Chapter 19: 2Q (page 1092)
What are the two objectives of accounting for income taxes?
Accounting is referred to as the first function of an accounting department. It involves the preparation of various accounting schedules to record the inflow and outflow of cash.
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Briefly describe some of the similarities and differences between GAAP and IFRS with respect to income tax accounting.
The accounting records of Shinault Inc. show the following data for 2017 (its first year of operations).
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 2017. Actual repair and labor costs related to the warranties in 2017 were \(10,000. The remainder is estimated to be paid evenly in 2018 and 2019.
5. Gross profit on an accrual basis was \)100,000. For tax purposes, \(75,000 was recorded on the installment-sales method.
6. Fines incurred for pollution violations were \)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 2017 and ending with taxable income in 2017. (b) Prepare the journal entry for 2017 to record income taxes payable, income tax expense, and deferred income taxes.
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.
(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.
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?
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