the loss carryforward will not be realized. (d) Using the assumption in (c), prepare the income tax section of the 2013 income statement, beginning with the line “Operating loss before income taxes.”
E19-24 (NOL Carryback and Carryforward, Valuation Account Needed)
Nielson Inc. reports the following pretax income (loss) for both book and tax purposes. (Assume the carryback provision is used where possible for a net operating loss.) Year Pretax Income (Loss) Tax Rate 2011 $110,000 34% 2012 90,000 34% 2013 (260,000) 38% 2014 220,000 38% Year Pretax Income (Loss) Tax Rate 2011 $100,000 40% 2012 90,000 40% 2013 (240,000) 45% 2014 120,000 45% The tax rates listed were all enacted by the beginning of 2011.
Instructions
(a) Prepare the journal entries for the years 2011–2014 to record income tax expense (benefit), income taxes payable (refundable), and the tax effects of the loss carryback and loss carryforward, assuming that based on the weight of available evidence, it is more likely than not that one-half of the benefits of the loss carryforward will not be realized. (b) Prepare the income tax section of the 2013 income statement, beginning with the line “Operating loss before income taxes.” (c) Prepare the income tax section of the 2014 income statement, beginning with the line “Income before income taxes.” 2 3 9 4 7 8 4 7 8
E19-25 (NOL Carryback and Carryforward, Valuation Account Needed)
Hayes Co. reported the following pretax financial income (loss) for the years 2011–2015. 2011 $240,000 2012 350,000 2013 90,000 2014 (550,000) 2015 180,000 Pretax financial income (loss) and taxable income (loss) were the same for all years involved. The enacted tax rate was 34% for 2011 and 2012, and 40% for 2013–2015. Assume the carryback provision is used first for net operating losses.
Instructions
(a) Prepare the journal entries for the years 2013–2015 to record income tax expense, income taxes payable (refundable), and the tax effects of the loss carryback and loss carryforward, assuming that based on the weight of available evidence, it is more likely than not that one-fifth of the benefits of the loss carryforward will not be realized. (b) Prepare the income tax section of the 2014 income statement, beginning with the line “Income (loss) before income taxes.” Problems 1191 4 7 8 See the book’s companion website, www.wiley.com/college/kieso, for a set of B Exercises. PROBLEMS
P19-1 (Three Differences, No Beginning Deferred Taxes, Multiple Rates)
The following information is available for Remmers Corporation for 2012. 1. Depreciation reported on the tax return exceeded depreciation reported on the income statement by $120,000. This difference will reverse in equal amounts of $30,000 over the years 2013–2016. 2. Interest received on municipal bonds was $10,000. 3. Rent collected in advance on January 1, 2012, totaled $60,000 for a 3-year period. Of this amount, $40,000 was reported as unearned at December 31, 2012, for book purposes. 4. The tax rates are 40% for 2012 and 35% for 2013 and subsequent years. 5. Income taxes of $320,000 are due per the tax return for 2012. 6. No deferred taxes existed at the beginning of 2012.
Instructions
(a) Compute taxable income for 2012. (b) Compute pretax financial income for 2012. (c) Prepare the journal entries to record income tax expense, deferred income taxes, and income taxes payable for 2012 and 2013. Assume taxable income was $980,000 in 2013. (d) Prepare the income tax expense section of the income statement for 2012, beginning with “Income before income taxes.”
P19-2 (One Temporary Difference, Tracked for 4 Years, One Permanent Difference, Change in Rate)
The pretax financial income of Truttman Company differs from its taxable income throughout each of 4 years as follows. Pretax financial income for each year includes a nondeductible expense of $30,000 (never deductible for tax purposes). The remainder of the difference between pretax financial income and taxable income in each period is due to one depreciation temporary difference. No deferred income taxes existed at the beginning of 2012. Pretax Taxable Year Financial Income Income Tax Rate 2012 $290,000 $180,000 35% 2013 320,000 225,000 40% 2014 350,000 260,000 40% 2015 420,000 560,000 40% 2 3 5 3 5 6
Instructions
(a) Prepare journal entries to record income taxes in all 4 years. Assume that the change in the tax rate to 40% was not enacted until the beginning of 2013. (b) Prepare the income statement for 2013, beginning with Income before income taxes.
P19-3 (Second Year of Depreciation Difference, Two Differences, Single Rate, Extraordinary Item)
The following information has been obtained for the Gocker Corporation. 1. Prior to 2012, taxable income and pretax financial income were identical. 2. Pretax financial income is $1,700,000 in 2012 and $1,400,000 in 2013. 3. On January 1, 2012, equipment costing $1,200,000 is purchased. It is to be depreciated on a straightline basis over 5 years for tax purposes and over 8 years for financial reporting purposes. (Hint: Use the half-year convention for tax purposes, as discussed in Appendix 11A.) 4. Interest of $60,000 was earned on tax-exempt municipal obligations in 2013. 5. Included in 2013 pretax financial income is an extraordinary gain of $200,000, which is fully taxable. 6. The tax rate is 35% for all periods. 7. Taxable income is expected in all future years.
Instructions
(a) Compute taxable income and income taxes payable for 2013. (b) Prepare the journal entry to record 2013 income tax expense, income taxes payable, and deferred taxes. (c) Prepare the bottom portion of Gocker’s 2013 income statement, beginning with “Income before income taxes and extraordinary item.” (d) Indicate how deferred income taxes should be presented on the December 31, 2013, balance sheet.
