Diana Paola Lagunes Blanco

A01321107
Sistema Financiero Internacional

CHAPTER 19 ACCOUNTIN G FOR INCOME TAXES

RESUME

The tax codes allow companies that report operating losses to clam a tax credit related to these losses
for taxes paid in the past (referred to as “carrybacks”) and to offset taxable income in periods folloeing
the operating loss (“carryforwards”). For tax carryforwards, companies also record a deferred tax
asset, which measures the expected future net cash inflows from lower taxable income in the future
periods. Companies must present financial information for the investment community that provides
a clear picture of present and potential tax obligations and tax benefits.

FUNDAMENTALS OF ACCOUNTING FOR INCOME

Pretax financial income is a financial reporting term, it’s also referred to income before taxes,
income for financial reporting purposes, or income for book purposes. They measure it with the
objective to providing useful information to investors and creditors. Taxable income is a tax
accounting term, indicates the amount used to compute income taxes payable. Income taxes provide
money to support government operations.
Income tax expense and income taxes payable differed over the years, but where equal in total. The
differences between income tax expense and income taxes payable. For financial reporting, use the
full accrual method to report revenues. For tax purposes, they use a modified cash basis. Difference
between income tax expense and income taxes payable is often referred to as a deferred tax amount.
In this case it is a deferred tax liability. In cases where taxes will be lower in the future, records a
deferred tax asset.
FUTURE TAXABLE AMOUNTS AND DEFERRED TAXES
Income taxes payable can differ from income tax expenses. This can happen when there are temporary
difference between the amount reported for tax purposes and those reported for book purposes. A
temporary difference is the difference between the tax basis of an asset or liability and its reported
(carrying or book) amount in the financial statements, which will result in taxable amounts or
deductible amounts in the future years. Taxable amounts increase taxable income in future years.
Deductible amount decrease taxable income in future years.
An assumption is that companies recover and settle the assets and liabilities at their reported amounts
(carrying amounts). This creates a requirement under accrual accounting to recognize currently the
deferred tax consequences of temporary differences. Companies recognize the amount of income
taxes that are payable (or refundable) when they recover and settle the reported amounts of the assets
and liabilities.
DEFERRED TAX LIABILITY
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. Companies may also compute the
deferred tax liability by preparing a schedule that indicates the future taxable amounts due to existing
temporary differences. The income tax expense has two components: current tax expense (the amount
of income taxes payable for the period) and deferred tax expense (the increase in the deferred tax
liability balance from the beginning to the end of the accounting period). El asiento de diario para
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representar esto:
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Income Tax Expense x

 Diana Paola Lagunes Blanco
A01321107
Sistema Financiero Internacional

Income Taxes Payable x

Deferred Tax Liability x

For record income tax expense, the change in the deferred tax liability and income taxes payable as
follow:
Income tax Expense x
Deferred Tax Liability x
Income Taxes Payable x

The deferred tax liability meets the definition of a liability established “Elements of Financial
Statements”, because:
1. It results form a past transaction
2. It’s a present obligation
3. It represents a future sacrifice.
SUMMARY OF INCOME TAX ACCOUNTING OBJECTIVES
One objective of accounting for income taxes is to recognize the amount of taxes payable or
refundable for the current day. A second objective is to recognize deferred tax liabilities and assets
for the future tax consequences of events already recognized in the financial statements or tax returns.
That amount will appear on future tax returns as income for the period when collected.
FUTURE DEDUCTIBLE AMOUNTS AND DEFERRED TAXES
For tax purposes, the warranty tax deduction is not allowed until paid. Companies reports this
future tax benefit in the balance sheets as a deferred tax asset. Deductible amount occur in future
tax returns. These future deductible amount cause taxable income to be less than pretax financial
income in the future as a result of an existing temporary difference.
DEFERRED TAX ASSET
A deferred tax asset is the deferred tax consequence attributable to deductible temporary differences.
A deferred tax asset represents the increase in taxes refundable (or saved) in future years as a result
of deductible temporary differences existing at the end of the current year. The deferred tax benefit
results form the increase in the deferred tax asset from the beginning to the end of the accounting
period.
Based on the conceptual definition of an asset, a deferred tax asset meets the three main conditions
for an item to be recognized as an asset:
1. It results from a past transaction
2. It gives rise to a probable benefit in the future
3. The entity controls access to the benefits.
DEFERRED TAX ASSET – VALUATION ALLOWANCE
A company should reduce a deferred tax asset by a valuation allowance if it more likely than not
that it will not realize some portion or all of the deferred tax asset. This means a level of likelihood
of at least slightly more than 50 percent. A company has a deductible temporary difference at the
end of its first year of operations. This record:
Income tax Expense x
Deferred Tax Liability x
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Income Taxes Payable x

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 Diana Paola Lagunes Blanco
A01321107
Sistema Financiero Internacional

