Deck 12: Accounting for Income Taxes

Question 1

Which of the following are temporary differences that are normally classified as expenses or losses and are deductible for income tax purposes after they are recognized for financial accounting income?

A) Product warranty liabilities
B) Advance rental receipts
C) Depreciable property
D) Fines and expenses resulting from a violation of law

Answer 1

A

Question 2

A company's only temporary difference results from using double declining balance depreciation for tax purposes and straight-line depreciation for financial reporting. The company purchases new plant assets each year. If currently enacted tax law will result in a higher tax rate for all future tax years, which accounting approach for deferred taxes will result in the lowest net income for this current year?

A) Nonallocation of deferred taxes.
B) Partial allocation of deferred taxes under the asset/liability method.
C) Comprehensive allocation of deferred taxes under the asset/liability method.
D) Comprehensive allocation of deferred taxes under the deferred method.

Answer 2

C

Question 3

A company has four "deferred income tax" accounts arising from timing differences involving (1) current assets, (2) noncurrent assets, (3) current liabilities, and (4) noncurrent liabilities. The presentation of these four "deferred income tax" accounts in the statement of financial position should be shown as

A) A single net non-current amount
B) A net current and a net noncurrent amount
C) Four accounts with no netting permitted
D) Valuation adjustments of the related assets and liabilities that gave rise to the deferred tax

Answer 3

B

Question 4

The accounting recognition of the benefit from a tax loss carryforward in most situations should be reported as

A) A reduction of the loss in the year of the loss with an appropriate valuation allowance
B) A prior period adjustment in whichever year the benefit is realized
C) As a component of income from continuing operations in the year in which the benefit is realized
D) An item on the retained earnings statement, not the income statement

Question 5

Smith Corporation owns only 25 percent of the voting stock of Jones Corporation, but exercises significant influence over its operating and financial policies. The tax effect of differences between taxable income and pretax accounting income attributable to undistributed earnings of Jones Corporation should be

A) Accounted for as a timing difference
B) Accounted for as a permanent difference
C) Ignored because it must be based on estimates and assumptions
D) Ignored because Smith holds less than 51 percent of the voting stock of Jones

Question 6

A major distinction between temporary and permanent differences is

A) Permanent differences are not representative of acceptable accounting practice
B) Temporary differences occur frequently, whereas permanent differences occur only once
C) Once an item is determined to be a temporary difference, it maintains that status; however, a permanent difference can change in status with the passage of time.
D) Temporary differences reverse themselves in subsequent accounting periods, whereas permanent differences do not reverse

Question 7

Which of the following is not an argument that an advocate of nonallocation of deferred taxes might use to support his/her position?

A) Income taxes result only from taxable income.
B) Income taxes are an expense of doing business and should be treated the same as other expenses of doing business under accrual accounting.
C) Income taxes are not levied on individual items of income or expense.
D) The current provision for income taxes is a better predictor of future cash flows than is income tax expense that includes deferred taxes.

Question 8

Which of the following would cause a deferred tax expense?

A) Write-down of goodwill due to impairment
B) Use of equity method where undistributed earnings of a 30 percent owned investee are related to probable future dividends
C) Premiums paid on insurance carried by company (beneficiary) on its officers or employees
D) Income is taxed at capital gains rates

Question 9

A machine with a 10-year useful life is being depreciated on a straight-line basis for financial statement purposes, and over 5 years for income tax purposes under the accelerated recovery cost system. Assuming that the company is profitable and that there are and have been no other timing differences, the related deferred income taxes would be reported in the balance sheet at the end of the first year of the estimated useful life as a

A) Current liability
B) Current asset
C) Noncurrent liability
D) Noncurrent asset

Question 10

A deferred tax asset represents a

A) Future tax expense
B) Future tax liability.
C) Future tax benefit
D) Future taxable amount

Question 11

Which of the following is an argument that an advocate of interperiod income tax allocation might use to support his/her position?

A) Income taxes result from taxable income.
B) Income taxes are an expense of doing business and should be treated the same as other expenses of doing business under accrual accounting.
C) Nonallocation of income taxes hides an economic difference between a company that employs tax strategies that reduce current tax payments than one that does not.
D) Income taxes are not incurred in anticipation of future benefits, nor are they expirations of cost to provide facilities to generate revenues.