P19-4 (Permanent and Temporary Differences, One Rate)
The accounting records of Shinault Inc. show the following data for 2012. 1. Life insurance expense on officers was $9,000. 2. Equipment was acquired in early January for $300,000. Straight-line depreciation over a 5-year life is used, with no salvage value. For tax purposes, Shinault used a 30% rate to calculate depreciation. 3. Interest revenue on State of New York bonds totaled $4,000. 4. Product warranties were estimated to be $50,000 in 2012. Actual repair and labor costs related to the warranties in 2012 were $10,000. The remainder is estimated to be paid evenly in 2013 and 2014. 5. Sales on an accrual basis were $100,000. For tax purposes, $75,000 was recorded on the installmentsales method. 6. Fines incurred for pollution violations were $4,200. 7. Pretax financial income was $750,000. The tax rate is 30%.
Instructions
(a) Prepare a schedule starting with pretax financial income in 2012 and ending with taxable income in 2012. (b) Prepare the journal entry for 2012 to record income taxes payable, income tax expense, and deferred income taxes.
P19-5 (NOL without Valuation Account)
Jennings Inc. reported the following pretax income (loss) and related tax rates during the years 2008–2014. Pretax financial income (loss) and taxable income (loss) were the same for all years since Jennings began business. The tax rates from 2011–2014 were enacted in 2011.
Instructions
(a) Prepare the journal entries for the years 2012–2014 to record income taxes payable (refundable), income tax expense (benefit), and the tax effects of the loss carryback and carryforward. Assume that Jennings elects the carryback provision where possible and expects to realize the benefits of any loss carryforward in the year that immediately follows the loss year. (b) Indicate the effect the 2012 entry(ies) has on the December 31, 2012, balance sheet. Pretax Income (loss) Tax Rate 2008 $ 40,000 30% 2009 25,000 30% 2010 50,000 30% 2011 80,000 40% 2012 (180,000) 45% 2013 70,000 40% 2014 100,000 35%  (c) Prepare the portion of the income statement, starting with “Operating loss before income taxes,” for 2012. (d) Prepare the portion of the income statement, starting with “Income before income taxes,” for 2013.
P19-6 (Two Differences, Two Rates, Future Income Expected)
Presented below are two independent situations related to future taxable and deductible amounts resulting from temporary differences existing at December 31, 2012. 1. Mooney Co. has developed the following schedule of future taxable and deductible amounts. 2. Roesch Co. has the following schedule of future taxable and deductible amounts. Both Mooney Co. and Roesch Co. have taxable income of $4,000 in 2012 and expect to have taxable income in all future years. The tax rates enacted as of the beginning of 2012 are 30% for 2012–2015 and 35% for years thereafter. All of the underlying temporary differences relate to noncurrent assets and liabilities.
Instructions
For each of these two situations, compute the net amount of deferred income taxes to be reported at the end of 2012, and indicate how it should be classified on the balance sheet.
P19-7 (One Temporary Difference, Tracked 3 Years, Change in Rates, Income Statement Presentation)
Crosley Corp. sold an investment on an installment basis. The total gain of $60,000 was reported for financial reporting purposes in the period of sale. The company qualifies to use the installment-sales method for tax purposes. The installment period is 3 years; one-third of the sale price is collected in the period of sale. The tax rate was 40% in 2012, and 35% in 2013 and 2014. The 35% tax rate was not enacted in law until 2013. The accounting and tax data for the 3 years is shown below. 2013 2014 2015 2016 2017 Taxable amounts $300 $300 $300 $ 300 $300 Deductible amount — — — (1,600) — 2013 2014 2015 2016 Taxable amounts $300 $300 $ 300 $300 Deductible amount — — (2,300) — Financial Tax Accounting Return 2012 (40% tax rate) Income before temporary difference $ 70,000 $70,000 Temporary difference 60,000 20,000 Income $130,000 $90,000 2013 (35% tax rate) Income before temporary difference $ 70,000 $70,000 Temporary difference –0– 20,000 Income $ 70,000 $90,000 2014 (35% tax rate) Income before temporary difference $ 70,000 $70,000 Temporary difference –0– 20,000 Income $ 70,000 $90,000
Instructions
(a) Prepare the journal entries to record the income tax expense, deferred income taxes, and the income taxes payable at the end of each year. No deferred income taxes existed at the beginning of 2012. (b) Explain how the deferred taxes will appear on the balance sheet at the end of each year. (Assume Installment Accounts Receivable is classified as a current asset.) (c) Draft the income tax expense section of the income statement for each year, beginning with “Income before income taxes.”
P19-8 (Two Differences, 2 Years, Compute Taxable Income and Pretax Financial Income)
The information below and on page 1194 was disclosed during the audit of Elbert Inc. 1. Amount Due Year per Tax Return 2012 $130,000 2013 104,000 2 3 9 2 5 7 2 3 5 9 Problems 1193 2. On January 1, 2012, equipment costing $600,000 is purchased. For financial reporting purposes, the company uses straight-line depreciation over a 5-year life. For tax purposes, the company uses the elective straight-line method over a 5-year life. (Hint: For tax purposes, the half-year convention as discussed in Appendix 11A must be used.) 3. In January 2013, $225,000 is collected in advance rental of a building for a 3-year period. The entire $225,000 is reported as taxable income in 2013, but $150,000 of the $225,000 is reported as unearned revenue in 2013 for financial reporting purposes. The remaining amount of unearned revenue is to be earned equally in 2014 and 2015. 4. The tax rate is 40% in 2012 and all subsequent periods. (Hint: To find taxable income in 2012 and 2013, the related income taxes payable amounts will have to be “grossed up.”) 5. No temporary differences existed at the end of 2011. Elbert expects to report taxable income in each of the next 5 years.