When the company determinates that it is more likely than not that it will not realize of this deferred
tax asset, it records:
Income Tax Expense x
Allowance to Reduce Deferred Tax Asset
to Expected Realizable Value x

This journal entry increases income tax expense in the current period because the company does not
expect to realize a favorable tax benefit for a portion of the deductible temporary difference.
Simultaneously establishes a valuation allowance to recognize the reduction in the carrying amount
of the deferred tax asset. This valuation account is a contra account. Then, the company evaluates this
allowance account at the end of each accounting period. The company makes the following entry to
adjust the valuation account:
Allowance to Reduce Deferred Tax Asset
to Expected Realizable Value x
Income Tax Expense x

The company should consider all available evidence, both positive and negative, to determine
whether, based on the weight of available evidence, it needs a valuation allowance.
INCOME STATEMENT PRESENTATION
Circumstances dictate whether a company should add or subtract the change in deferred income taxes
to or from income taxes payable in computing income tax expense. In the income statement or in the
notes to the financial statements, a company should disclose the significant components of income
tax expense attributable to continuing operations. Another option is to simply report the total income
tax expense on the income statement, and then indicate in the notes to the financial statements the
current and deferred portions. Income tax expense is often referred to as “Provision for income taxes”.
SPECIFIC DIFFERENCES
Numerous items create differences between pretax financial income and taxable income, these are
two: temporary and permanent. Taxable temporary differences are temporary differences that will
result in taxable amounts in future years when he relates assets are recovered. Deductible temporary
differences are temporary differences that will result in deductible amounts in future years, when the
related book liabilities are settled. Taxable temporary differences give rise to recording deferred tax
liabilities. Examples of temporary differences:

- Revenue or fair are taxable after they are recognized in financial income
- Expenses or losses are deductible after they are recognized in financial income
- Revenues or gains are taxable before they are recognized in financial income
- Expenses or losses are deductible before they are recognized in financial income.

Originating and Reversing Aspects of Temporary Differences is the initial differences between the
book basis of an asset or liability. Occurs when eliminating a temporary difference that originated in
prior periods and then moving the related tax effect from the deferred tax account.

Permanent differences result from items that enter into pretax financial income but never into
taxable income or enter into income but never into pretax financial income. Affect only the period in
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which the difference occurs, they do not give rise to future taxable or deductible amounts. Companies
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recognized no deferred tax consequences. Examples of permanent differences:

 Diana Paola Lagunes Blanco
A01321107
Sistema Financiero Internacional

- Items are recognized for financial reporting purposes but not for tax purposes.
- items are recognized for tax purposes but not for financial reporting purposes.

TAX RATE CONSIDERATION

The enacted tax rate did not change from one year to next. To compute the deferred income tax
amount to report in the balance sheet, a company multiplies the cumulative temporary difference by
the current tax rate.

FUTURE TAX RATES

If tax rates are expected to change in the future a company should use the enacted tax rate expected
to apply. A company must consider presently enacted changes in the tax rate that become effective for
a particular future year(s) when determining the tax rate to apply to existing temporary differences.
If new rates are not yet enacted for future, the company should use the current rate. In determining
the appropriate enacted tax rate for a giver year, companies must use the average tax rate. In
computing deferred income taxes, companies for which graduate tax rates are a significant factor
must therefore determine the average tax rate and use that rate.

REVISION OF FUTURE TAX RATES

When change in the tax rate is enacted, companies should record its effect on the existing deferred income
tax accounts immediately. A company reports the effect as an adjustment to income tax expense in the
period of the change.

ACCOUNTING FOR NET OPERATING LOSSES

A net operating loss (NOL) occurs for tax purposes in a year when tax-deductible expenses exceed
taxable revenues. An inequitable tax burden would result if companies were taxed during profitable
periods without receiving any tax relief during periods of net operating losses. Companies accomplish
the income averaging provision through the carryback and carryforward of NOL. A company pays
no income taxes for a year in which it incurs a net operating loss.
Loss carrybacks, a company may carry the net operating loss back two years and recive refunds for
income taxes paid in those years. The company must applt the loss to the earlier year first and then to
the second tear. For accounting as well as tax purpose the refunds represent the tax effect of the loss
carryback. Since the tax loss gives rise to a refund that is both measurable and currenly realizable, the
company should recognize the associated tax benefit in this loss period. The company should makes
the following entry:
Income Tax Receivable x
Benefit due to loss carrybacks x

And reports the account debited, income tax refund receivable, on the balance sheet.
It may carryforward any loss remaining after the two-year carryback up to 20 years to offset future
taxable income. A company may forgo the loss carryback and use only the loss carryforward option,
offsetting future taxable income for up 20 years. Operating losses can be substantial. Because
companies use carryforwards to offser future taxable income, the tax effect of a loss carryforward
represents future tax savings, which depends on future earnings, an uncertain prospect.
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There should be different requirements for recognition of a deferred tax asset for deductible temporary
differences, and operating loss carryforwards.
 Diana Paola Lagunes Blanco
A01321107
Sistema Financiero Internacional