Question 12

Differences between taxable income and pretax accounting income arising from transactions that, under applicable tax laws and regulations, will not be offset by corresponding differences or "turn around" in future periods is a definition of

A) Permanent differences
B) Timing differences
C) Intraperiod tax allocation
D) Interperiod tax allocation

Question 13

Under the asset-liability method, deferred taxes should be presented on the balance sheet

A) As one net non-current amount
B) In two amounts: one for the net current amount and one for the net non-current amount
C) In two amounts: one for the net debit amount and one for the net credit amount
D) As reductions of the related asset or liability accounts

Question 14

Taxable income of a corporation differs from pretax financial income because of Permanent Differences Temporary Differences

A) No Yes
B) Yes Yes
C) No No
D) Yes No

Question 15

Intraperiod tax allocation arises because

A) Items included in the determination of taxable income may be presented in different sections of the financial statements
B) Income taxes must be allocated between current and future periods
C) Certain revenues and expenses appear in the financial statements either before or after they are included in taxable income
D) Certain revenues and expenses appear in the financial statements but are excluded from taxable income

Question 16

Assuming no prior period adjustments, would the following affect net income? Interperiod Intraperiod
Income tax Income tax
Allocation Allocation

A) Yes Yes
B) Yes No
C) No Yes
D) No No

Question 17

A net operating loss carryoverforward that occurs in a company's second year of operations

A) May cause a company to report a tax benefit in the current period income statement.
B) Has no effect on income tax expense of the current period because no taxes are paid.
C) Causes a company to report a deferred income tax liability for taxes that are not paid currently.
D) Results in future taxable amounts.

Question 18

With respect to the difference between taxable income and pretax accounting income, the tax effect of the undistributed earnings of a subsidiary included in consolidated income should normally be

A) Accounted for as a timing difference
B) Accounted for as a permanent difference
C) Ignored because it must be based on estimates and assumptions
D) Ignored because it cannot be presumed that all undistributed earnings of a subsidiary will be transferred to the parent company

Question 19

Under the comprehensive deferred interperiod method of tax allocation, deferred taxes are determined on the basis of

A) Tax rates in effect when the timing differences originate without adjustment for subsequent changes in tax rates
B) Tax rates expected to be in effect when the items giving rise to the timing differences reverse themselves
C) Net valuations of assets or liabilities
D) Averages determined on an industry-by-industry basis

Question 20

Which of the following is a permanent difference?

A) Product warranty liabilities
B) Installment sales accounted for on an accrual basis
C) Deductible pension funding exceeding expense
D) Interest received on state and municipal obligations

Question 21

How is the earnings conservatism ratio calculated? Discuss the rationale behind the calculation of a company's earnings conservatism ratio.

Question 22

Describe the accounting treatment for net operating losses.

Question 23

Which of the following will result in a deferred tax asset?

A) Using the installment sales method for tax purposes, while using point of sale for financial reporting.
B) Reporting an unrealized gain for a trading security.
C) Using accelerated depreciation for tax purposes and straight-line depreciation for financial reporting.
D) Reporting an expected loss on from a lawsuit in the income statement, when it cannot be reported on the tax return until it is actually incurred.

Question 24

What is the difference between a future taxable amount and a future deductible amount?

Question 25

What are the objectives of accounting for income taxes?

Question 26

A company that has both short-term deferred tax assets of $22,000, long-term deferred tax liabilities of $36,000, short-term deferred tax liabilities of $51,000 and short-term deferred tax assets of $60,000 should report

A) A current asset for $22,000, a current liability for $36,000, a long-term asset for $60,000, and a long-term liability for $51,000.
B) A current liability for $14,000 and a long-term asset for $9,000.
C) A non-current liability for $5,000.
D) A current liability for $14,000, a long-term asset for $60,000, and a long-term liability for $51,000.

Question 27

With regard to uncertain tax positions, the FASB requires that companies recognize a tax benefit when

A) It is probable and can be reasonably estimated
B) There is at least a 51% probability that the uncertain tax position will be approved by the taxing authorities
C) It is more likely than not that the tax position will be sustained upon audit
D) All of the above

Question 28

Distinguish between an originating temporary difference and a reversing temporary difference.

Question 29

A net operating loss:

A) Must always be carried back 2 years
B) Occurs when a company reports a net loss in their income statement
C) May be carried forward indefinitely
D) Must always be carried forward 20 years

Question 30

Describe the three types of permanent differences. `

Question 31

Define the following types of differences between financial accounting income and taxable income:
a. Temporary
Most temporary differences between pretax financial accounting income and taxable income arise because the timing of revenues, gains, expenses, or losses in financial accounting income occurs in a different period from taxable income. These timing differences result in assets and liabilities having different bases for financial accounting purposes than for income tax purposes at the end of a given accounting period. Additional temporary differences occur because specific provisions of the IRC create different bases for depreciation or for gain or loss recognition for income tax purposes than are used for financial accounting purposes.
b. Permanent
Certain events and transactions cause differences between pretax accounting income and taxable income to be permanent. Most permanent differences between pretax financial accounting income and taxable income occur when specific provisions of the IRC exempt certain types of revenue from taxation or prohibit the deduction of certain types of expenses. Others occur when the IRC allows tax deductions that are not expenses under GAAP. Permanent differences arise because of federal economic policy or because Congress may wish to alleviate a provision of the IRC that falls too heavily on one segment of the economy.

Question 32

Which of the following will result in a deferred tax liability?

A) A net operating loss carryover.
B) Reporting an unrealized gain for a trading security.
C) Reporting an unrealized gain for an available-for-sale security.
D) Reporting an expected loss on from a lawsuit in the income statement, when it cannot be reported on the tax return until it is actually incurred.