Instructions
(a) Determine the amount to report for deferred income taxes at the end of 2012, and indicate how it should be classified on the balance sheet. (b) Prepare the journal entry to record income taxes for 2012. (c) Draft the income tax section of the income statement for 2012, beginning with “Income before income taxes.” (Hint: You must compute taxable income and then combine that with changes in cumulative temporary differences to arrive at pretax financial income.) (d) Determine the deferred income taxes at the end of 2013, and indicate how they should be classified on the balance sheet. (e) Prepare the journal entry to record income taxes for 2013. (f) Draft the income tax section of the income statement for 2013, beginning with “Income before income taxes.”
P19-9 (Five Differences, Compute Taxable Income and Deferred Taxes, Draft Income Statement)
Wise Company began operations at the beginning of 2013. The following information pertains to this company. 1. Pretax financial income for 2013 is $100,000. 2. The tax rate enacted for 2013 and future years is 40%. 3. Differences between the 2013 income statement and tax return are listed below: (a) Warranty expense accrued for financial reporting purposes amounts to $7,000. Warranty deductions per the tax return amount to $2,000. (b) Gross profit on construction contracts using the percentage-of-completion method per books amounts to $92,000. Gross profit on construction contracts for tax purposes amounts to $67,000. (c) Depreciation of property, plant, and equipment for financial reporting purposes amounts to $60,000. Depreciation of these assets amounts to $80,000 for the tax return. (d) A $3,500 fine paid for violation of pollution laws was deducted in computing pretax financial income. (e) Interest revenue earned on an investment in tax-exempt municipal bonds amounts to $1,500. (Assume (a) is short-term in nature; assume (b) and (c) are long-term in nature.) 4. Taxable income is expected for the next few years.
Instructions
(a) Compute taxable income for 2013. (b) Compute the deferred taxes at December 31, 2013, that relate to the temporary differences described above. Clearly label them as deferred tax asset or liability. (c) Prepare the journal entry to record income tax expense, deferred taxes, and income taxes payable for 2013. (d) Draft the income tax expense section of the income statement, beginning with “Income before income taxes.” CONCEPTS FOR ANALYS I S
CA19-1 (Objectives and Principles for Accounting for Income Taxes)
The amount of income taxes due to the government for a period of time is rarely the amount reported on the income statement for that period as income tax expense.
Instructions
(a) Explain the objectives of accounting for income taxes in general-purpose financial statements. (b) Explain the basic principles that are applied in accounting for income taxes at the date of the financial statements to meet the objectives discussed in (a). (c) List the steps in the annual computation of deferred tax liabilities and assets.
CA19-2 (Basic Accounting for Temporary Differences)
Dexter Company appropriately uses the assetliability method to record deferred income taxes. Dexter reports depreciation expense for certain machinery purchased this year using the modified accelerated cost recovery system (MACRS) for income tax purposes and the straight-line basis for financial reporting purposes. The tax deduction is the larger amount this year. Dexter received rent revenues in advance this year. These revenues are included in this year’s taxable income. However, for financial reporting purposes, these revenues are reported as unearned revenues, a current liability.
Instructions
(a) What are the principles of the asset-liability approach? (b) How would Dexter account for the temporary differences? (c) How should Dexter classify the deferred tax consequences of the temporary differences on its balance sheet?
CA19-3 (Identify Temporary Differences and Classification Criteria)
The asset-liability approach for recording deferred income taxes is an integral part of generally accepted accounting principles.
Instructions
(a) Indicate whether each of the following independent situations should be treated as a temporary difference or as a permanent difference, and explain why. (1) Estimated warranty costs (covering a 3-year warranty) are expensed for financial reporting purposes at the time of sale but deducted for income tax purposes when paid. (2) Depreciation for book and income tax purposes differs because of different bases of carrying the related property, which was acquired in a trade-in. The different bases are a result of different rules used for book and tax purposes to compute the basis of property acquired in a trade-in. (3) A company properly uses the equity method to account for its 30% investment in another company. The investee pays dividends that are about 10% of its annual earnings. (4) A company reports a gain on an involuntary conversion of a nonmonetary asset to a monetary asset. The company elects to replace the property within the statutory period using the total proceeds so the gain is not reported on the current year’s tax return. (b) Discuss the nature of the deferred income tax accounts and possible classifications in a company’s balance sheet. Indicate the manner in which these accounts are to be reported.
CA19-4 (Accounting and Classification of Deferred Income Taxes) Part A
This year, Gumowski Company has each of the following items in its income statement. 1. Gross profits on installment sales. 2. Revenues on long-term construction contracts. 3. Estimated costs of product warranty contracts. 4. Premiums on officers’ life insurance policies with Gumowski as beneficiary.
Instructions
(a) Under what conditions would deferred income taxes need to be reported in the financial statements? (b) Specify when deferred income taxes would need to be recognized for each of the items above, and indicate the rationale for such recognition. Part B Gumowski Company’s president has heard that deferred income taxes can be classified in different ways in the balance sheet.
