MANAGEMENT DECISIONS AND FINANCIAL ACCOUNTING REPORTS

1. MANAGEMENT DECISIONS AND FINANCIAL ACCOUNTING REPORTS Baginski & Hassell

2. Chapter 11 Accounting for T A X E S

3. TAXES • Topics • Sales taxes • Property taxes • Income taxes I just want my taxes to be BELOW ZERO!

4. SALES TAXES (Non-federal) • Sales taxes collected are held (as a trustee), then remitted to taxing authorities. • Sales taxes paid become part of the cost of acquiring the purchase (asset) being taxed. • Sales taxes on items treated as a period expense are, therefore, also treated as a period expense.

5. PROPERTY TAXES • In general, property taxes paid are treated as a period expense and matched against period revenues. • Property taxes incurred on factory items are treated as factory overhead items (to be allocated to inventory produced).

6. INCOME TAXES • Differences in GAAP and the tax code lead to book/tax differences. • The text cases are based on the premise that difference in cash-basis and accrual- basis accounting are immaterial; differences in GAAP and TAX LAW become the emphasis.

7. Book/tax differences are classified as • Temporary (creates accounting problems) • Example: Straight-line depreciation for book purposes; MACRS for tax purposes • Example: Warranty expenses accrued for book purposes; not tax deductible until paid. • Permanent (no unusual accounting) • Temporary differences create the need to calculate “Deferred income tax” related items.

8. Temporary Differences and Deferred Income Taxes • Temporary differences originate in a single year (or over a series of years) and reverse in a single year (or over a series of years). • Any related deferred income tax amounts are initiated in a single year (or over a series of years) and reverse in a single year (or over a series of years).

9. “Temporary” Book versus Tax Cases Incomes: Recognized by tax law ahead of books. Recognized on books ahead of tax law. Expenses: Recognized by tax law ahead of books. Recognized on books ahead of tax law. FAQ: Which creates deferred debt? …deferred receivable?

12. Deferred Income Tax Related Accounts’ Presentation • The classification of “deferred income tax” accounts depends on the current or noncurrent classifications in the event(s) generating the “deferred tax” item. Examples follow: • The deferred income liability associated with depreciable noncurrent assets is classified as noncurrent.

13. The deferred income tax asset associated with estimated warranty accruals (to be paid within one year) is classified as current because the warranty liability is current. • Any deferred income tax asset associated with estimated warranty liabilities (to be paid beyond one year) is classified as noncurrent because the warranty liability is noncurrent.

14. Income Tax Expense(Provision for Income Taxes) • On the income statement: • Income tax expense is reported below “Income before income taxes” (i.e., pretax income). • Income tax expense is separated into current and deferred components on the income statement.

16. Current portion of income tax expense: the amount of income taxes owed to Federal, State, and Local taxing authorities for the current year. • Noncurrent portion of income tax expense: the net change in the “deferred income tax” asset and liability accounts during the current year.

17. Net Operating Losses (NOLs) • NOLs can be carried back if the corporation elects to do so; else, the NOL is carried forward (carried back for two years and forward for twenty years). • The tax consequences of an NOL are dependent upon the tax rates in the years to which the NOL is ultimately applied.

18. When an NOL is used, it is applied against taxable incomes on the various tax returns, thereby reducing income taxes payable. • An NOL carryback generates an income tax refund receivable, the offset being a income tax benefit during the current year.

19. An NOL carryforward generates a deferred income tax asset and creates an income tax benefit for the current period, given that it is more likely than not that the NOL carryforward will be applied in the next (per current law) 20 years • If it is more likely than not that the NOL carryforward will be less than fully applied in the next 20 years, then ... • A valuation allowance is used to reduce the deferred income tax asset, and the income tax expense is reduced by the allowance.

20. Effects of Income Tax Rate Change When enacted, any change in income tax rates requires the deferred income tax amounts to be recalculated to conform to new tax rates. Pay me now, or pay me later!

21. Intraperiod Income Tax Allocation to Extraordinary Items, Discontinued Operations, and Cumulative Effects of Accounting Changes • Extraordinary items, discontinued operations, and cumulative effects are shown at the bottom of the income statement, net of income tax effects. • Example: Shane Company’s 2004 Partial Income Statement follows ...

24. Effective Income Tax Rate If a corporation’s effective tax rate is different from the Federal statutory tax rate (currently 35%), then the firm presents a reconciliation from the statutory rate to the effective tax rate in a footnote.

25. The Provision for Income Taxes exceeds the U.S. Federal Statutory Rate as a Result of the Following Differences

26. Example: One Permanent Difference, Two Temporary Differences • Facts: The Petersen Co. began operations on January 1, 2004. The following information is presented for 2004 and 2005. • All book and tax amounts were the same except for three items. • Assume that all items are treated the same for Federal and State income tax purposes.

29. Compute Corporate Taxable Income and Income Taxes Payable Form 1120

32. Income Statement Presentation

33. Deferred Income Taxes Computed on Temporary Differences

34. Summary • Difference is a taxable amount; the ending deferred tax amount is a deferred income tax liability. • Deferred tax amount is noncurrent because property, plant, and equipment is noncurrent. • Increase in a deferred income tax liability increases income tax expense.

37. Balance Sheet Presentation • Assume that during the year Petersen Co. made tax payments equal to 90% of income taxes payable for the year. • Therefore, the FYE tax liability is the remaining 10% of the total amount.

38. Petersen Co.:

39. Statement of Cash Flows • Income taxes are an operating activity • Direct method: amount of taxes paid • Indirect method: change in taxes payable and deferred tax accounts are adjustments to net income

40. End of Chapter 11