19 Accounting for Income Taxes CONCEPTS FOR ANALYSIS 19
CONCEPTS FOR ANALYSIS
CA19-1 WRITING (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 WRITING (Basic Accounting for Temporary Differences) Dexter Company appropriately uses the asset-liability 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 the manner in which these accounts are to be reported on the balance sheet.
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) Indicate where deferred income taxes are 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, 2017, Higley Corporation has one temporary difference which will reverse and cause taxable amounts in 2018. In 2017, a new tax act set taxes equal to 45% for 2017, 40% for 2018, and 34% for 2019 and years thereafter.
Instructions
Explain what circumstances would call for Higley to compute its deferred tax liability at the end of 2017 by multiplying the cumulative temporary difference by:
(a) 45%.
(b) 40%.
(c) 34%.
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...
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 ETHICS (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?