Instructions
Identify the conditions under which deferred income taxes would be classified as a noncurrent item in the balance sheet. What justification exists for such classification? (AICPA adapted)
CA19-5 (Explain Computation of Deferred Tax Liability for Multiple Tax Rates)
At December 31, 2012, Higley Corporation has one temporary difference which will reverse and cause taxable amounts in 2013. In 2012, a new tax act set taxes equal to 45% for 2012, 40% for 2013, and 34% for 2014 and years thereafter.
Instructions
Explain what circumstances would call for Higley to compute its deferred tax liability at the end of 2012 by multiplying the cumulative temporary difference by: (a) 45%. (b) 40%. (c) 34%. Concepts for Analysis 1195
CA19-6 (Explain Future Taxable and Deductible Amounts, How Carryback and Carryforward Affects Deferred Taxes)
Maria Rodriquez and Lynette Kingston are discussing accounting for income taxes. They are currently studying a schedule of taxable and deductible amounts that will arise in the future as a result of existing temporary differences. The schedule is as follows. Current Years Future Years 2012 2013 2014 2015 2016 Taxable income $850,000 Taxable amounts $375,000 $375,000 $375,000 $375,000 Deductible amounts (2,400,000) Enacted tax rate 50% 45% 40% 35% 30%
Instructions
(a) Explain the concept of future taxable amounts and future deductible amounts as illustrated in the schedule. (b) How do the carryback and carryforward provisions affect the reporting of deferred tax assets and deferred tax liabilities?
CA19-7 (Deferred Taxes, Income Effects)
Stephanie Delaney, CPA, is the newly hired director of corporate taxation for Acme Incorporated, which is a publicly traded corporation. Ms. Delaney’s first job with Acme was the review of the company’s accounting practices on deferred income taxes. In doing her review, she noted differences between tax and book depreciation methods that permitted Acme to realize a sizable deferred tax liability on its balance sheet. As a result, Acme paid very little in income taxes at that time. Delaney also discovered that Acme has an explicit policy of selling off plant assets before they reversed in the deferred tax liability account. This policy, coupled with the rapid expansion of its plant asset base, allowed Acme to “defer” all income taxes payable for several years, even though it always has reported positive earnings and an increasing EPS. Delaney checked with the legal department and found the policy to be legal, but she’s uncomfortable with the ethics of it.
Instructions
Answer the following questions. (a) Why would Acme have an explicit policy of selling plant assets before the temporary differences reversed in the deferred tax liability account? (b) What are the ethical implications of Acme’s “deferral” of income taxes? (c) Who could be harmed by Acme’s ability to “defer” income taxes payable for several years, despite positive earnings? (d) In a situation such as this, what are Ms. Delaney’s professional responsibilities as a CPA?
FINANCIAL REPORTING

Financial Reporting Problem

The Procter & Gamble Company (P&G)
The financial statements of P&G are presented in Appendix 5B or can be accessed at the book’s companion website, www.wiley.com/college/kieso.
Instructions
Refer to P&G’s financial statements and the accompanying notes to answer the following questions. (a) What amounts relative to income taxes does P&G report in its: (1) 2009 income statement? (2) June 30, 2009, balance sheet? (3) 2009 statement of cash flows? (b) P&G’s provision for income taxes in 2007, 2008, and 2009 was computed at what effective tax rates? (See the notes to the financial statements.) (c) How much of P&G’s 2009 total provision for income taxes was current tax expense, and how much was deferred tax expense? (d) What did P&G report as the signifi cant components (the details) of its June 30, 2009, deferred tax assets and liabilities?
Comparative Analysis Case
The Coca-Cola Company and PepsiCo, Inc.
Instructions
Go to the book’s companion website and use information found there to answer the following questions related to The Coca-Cola Company and PepsiCo, Inc. (a) What are the amounts of Coca-Cola’s and PepsiCo’s provision for income taxes for the year 2009? Of each company’s 2009 provision for income taxes, what portion is current expense and what portion is deferred expense? (b) What amount of cash was paid in 2009 for income taxes by Coca-Cola and by PepsiCo? (c) What was the U.S. federal statutory tax rate in 2009? What was the effective tax rate in 2009 for Coca-Cola and PepsiCo? Why might their effective tax rates differ? (d) For year-end 2009, what amounts were reported by Coca-Cola and PepsiCo as (1) gross deferred tax assets and (2) gross deferred tax liabilities? (e) Do either Coca-Cola or PepsiCo disclose any net operating loss carrybacks and/or carryforwards at year-end 2009? What are the amounts, and when do the carryforwards expire?
