HOMEWORK - INCOME TAXES
Arepentido, Jessica P. Prof. Mohammad Bin Siradj M. Abantas
BSA 2201-1M 20160139775
1. Explain the difference between pretax financial income and taxable income.
Pretax financial income is a financial reporting term. It also is often referred to as income
before taxes, income for financial reporting purposes, or income for book purposes.
Companies determine pretax financial income according to IFRS. They measure it with the
objective of providing useful information to investors and creditors.
Taxable income (income for tax purposes) is a tax accounting term. It indicates the amount
used to compute income taxes payable. Companies determine taxable income according to
the tax regulations. Income taxes provide money to support government operations.
2. What are the two objectives of accounting for income taxes?
One objective of accounting for income taxes is to recognize the amount of taxes payable or
refundable for the current year. A second is to recognize deferred tax liabilities and assets
for the future tax consequences of events that have already been recognized in the financial
statements or tax returns.
3. Interest on governmental bonds is often referred to as a permanent difference when
determining the proper amount to report for deferred taxes. Explain the meaning of
permanent differences, and give two other examples.
A permanent difference is a difference between taxable income and pretax financial income
that, under existing applicable tax laws and regulations, will not be offset by corresponding
differences or “turn around” in other periods. Therefore, a permanent difference is caused
by an item that:
is included in pretax financial income but never in taxable income, or
is included in taxable income but never in pretax financial income.
Examples of permanent differences are:
premiums paid on officers’ life insurance policies in which the company is the
beneficiary (such premiums are not allowable expenses for determining taxable
income but are expenses for determining pretax financial income), and
fines and expenses resulting from a violation of law.
4. Explain the meaning of a temporary difference as it relates to deferred tax computations,
and give three examples.
A temporary difference is a difference between the tax basis of an asset or liability and its
reported (carrying or book) amount in the financial statements that will result in taxable
amounts or deductible amounts in future years when the reported amount of the asset is
recovered or when the reported amount of the liability is settled. The temporary differences
discussed in this chapter all result from differences between taxable income and pretax
financial income which will reverse and result in taxable or deductible amounts in future
periods.
Examples of temporary differences are:
Gross profit or gain on installment sales reported for financial reporting purposes
at the date of sale and reported in tax returns when later collected.
Depreciation for financial reporting purposes is less than that deducted in tax
returns in early years of assets’ lives because of using an accelerated depreciation
method for tax purposes.
Rent and royalties taxed when collected, but deferred for financial reporting
purposes and recognized as revenue when earned in later periods. (4) Unrealized
gains or losses recognized in income for financial reporting purposes but deferred
for tax purposes.
5. Differentiate between an originating temporary difference and a reversing difference.
Explain the difference between pretax financial income and taxable income.
An originating temporary difference is the initial difference between the book basis and the
tax basis of an asset or liability. A reversing difference occurs when a temporary difference
that originated in prior periods is eliminated and the related tax effect is removed from the
tax account.
6. What is the difference between a future taxable amount and a future deductible amount?
When is it not appropriate to recognize a portion or all of a deferred tax asset?
A future taxable amount will increase taxable income relative to pretax financial income in
future periods due to temporary differences existing at the balance sheet date. A future
deductible amount will decrease taxable income relative to pretax financial income in future
periods due to existing temporary differences.
A deferred tax asset is recognized for all deductible temporary differences. However, a
deferred tax asset should be reduced by a valuation account if, based on all available
evidence, it is more likely than not that some portion or all of the deferred tax asset will not
be realized. More likely than not means a level of likelihood that is slightly more than 50%.
7. How are deferred tax assets and deferred tax liabilities reported on the statement of
financial position?
Deferred tax accounts are reported on the balance sheet as assets and liabilities. They
should be classified in a net current and a net noncurrent amount. An individual deferred
tax liability or asset is classified as current or noncurrent based on the classification of the
related asset or liability for financial reporting purposes. A deferred tax asset or liability is
considered to be related to an asset or liability if reduction of the asset or liability will cause
the temporary difference to reverse or turn around. A deferred tax liability or asset that is
not related to an asset or liability for financial reporting purposes, including deferred tax
assets related to loss carryforwards, shall be classified according to the expected reversal
date of the temporary difference.
8. Describe the procedure(s) involved in classifying deferred tax amounts on the statement of
financial position.
The balances in the deferred tax accounts should be analyzed and classified on the balance
sheet in two categories: one for the net current amount, and one for the net noncurrent
amount. This procedure is summarized as indicated below.
Classify the amounts as current or noncurrent. If an amount is related to a specific
asset or liability, it should be classified in the same manner as the related asset or
liability. If not so related, it should be classified on the basis of the expected reversal
date.
Determine the net current amount by summing the various deferred tax assets and
liabilities classified as current. If the net result is an asset, report on the balance
sheet as a current asset; if it is a liability, report as a current liability.
Determine the net noncurrent amount by summing the various deferred tax assets
and liabilities classified as noncurrent. If the net result is an asset, report on the
balance sheet as a noncurrent asset (“other assets” section); if it is a liability, report
as a long-term liability.
9. What are some of the reasons that the components of income tax expense should be
disclosed and a reconciliation between the statutory tax rate and the effective rate be
provided?
Some of the reasons for requiring income tax component disclosures are:
Assessment of the quality of earnings. Many investors seeking to assess the quality
of a company’s earnings are interested in the reconciliation of pretax financial
income to taxable income. Earnings that are enhanced by a favorable tax effect
should be examined carefully, particularly if the tax effect is nonrecurring.
Better prediction of future cash flows. Examination of the deferred portion of
income tax expense provides information as to whether taxes payable are likely to
be higher or lower in the future.
10. Differentiate between “loss carryback” and “loss carryforward.” Which can be accounted for
with the greater certainty when it arises? Why?
The loss carryback provision permits a company to 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 second preceding year first and then to the preceding year.
The loss carryforward provision permits a company to carry forward a net operating loss
twenty years, offsetting future taxable income. The loss carryback can be accounted for with
more certainty because the company knows whether it had taxable income in the past; such
is not the case with income in the future.