CARRYFORWARDS WITHOUT VALUATION ALLOWANCE

The accounting for an operating loss carryforward the company needs to record the benefits of the
carryback and the carryforward:
To recognize benefit of loss carryback
Income tax refund receivable x
Benefit due to loss carryback x
To recognize benefit of loss carryforwards
Deferred Tax Asset x
Benefit due to loss carryforwards x

This current tax benefit is the income tax refundable for the year. The deferred tax benefit for the
year which results from an increase in the deferred tax asset.
CARRYFORWARD WITH VALUATION ALLOWANCE
Assume that it is more likely than not that company will not realize the entire NOL carryforward in
future years and makes the following journal entries:
To recognize benefit of loss carryback
Income tax refund receivable x
Benefit due to loss carryback x
To recognize benefit of loss carryforward
Deferred tax asset x
Benefit due to loss carryforward x
To record allowance amount
Benefit due to loss carryforwards x
Allowance to reduce deferred tax asset
to expected realizable value x

The latter entry indicates that because positive evidence of enough quality and quantity is unavailable
to counteract the negative evidence. The company needs a valuation allowance. If company realizes
the deferred tax asset, it thus no longer needs the allowance. It’s records the following entries:
To record current and deferred income taxes
Income tax expense x
Deferred Asset x
Income tax payable x
To eliminate allowance and recognize loss carryforward
Allowance to reduce deferred tax asset to
Expected realizable value x
Benefit due to loss carryforward x

Another method is to report only one line for total income tax expense on the face of the income
statement and disclose the components of income tax expense in the notes to the financial statements.
VALUATION ALLOWANCE REVISTED
A company should consider all positive and negative information in determining whether it needs a
valuation allowance. Whether the company will realize a deferred tax asset depends on whether
sufficient taxable income exits or will exist within the carryforward period available under tax law.
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 Diana Paola Lagunes Blanco
A01321107
Sistema Financiero Internacional

If any of these sources is sufficient to support a conclusion that a valuation allowances is unnecessary,
a company need not consider other sources. Forming a conclusion that a valuation allowances is not
needed is difficult when there is negative evidence. Companies may also cite positive evidence
indicating that a valuation allowance is not needed.
The use of valuation allowance provides a company whit an opportunity to manage its earnings. Some
companies may set up a valuation account and the use it to increase income as needed. Others may
take the income immediately to increase capital or to offset large negative charges incomes.

FINANCIAL STATEMENT PRESENTATION

An individual feferred tax liabiality or asset is classified as current or noncurrent based on the
classification of the related asset or liability for financial reporting purposes. A company considers a
deferred tax asset or liability if reduction of the asset or liability causes the temporary difference to
reverse or turn around. Should calissify a deferred tax liability or asset that is unrealated to an asset
or liability for financial reporting, including a deferred tax asset related to a loss carryforward,
according to the expected reversal date of the temporary difference.
Most companies engage in many transactions that give rise to deferred taxes. Companies should
classify the balances in the deferred tax accounts in two categories: one for the net current amount
and one for the net noncurrent amount. This procedure ass follows:
1. Classify the amounts as a current or noncurrent.
2. Determinate the net current amount by summing the various deferred tax assets and liabilities
classified as current
3. Determinate the net current amount by summing the various deferred tax assets and liabilities
classified as noncurrent.
A deferred tax asset or liability may not be related on an asset or liability for financial reporting
purposes. A company should report the tax effect of any temporary difference reversing next year as
current, and the remainder as noncurrent. If a deferred tax asset is noncurrent, a company should
classify in the “other assets” section.
INCOME STATEMENT
Companies should allocate income tax expense to continuing operations, discontinued operations,
extraordinary items a prior period adjustment. This approach is referred to as intraperiod tax
allocation. Companies should disclose the significant components of income tax expense attributable
to continuing operations-
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1. Current tax expense or benefit

2. Deferred tax expense or benefit, exclusive of other components listed below
 Diana Paola Lagunes Blanco
A01321107
Sistema Financiero Internacional

3. Investment tax credits

4. Government grants
5. The benefits of operating loss carryforwards
6. Tax expense that results from allocating tax benefits
7. Adjustments of a deferred tax liability or asset for enacted changes in tax laws or rules o a
change in the tax status of a company
8. Adjustments of the beginning of the year balance of a valuation allowance.
Companies must also reconcile income tax expense attributable to continuing operations with the
amount that results from applying domestic federal statutory tax rates to pretax income from
continuing significant reconciling items. These income tax disclosures are required for several
reasons:
1. Assessing quality earnings
2. Making better predictions of the future cash flows
3. Predicting future cash flows for operating loss carryforwards.
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