Financial Statement Analysis Case
Homestake Mining Company Homestake Mining Company is a 120-year-old international gold mining company with substantial gold mining operations and exploration in the United States, Canada, and Australia. At year-end, Homestake reported the following items related to income taxes (thousands of dollars). Total current taxes $ 26,349 Total deferred taxes (39,436) Total income and mining taxes (the provision for taxes per its income statement) (13,087) Deferred tax liabilities $303,050 Deferred tax assets, net of valuation allowance of $207,175 95,275 Net deferred tax liability $207,775 Note 6: The classifi cation of deferred tax assets and liabilities is based on the related asset or liability creating the deferred tax. Deferred taxes not related to a specifi c asset or liability are classifi ed based on the estimated period of reversal. Tax loss carryforwards (U.S., Canada, Australia, and Chile) $71,151 Tax credit carryforwards $12,007
Instructions
(a) What is the significance of Homestake’s disclosure of “Current taxes” of $26,349 and “Deferred taxes” of $(39,436)? (b) Explain the concept behind Homestake’s disclosure of gross deferred tax liabilities (future taxable amounts) and gross deferred tax assets (future deductible amounts). (c) Homestake reported tax loss carryforwards of $71,151 and tax credit carryforwards of $12,007. How do the carryback and carryforward provisions affect the reporting of deferred tax assets and deferred tax liabilities? Using Your Judgment 1197
Accounting, Analysis, and Principles
Allman Company, which began operations at the beginning of 2010, produces various products on a contract basis. Each contract generates a gross profit of $80,000. Some of Allman’s contracts provide for the customer to pay on an installment basis. Under these contracts, Allman collects one-fifth of the contract revenue in each of the following four years. For financial reporting purposes, the company recognizes gross profit in the year of completion (accrual basis); for tax purposes, Allman recognizes gross profit in the year cash is collected (installment basis). Presented below is information related to Allman’s operations for 2012: 1. In 2012, the company completed seven contracts that allow for the customer to pay on an installment basis. Allman recognized the related gross profi t of $560,000 for fi nancial reporting purposes. It reported only $112,000 of gross profi t on installment sales on the 2012 tax return. The company expects future collections on the related installment receivables to result in taxable amounts of $112,000 in each of the next four years. 2. In 2012, nontaxable municipal bond interest revenue was $28,000. 3. During 2012, nondeductible fi nes and penalties of $26,000 were paid. 4. Pretax fi nancial income for 2012 amounts to $500,000. 5. Tax rates (enacted before the end of 2012) are 50% for 2012 and 40% for 2013 and later. 6. The accounting period is the calendar year. 7. The company is expected to have taxable income in all future years. 8. The company has no deferred tax assets or liabilities at the end of 2011.
Accounting
Prepare the journal entry to record income taxes for 2012.
Analysis
Classify deferred income taxes on the balance sheet at December 31, 2012, and indicate, starting with income before income taxes, how income taxes are reported on the income statement. What is Allman’s effective tax rate?
Principles
Explain how the conceptual framework is used as a basis for determining the proper accounting for deferred income taxes.
BRIDGE TO THE PROFESSION

Professional Research: FASB Codifi cation
Kleckner Company started operations in 2009, and although it has grown steadily, the company reported accumulated operating losses of $450,000 in its first four years in business. In the most recent year (2013), Kleckner appears to have turned the corner and reported modest taxable income of $30,000. In addition to a deferred tax asset related to its net operating loss, Kleckner has recorded a deferred tax asset related to product warranties and a deferred tax liability related to accelerated depreciation. Given its past operating results, Kleckner has established a full valuation allowance for its deferred tax assets. However, given its improved performance, Kleckner management wonders whether the company can now reduce or eliminate the valuation allowance. They would like you to conduct some research on the accounting for its valuation allowance.
Instructions
If your school has a subscription to the FASB Codification, go to http://aaahq.org/ascLogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses. (a) Briefly explain to Kleckner management the importance of future taxable income as it relates to the valuation allowance for deferred tax assets. (b) What are the sources of income that may be relied upon to remove the need for a valuation allowance? (c) What are tax-planning strategies? From the information provided, does it appear that Kleckner could employ a tax-planning strategy to support reducing its valuation allowance?
Professional Simulation
In this simulation, you are asked to address questions related to the accounting for taxes. Prepare responses to all parts. IFRS Insights 1199 Johnny Bravo Company began operations in 2012 and has provided the following information. 1. Pretax financial income for 2012 is $100,000. 2. The tax rate enacted for 2012 and future years is 40%. 3. Differences between the 2012 income statement and tax return are listed below. (a) Warranty expense accrued for financial reporting purposes amounts to $5,000. Warranty deductions per the tax return amount to $2,000. (b) Gross profit on construction contracts using the percentage-of-completion method for book purposes amounts to $92,000. Gross profit on construction contracts for tax purposes amounts to $62,000. (c) Depreciation of property, plant, and equipment for financial reporting purposes amounts to $60,000. Depreciation of these assets amounts to $80,000 for the tax return. (d) A $3,500 fine paid for violation of pollution laws was deducted in computing pretax financial income. (e) Interest revenue earned on an investment in tax-exempt municipal bonds amounts to $1,400. 4. Taxable income is expected for the next few years. Prepare the journal entry to record income tax expense, deferred taxes, and income taxes payable for 2012. Draft the income tax expense section of the income statement beginning with “Income before income taxes.” Directions Situation Journal Entry Financial Statements Resources Directions Situation Journal Entry Financial Statements Resources Directions Situation Journal Entry Financial Statements Resources 1 2 3 45 A B C +
KWW_Professional_Simulation
Accounting for Taxes Time Remaining 2 hours 40 minutes Unsplit Split Horiz Split Vertical Spreadsheet Calculator Exit The accounting for income taxes in IFRS is covered in IAS 12 (“Income Taxes”). Similar to GAAP, IFRS uses the asset and liability approach for recording deferred taxes. The differences between IFRS and GAAP involve a few exceptions to the asset-liability approach; some minor differences in the recognition, measurement, and disclosure criteria; and differences in implementation guidance. IFRS Insights
RELEVANT FACTS
The classifi cation of deferred taxes under IFRS is always non-current. As indicated in the chapter, GAAP classifi es deferred taxes based on the classifi cation of the asset or liability to which it relates. Under IFRS, an affi rmative judgment approach is used, by which a deferred tax asset is recognized up to the amount that is probable to be realized. GAAP uses an impairment approach. In this approach, the deferred tax asset is recognized in full. It is then reduced by a valuation account if it is more likely than not that all or a portion of the deferred tax asset will not be realized. IFRS uses the enacted tax rate or substantially enacted tax rate. (“Substantially enacted” means virtually certain.) For GAAP, the enacted tax rate must be used. The tax effects related to certain items are reported in equity under IFRS. That is not the case under GAAP, which charges or credits the tax effects to income. GAAP requires companies to assess the likelihood of uncertain tax positions being sustainable upon audit. Potential liabilities must be accrued and disclosed if the position is “more likely than not” to be disallowed. Under IFRS, all potential liabilities must be recognized. With respect to measurement, IFRS uses an expected-value approach to measure the tax liability, which differs from GAAP.
