CHAPTER 19
Accounting for Income Taxes
LEARNING OBJECTIVES
1. Describe the fundamentals of accounting for income taxes.
2. Identify additional issues in accounting for income taxes.
CHAPTER REVIEW
Introduction
1. Chapter 19 addresses the issues related to accounting for income taxes. Taxable income is
2. (L.O. 1) Due to the fact that tax regulations and accounting principles differ in many
ways, taxable income and financial income frequently differ. The following represent
3. (L.O. 2) The items discussed in paragraph 2 above can result in temporary differences
between the amounts reported for book purposes and those reported for tax purposes. A
temporary difference is the difference between the tax basis of an asset or liability and its
Deferred Tax Liability
4. A deferred tax liability is the amount of deferred tax consequence attributable to the
5. Deferred tax liabilities meet the definitions of a liability because (a) they result from past
transactions, (b) a present obligation exists, and (c) future outflows of resources will result
6. For example, assume Angles Company has a taxable temporary difference of €5,000,000
at the end of its initial year of operations. Its tax rate is 45%, which means a deferred tax
Deferred Tax Asset
7. Due to the fact that deductible amounts can arise in the future as a result of temporary
differences at the end of the current year, the deferred tax consequences of these
deductible amounts should be recognized as a deferred tax asset. A deferred tax asset
8. A deferred tax asset is recognized for all deductible temporary differences. However,
deferred tax assets should be reduced if, based on available evidence, it is probable that
some portion or all of the deferred tax asset will not be realized. Probable is defined as a
level of likelihood of at least slightly more than 50%. For example, assume Angles Company
Income Statement Presentation
9. (L.O. 2) The formula to compute income tax expense (benefit) is as follows:
Income Tax Change in Total Income
Temporary and Permanent Differences
10. Differences between taxable income and accounting income can be categorized as either
(a) temporary differences or (b) permanent differences. Temporary differences arise
11. Temporary differences originate in one period and reverse or “turn around” in one or more
subsequent periods. For example, when a company records a product warranty liability,
12. Two concepts related to temporary differences are originating differences and reversing
differences. An originating difference is the initial temporary difference between the book
13. Permanent differences are items that (a) enter into financial income but never into taxable
income or (b) enter into taxable income but never into financial income. Examples of perma-
Future Tax Rates
14. When recording deferred income taxes consideration must be given to the tax rate in
effect when the timing differences reverse. Normally, the current tax rate is used to
Accounting for Tax Losses
15. (L.O. 3) A net operating loss occurs for tax purposes in a year when tax-deductible
expenses exceed taxable revenues. Under certain circumstances tax laws permit
16. A company may carry a net operating loss back two years and receive refunds for income
taxes paid in those years. The loss must be applied to the earliest year first and then to
17. When a company carries a tax loss back, the tax loss gives rise to a refund that is both
measurable and currently realizable; therefore, the associated tax benefit should be
Financial Statement Presenation: Statement of Financial Position
18. (L.O. 4) Deferred income taxes are reported on the statement of financial position as non-
Financial Statement Presentation: Income Statement
19. Income tax expense (or benefit) should be allocated to continuing operations, discontinued
operations, other comprehensive income, and prior period adjustments. This approach is
referred to as intraperiod tax allocation. Companies are required to provide one of the
following disclosures:
• A numerical reconciliation between tax expense (benefit) and the product of accounting
profit multiplied by the applicable tax rate(s), disclosing also the basis on which the
Asset-Liability Method
20. The IASB believes that the asset-liability method is the most consistent method for
accounting for income taxes. One objective of this approach is to recognize the amount of
taxes payable or refundable for the current year. A second objective is to recognize
deferred tax liabilities and assets for the future tax consequences of events that have
b. A deferred tax liability or asset is recognized for the estimated future tax effects attributed
to temporary differences and carryforwards.
Interperiod Tax Allocation
*21. (L.O. 5) A comprehensive illustration of a deferred income tax problem is included in
Appendix 19-A. This illustration is one that should be analyzed and studied as it will provide
a sound basis for an understanding of the many aspects of accounting for income taxes.
LECTURE OUTLINE
The material in this chapter can be covered in three class periods. The conceptual issues in this
chapter are difficult and the accounting procedures complex..
A. (L.O. 1) Taxable Income and Financial Income.
1. Taxable income is calculated in accordance with prescribed tax regulations and rules.
B. Deferred Income Taxes.
1. A temporary difference is the difference between the tax basis of an asset or liability
and its reported amount in the financial statements that will result in taxable amounts or
deductible amounts in future years when the asset is recovered or the liability is settled.
C. Deferred Tax Liability.
1. A deferred tax liability represents the increase in taxes payable in future years as
a result of taxable temporary differences existing at the end of the current year.
2. Calculation of deferred tax liability.
3. Income tax expense (benefit) has two components:
a. Deferred tax expense (benefit) is the increase (decrease) in the deferred tax
4. Discuss whether a deferred tax liability meets the definition of a liability.
D. Objectives of accounting for income taxes under the asset-liability method.
1. Recognize the amount of taxes payable or refundable for the current year.
E. Deferred Tax Asset.
1. A deferred tax asset represents the increase in taxes refundable (saved) in future
years as a result of deductible temporary differences at the end of the current year.
Discuss whether a deferred tax asset meets the conceptual definition of an asset.
a. Results from a past transaction.
2. Calculation of deferred tax asset.
a. Book basis—tax basis of asset or liability = cumulative temporary difference;
cumulative temporary difference x enacted tax rate.
4. Deferred tax assets should be reduced if it is probable that some portion or all of the
deferred tax asset will not be realized.
a. Evaluate available evidence, both positive and negative.
2. Deferred tax expense.
G. Temporary and Permanent Differences.
1. Provide examples of temporary differences.
2. Provide examples of permanent differences.
(There are no defined tax consequences to be recognized.)
a. Items recognized for accounting but not for taxes.
H. Discuss the tax rates used to compute deferred income tax amounts.
1. Current tax rate. Use when currently enacted tax rate will not change.
I. (L.O. 3) Accounting for Net Operating Losses.
1. Illustrate loss carryback (2 years).
a. Refund is recorded and reported as a receivable on the statement of financial
position.
(2) Benefit Due to Loss Carryforward recorded and reported on income statement
of current period as a contra-income tax expense.
J. (L.O. 4) Financial Statement Presentation.
1. Statement of financial position.
a. Deferred tax assets and deferred tax liabilities are separately recognized,
2. Income Statement.
a. Intraperiod tax allocation.
K. Principles of the Asset-Liability Method.
1. Objectives.
a. Recognize amount of taxes payable or refundable for current year.
2. Annual procedures for the computation of deferred income taxes.