Question 33

Discuss the arguments for and against discounting deferred taxes.

Question 34

When is it appropriate to record a valuation account for a deferred tax asset?

Question 35

Which of the following causes a permanent difference between taxable income and financial accounting income?

A) The useful life of an asset is 10 years. The asset is depreciated over 7 years for tax purposes.
B) Rent received in advance is taxable upon receipt.
C) A life insurance premium paid by the corporation on a policy that names the corporation as the beneficiary.
D) A penalty paid to a bank when a CD is cashed before its maturity date.

Question 36

A deferred tax liability represents the:

A) Increase in taxes payable in future years as a result of taxable temporary differences
B) Increase in taxes saved in future years as a result of deductible temporary differences
C) Decrease in taxes saved in future years as a result of deductible temporary differences
D) Decrease in taxes payable in future years as a result of taxable temporary differences

Question 37

Discuss the arguments for and against interperiod tax allocation.

Question 38

An increase in the deferred income tax asset valuation allowance

A) Occurs when there is an operating loss carryforward.
B) Has no effect on income tax expense.
C) Occurs when there is an expected increase in future taxable income.
D) Increases income tax expense.

Question 39

Which of the following approaches to interperiod tax allocation best represents an example of the matching principle?

A) The deferred method of interperiod income tax allocation
B) Discounting deferred income taxes
C) Nonallocation of income taxes
D) The asset/liability method of income tax allocation.

Question 40

Discuss the arguments for comprehensive vs. partial allocation of interperiod taxes.

Question 41

Discuss how SFAS No. 109, now FASB ASC 740, changed the accounting for deferred tax assets.

Question 42

Describe accounting for uncertain tax positions under FIN No. 48, now FASB ASC 740-10-25.

Question 43

Define the following:
a. Deferred method of income tax allocation
The deferred method of income tax allocation is an income statement approach. It is based on the concept that income tax expense is related to the period in which income is recognized. The deferred method measures income tax expense as though the current period pretax financial accounting income is reported on the current year's income tax return. The tax effect of a temporary difference is the difference between income taxes computed with and without inclusion of the temporary difference. The resulting difference between income tax expense and income taxes currently payable is a debit or credit to the deferred income tax account.
The deferred tax account balance is reported in the balance sheet as deferred tax credit or deferred tax charge. Under the deferred method, the deferred tax amount reported on the balance sheets is the effect of temporary differences that will reverse in the future and that are measured using the income tax rates and laws in effect when the differences originated. No adjustments are made to deferred taxes for changes in the income tax rates or tax laws that occur after the period of origination. When the deferrals reverse, the tax effects are recorded at the rates that were in existence when the temporary differences originated.
b. Asset-liability method of income tax allocation
The asset/liability method of income tax allocation is balance sheet oriented. The intent is to accrue and report the total tax benefit or taxes payable that will actually be realized or assessed on temporary differences when their respective future taxable or deductible amounts are expected to occur. A temporary difference is viewed as giving rise to either a tax benefit that will result in a decrease in future tax payments or a tax liability that will be paid in the future at tax rates that are then current. Theoretically, the future tax rates used should be estimated, based on expectations regarding future tax law changes. However, GAAP requires that the future tax rates used to determine current period deferred tax asset and liability balances be based on currently enacted tax law.
Under the asset/liability method, the deferred tax amount reported on the balance sheet measures the future tax consequences of existing temporary differences using the currently enacted tax rates and laws that will be in effect when those tax consequences are expected to occur. At the end of each accounting period, or when the temporary differences that caused the company to report a deferred tax asset or liability no longer exist, companies adjust their deferred tax asset and liability account balances to reflect any changes in the income tax rates. Stated differently, at year-end companies report deferred tax asset and liability balances that measure the future tax consequences of anticipated deductible and taxable amounts that were caused by current and prior period temporary differences. The reported amounts are measured using tax rates that under currently enacted tax law will be in effect in those years when the deductible and taxable amounts are expected to occur. This practice results in reporting deferred tax assets and liabilities at their expected realizable values.
c. Net-of-tax method
The net-of-tax method is more a method of disclosure than a different method of calculating deferred taxes. Under this method, the income tax effects of temporary differences are computed by applying either the deferred method or the asset/liability method. The resulting deferred taxes, however, are not separately disclosed on the balance sheet. Instead, under the net-of-tax method the deferred charges (tax assets) or deferred credits (tax liabilities) are treated as adjustments of the accounts to which the temporary differences relate. Generally, the accounts are adjusted through the use of a valuation allowance rather than directly. For instance, if a temporary difference results from additional tax depreciation, the related tax effect would be subtracted (by means of a valuation account) from the cost of the asset (along with accumulated depreciation) to determine the carrying value of the depreciable asset. Similarly, the carrying value of installment accounts receivable would be reduced for the expected increase in income taxes that will occur when the receivable is collected (and taxed). Reversals of temporary differences would reduce the valuation allowance accounts.

Question 44

Describe the use of the valuation allowance for deferred tax assets.