ABOUT THE NUMBERS

Deferred Tax Asset (Non-Recognition)
Under IFRS, companies recognize a deferred tax asset for all deductible temporary differences. However, based on available evidence, a company should reduce a deferred tax asset if it is probable that it will not realize some portion or all of the deferred tax asset. “Probable” means a level of likelihood of at least slightly more than 50 percent. Assume that Jensen Co. has a deductible temporary difference of $1,000,000 at the end of its first year of operations. Its tax rate is 40 percent, which means it records a deferred tax asset of $400,000 ($1,000,000 3 40%). Assuming $900,000 of income taxes payable, Jensen records income tax expense, the deferred tax asset, and income taxes payable as follows. Income Tax Expense 500,000 Deferred Tax Asset 400,000 Income Taxes Payable 900,000 After careful review of all available evidence, Jensen determines that it is probable that it will not realize $100,000 of this deferred tax asset. Jensen records this reduction in asset value as follows. Income Tax Expense 100,000 Deferred Tax Asset 100,000 This journal entry increases income tax expense in the current period because Jensen does not expect to realize a favorable tax benefi t for a portion of the deductible temporary difference. Jensen simultaneously recognizes a reduction in the carrying amount of the deferred tax asset. Jensen then reports a deferred tax asset of $300,000 in its statement of fi nancial position. Jensen evaluates the deferred tax asset account at the end of each accounting period. If, at the end of the next period, it expects to realize $350,000 of this deferred tax asset, Jensen makes the following entry to adjust this account. Deferred Tax Asset ($350,000 2 $300,000) 50,000 Income Tax Expense 50,000 Jensen should consider all available evidence, both positive and negative, to determine whether, based on the weight of available evidence, it needs to adjust the deferred tax asset. For example, if Jensen has been experiencing a series of loss years, it reasonably assumes that these losses will continue. Therefore, Jensen will lose the benefit of the future deductible amounts. Generally, sufficient taxable income arises from temporary taxable differences that will reverse in the future or from a tax-planning strategy that will generate taxable income in the future. Illustration
IFRS19-1 shows how
Ahold describes its reporting of deferred assets. IFRS Insights 1201 Carryforward (Non-Recognition) To illustrate non-recognition of a loss carryforward, assume that Groh Inc. has tax benefi ts of $110,000 associated with a NOL carryback and a potential deferred tax asset of $80,000 associated with an operating loss carryforward of $200,000, assuming a future tax rate of 40% ($200,000 3 40%). However, if it is probable that Groh will not realize the entire NOL carryforward in future years, it does not recognize this deferred tax asset. To illustrate, Groh makes the following journal entry in 2012 to record only the tax refund receivable. ILLUSTRATION
IFRS19-1
Deferred Tax Asset Disclosure Ahold Note 11. Signifi cant judgment is required in determining whether deferred tax assets are realizable. Ahold determines this on the basis of expected taxable profi ts arising from recognized deferred tax liabilities and on the basis of budgets, cash fl ow forecasts, and impairment models. Where utilization is not considered probable, deferred taxes are not recognized. To recognize benefit of loss carryback Income Tax Refund Receivable 110,000 Benefit Due to Loss Carryback (Income Tax Expense) 110,000 Illustration
IFRS19-2 shows Groh’s 2012 income statement presentation.

ILLUSTRATION
IFRS19-2
Recognition of Benefi t of Loss Carryback Only GROH INC. INCOME STATEMENT (PARTIAL) FOR 2012 Operating loss before income taxes $(500,000) Income tax benefit Benefit due to loss carryback 110,000 Net loss $(390,000) In 2013, assuming that Groh has taxable income of $250,000 (before considering the carryforward), subject to a tax rate of 40 percent, it realizes the deferred tax asset. Groh records the following entries. To recognize deferred tax asset and loss carryforward Deferred Tax Asset 80,000 Benefit Due to Loss Carryforward (Income Tax Expense) 80,000 To record current and deferred income taxes Income Tax Expense 100,000 Deferred Tax Asset 80,000 Income Taxes Payable 20,000 Groh reports the $80,000 Benefi t Due to the Loss Carryforward on the 2013 income statement. The company did not recognize it in 2012 because it was probable that it would not be realized. Assuming that Groh derives the income for 2013 from continuing operations, it prepares the income statement as shown in Illustration
IFRS19-3.

ILLUSTRATION
IFRS19-3
Recognition of Benefi t of Loss Carryforward When Realized GROH INC. INCOME STATEMENT (PARTIAL) FOR 2013 Income before income taxes $250,000 Income tax expense Current $ 20,000 Deferred 80,000 Benefit due to loss carryforward (80,000) 20,000 Net income $230,000 Another method is to report only one line for total income tax expense of $20,000 on the face of the income statement and disclose the components of income tax expense in the notes to the fi nancial statements.
Statement of Financial Position Classifi cation
Companies classify taxes receivable or payable as current assets or current liabilities. Although current tax assets and liabilities are separately recognized and measured, they are often offset in the statement of fi nancial position. The offset occurs because companies normally have a legally enforceable right to offset a current tax asset (Taxes Receivable) against a current tax liability (Taxes Payable) when they relate to income taxes levied by the same taxation authority. Deferred tax assets and deferred tax liabilities are also separately recognized and measured but may be offset in the statement of fi nancial position. Companies are permitted to offset deferred tax assets and deferred tax liabilities if, and only if: (1) the company has a legally enforceable right to offset current tax assets against current tax liabilities; and (2) the deferred tax assets and the deferred tax liabilities relate to income taxes levied by the same tax authority and for the same company. The net deferred tax asset or net deferred tax liability is reported in the non-current section of the statement of fi nancial position. Deferred tax amounts should not be discounted. The IASB apparently considers discounting to be an unnecessary complication even if the effects are material. To illustrate, assume that K. Scott Company has four deferred tax items at December 31, 2012, as shown in Illustration

IFRS19-4.

ILLUSTRATION
IFRS19-4
Classifi cation of Temporary Differences Resulting Deferred Tax Temporary Difference (Asset) Liability 1. Rent collected in advance: recognized when earned for accounting purposes and when received for tax purposes. $(42,000) 2. Use of straight-line depreciation for accounting purposes and accelerated depreciation for tax purposes. $214,000 3. Recognition of profits on installment sales during period of sale for accounting purposes and during period of collection for tax purposes. 45,000 4. Warranty liabilities: recognized for accounting purposes at time of sale; for tax purposes at time paid. (12,000) Totals $(54,000) $259,000 As indicated, K. Scott has a total deferred tax asset of $54,000 and a total deferred tax liability of $259,000. Assuming these two items can be offset, K. Scott reports a deferred tax liability of $205,000 ($259,000 2 $54,000) in the non-current liability section of its statement of fi nancial position.
ON THE HORIZON
The IASB and the FASB have been working to address some of the differences in the accounting for income taxes. Some of the issues under discussion are the term “probable” under IFRS for recognition of a deferred tax asset, which might be interpreted to mean “more likely than not.” If the term is changed, the reporting for impairments of deferred tax assets will be essentially the same between GAAP and IFRS. In addition, the IASB is considering adoption of the classifi cation approach used in GAAP for deferred assets and liabilities. Also, GAAP will likely continue to use the enacted tax rate in computing deferred taxes, except in situations where the taxing jurisdiction is not involved. In that case, companies should use IFRS, which is based on enacted rates or substantially enacted tax rates. Finally, the issue of allocation of deferred income taxes to equity for certain transactions under IFRS must be addressed in order to converge with GAAP, which allocates the effects to income. At the time of this printing, deliberations on the income tax project have been suspended indefi nitely.
IFRS SELF-TEST QUESTIONS
1. Which of the following is false? (a) Under GAAP, deferred taxes are reported based on the classifi cation of the asset or liability to which it relates. (b) Under IFRS, some potential liabilities are not recognized. (c) Under GAAP, the enacted tax rate is used to measure deferred tax assets and liabilities. (d) Under IFRS, all deferred tax assets and liabilities are classifi ed as non-current. 2. Which of the following statements is correct with regard to IFRS and GAAP? (a) Under GAAP, all potential liabilities related to uncertain tax positions must be recognized. (b) The tax effects related to certain items are reported in equity under GAAP; under IFRS, the tax effects are charged or credited to income. (c) IFRS uses an affi rmative judgment approach for deferred tax assets, whereas GAAP uses an impairment approach for deferred tax assets. (d) IFRS classifi es deferred taxes based on the classifi cation of the asset or liability to which it relates. 3. Under IFRS: (a) “probable” is defi ned as a level of likelihood of at least slightly more than 60%. (b) a company should reduce a deferred tax asset when it is likely that some or all of it will not be realized by using a valuation allowance. (c) a company considers only positive evidence when determining whether to recognize a deferred tax asset. (d) deferred tax assets must be evaluated at the end of each accounting period. 4. Stephens Company has a deductible temporary difference of $2,000,000 at the end of its fi rst year of operations. Its tax rate is 40 percent. Stephens has $1,800,000 of income taxes payable. After a careful review of all available evidence, Stephens determines that it is probable that it will not realize $200,000 of this deferred tax asset. On Stephens Company’s statement of fi nancial position at the end of its fi rst year of operations, what is the amount of deferred tax asset? (a) $2,000,000. (c) $800,000. (b) $1,800,000. (d) $600,000. IFRS Insights 1203 5. Lincoln Company has the following four deferred tax items at December 31, 2012. The deferred tax assets and the deferred tax liabilities relate to income taxes levied by the same tax authority. On Lincoln’s December 31, 2012, statement of fi nancial position, it will report: (a) $394,000 non-current deferred tax liability and $689,000 non-current deferred tax asset. (b) $330,000 non-current liability and $625,000 current deferred tax asset. (c) $295,000 non-current deferred tax asset. (d) $295,000 current tax receivable.
IFRS CONCEPTS AND APPLICATION

IFRS19-1
Where can authoritative IFRS related to the accounting for taxes be found?
IFRS19-2
Briefl y describe some of the similarities and differences between GAAP and IFRS with respect to income tax accounting.
IFRS19-3
Describe the current convergence efforts of the FASB and IASB in the area of accounting for taxes.
IFRS19-4
How are deferred tax assets and deferred tax liabilities reported on the statement of fi nancial position under IFRS?
IFRS19-5
Describe the procedure(s) involved in classifying deferred tax amounts on the statement of fi nancial position under IFRS.
IFRS19-6
At December 31, 2012, Hillyard Corporation has a deferred tax asset of $200,000. After a careful review of all available evidence, it is determined that it is probable that $60,000 of this deferred tax asset will not be realized. Prepare the necessary journal entry.
IFRS19-7
Rode Inc. incurred a net operating loss of $500,000 in 2012. Combined income for 2010 and 2011 was $350,000. The tax rate for all years is 40%. Rode elects the carryback option. Prepare the journal entries to record the benefi ts of the loss carryback and the loss carryforward.
IFRS19-8
Use the information for Rode Inc. given in
IFRS19-7. Assume that it is probable that the entire net operating loss carryforward will not be realized in future years. Prepare the journal entry(ies) necessary at the end of 2012.

IFRS19-9
Youngman Corporation has temporary differences at December 31, 2012, that result in the following deferred taxes. Deferred tax asset $24,000 Deferred tax liability $69,000 Indicate how these balances would be presented in Youngman’s December 31, 2012, statement of fi nancial position. Deferred Deferred Temporary Difference Tax Asset Tax Liability Rent collected in advance: recognized when earned for accounting purposes and when received for tax purposes $652,000 Use of straight-line depreciation for accounting purposes and accelerated depreciation for tax purposes $330,000 Recognition of profi ts on installment sales during period of sale for accounting purposes and during period of collection for tax purposes 64,000 Warranty liabilities: recognized for accounting purposes at time of sale; for tax purposes at time paid 37,000
IFRS19-10
At December 31, 2012, Cascade Company had a net deferred tax liability of $450,000. An explanation of the items that compose this balance is as follows. In analyzing the temporary differences, you fi nd that $30,000 of the depreciation temporary difference will reverse in 2013, and $120,000 of the temporary difference due to the installment sale will reverse in 2013. The tax rate for all years is 40%.
Instructions
Indicate the manner in which deferred taxes should be presented on Cascade Company’s December 31, 2012, statement of fi nancial position.
IFRS19-11
Callaway Corp. has a deferred tax asset account with a balance of $150,000 at the end of 2012 due to a single cumulative temporary difference of $375,000. At the end of 2013, this same temporary difference has increased to a cumulative amount of $500,000. Taxable income for 2013 is $850,000. The tax rate is 40% for all years.
Instructions
(a) Record income tax expense, deferred income taxes, and income taxes payable for 2013, assuming that it is probable that the deferred tax asset will be realized. (b) Assuming that it is probable that $30,000 of the deferred tax asset will not be realized, prepare the journal entry at the end of 2013 to recognize this probability.
Professional Research

IFRS19-12
Kleckner Company started operations in 2009, and although it has grown steadily, the company reported accumulated operating losses of $450,000 in its fi rst four years in business. In the most recent year (2013), Kleckner appears to have turned the corner and reported modest taxable income of $30,000. In addition to a deferred tax asset related to its net operating loss, Kleckner has recorded a deferred tax asset related to product warranties and a deferred tax liability related to accelerated depreciation. Given its past operating results, Kleckner has determined that it is not probable that it will realize any of the deferred tax assets. However, given its improved performance, Kleckner management wonders whether there are any accounting consequences for its deferred tax assets. They would like you to conduct some research on the accounting for recognition of its deferred tax asset.
Instructions
Access the IFRS authoritative literature at the IASB website (http://eifrs.iasb.org/ ). When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following questions. (Provide paragraph citations.) (a) Briefl y explain to Kleckner management the importance of future taxable income as it relates to the recognition of deferred tax assets. (b) What are the sources of income that may be relied upon in assessing realization of a deferred tax asset? Temporary Differences in Deferred Taxes Resulting Balances 1. Excess of tax depreciation over book depreciation. $200,000 2. Accrual, for book purposes, of estimated loss contingency from pending lawsuit that is expected to be settled in 2013. The loss will be deducted on the tax return when paid. $ (50,000) 3. Accrual method used for book purposes and installment method used for tax purposes for an isolated installment sale of an investment. $300,000 (c) What are tax-planning strategies? From the information provided, does it appear that Kleckner could employ a tax-planning strategy in evaluating its deferred tax asset?
International Financial Reporting Problem:

Marks and Spencer plc

IFRS19-13
The fi nancial statements of Marks and Spencer plc (M&S) are available at the book’s companion website or can be accessed at http://corporate.marksandspencer. com/documents/publications/2010/Annual_Report_2010.
Instructions
Refer to M&S’s financial statements and the accompanying notes to answer the following questions. (a) What amounts relative to income taxes does M&S report in its: (1) 2010 income statement? (2) 3 April 2010 statement of fi nancial position? (3) 2010 statement of cash fl ows? (b) M&S’s provision for income taxes in 2009 and 2010 was computed at what effective tax rates? (See the notes to the fi nancial statements.) (c) How much of M&S’s 2010 total provision for income taxes was current tax expense, and how much was deferred tax expense? (d) What did M&S report as the signifi cant components (the details) of its 3 April 2010 deferred tax assets and liabilities?
ANSWERS TO IFRS SELF-TEST QUESTIONS
1. b 2. c 3. d 4. d 5. c  




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