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Chapter16: Accounting for Income Taxes

Financial Statement Presentation

Balance Sheet Classification

In a classified balance sheet, deferred tax assets and deferred tax liabilities are classified as either current or noncurrent according to how the related assets or liabilities are classified for financial reporting. For instance, a deferred tax liability arising from different depreciation methods being used for tax and book purposes would be classified as noncurrent because depreciable assets are reported as noncurrent. A deferred tax asset or deferred tax liability is considered to be related to an asset or liability if reduction (including amortization) of that asset or liability will cause the temporary difference to reverse.

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   Let's carry the illustration forward one year (see Illustration 16-9A) and assume a performance turnaround in 2012 resulted in pretax accounting income of $15 million.

ILLUSTRATION 16-9A
Determining and Recording Income Taxes—2012

$15 million of the carryforward can be used to offset 2012 income. The remaining $35 million is carried forward up to 19 more years.

The $20 million deferred tax asset is reduced to $14 million.

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   Most companies will have several different types of temporary differences that give rise to deferred tax amounts. The several deferred tax assets and liabilities should not be reported individually but combined instead into two summary amounts. Current deferred tax assets and liabilities should be offset (netted together). The resulting net current amount is then reported as either a current asset (if deferred tax assets exceed deferred tax liabilities) or current liability (if deferred tax liabilities exceed deferred tax assets). Similarly, a single net noncurrent amount should be reported as a net noncurrent asset or a net noncurrent liability. This is demonstrated in Illustration 16-10 on the next page.

A net current amount and a net noncurrent amount are reported as either an asset or a liability.

DEFERRED TAX AMOUNT NOT RELATED TO A SPECIFIC ASSET OR LIABILITY.   Sometimes, a deferred tax asset or a deferred tax liability cannot be identified with a specific asset or liability. When that's the case, classification should be according to when the underlying temporary difference is expected to reverse. For instance, some organization costs are recognized as expenses for financial reporting purposes when incurred, but are deducted for tax purposes in later years. When such expenditures are made, an expense is recorded, but no asset or liability is recognized on the balance sheet. The deferred tax asset recognized for the future deductible amounts is classified as a current asset for the tax effect of the deduction expected next year, and as a noncurrent asset for the tax effect of the deductions expected in later years.

A deferred tax asset or liability that is not related to a specific asset or liability should be classified according to when the underlying temporary difference is expected to reverse.

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ILLUSTRATION 16-10
Balance Sheet Classification and Presentation

The current or noncurrent classification of deferred tax assets and deferred tax liabilities is the same as that of the related assets or liabilities.

Warren Properties, Inc., had future taxable amounts and future deductible amounts relating to temporary differences between the tax bases of the assets and liabilities indicated below and their financial reporting amounts:

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Note: Before offsetting assets and liabilities within the current and noncurrent categories, the total of deferred tax assets is $26 ($6 + 8 + 12) and the total of deferred tax liabilities is $48 ($4 + 2 + 42).

   Operating loss carryforwards also are unrelated to a specific asset or liability and so are classified as current or noncurrent according to when future income is expected to be sufficient to realize the benefit of the carryforward.

VALUATION ALLOWANCE.    Any valuation allowance for deferred tax assets should be allocated between the current and noncurrent amount in proportion to the amounts of deferred tax assets that are classified as current and noncurrent. In our illustration, all three deferred tax assets were classified as current, so any valuation allowance would be reported with the net current deferred tax asset.

A valuation allowance is allocated between current and noncurrent on a pro rata basis.

Disclosure Notes

DEFERRED TAX ASSETS AND DEFERRED TAX LIABILITIES.    Additional disclosures are required pertaining to amounts reported on the balance sheet. Disclosure notes should reveal the:

  

Total of all deferred tax liabilities ($48 million in our Illustration 16-10 Note).

  

Total of all deferred tax assets ($26 million in our Illustration 16-10 Note).

  

Total valuation allowance recognized for deferred tax assets.

  

Net change in the valuation allowance.

  

Approximate tax effect of each type of temporary difference (and carryforward).

     In its 2009 balance sheet, the Walmart Stores, Inc. reported the composition of its net deferred tax liabilities as shown in Graphic 16-5.

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GRAPHIC 16-5
Disclosure of Deferred Taxes—Walmart

Real World Financials

Note 5: Income Taxes (in part)

Items that give rise to significant portions of the deferred tax accounts are as follows:

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   The deferred taxes noted above are classified as follows in the balance sheet:

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OPERATING LOSS CARRYFORWARDS.    In addition, the amounts and expiration dates should be revealed for any operating loss carryforwards. Remember, operating losses can be carried forward for reduction of future taxable income for 20 years. This potential tax benefit can foreshadow desirable cash savings for the company if earnings sufficient to absorb the loss carryforwards are anticipated before their expiration date. The presence of large operating loss carryforwards also can make an unprofitable company an attractive target for acquisition by a company that could use those loss carryforwards to shelter its own earnings from taxes with that loss deduction. If the IRS determines that an acquisition is made solely to obtain the tax benefits of operating loss carryforwards, the deductions will not be allowed. However, motivation is difficult to determine, so it is not uncommon for companies to purchase operating loss carryforwards.

INCOME TAX EXPENSE.    Disclosures also are required pertaining to the income tax expense reported in the income statement. Disclosure notes should reveal the:

  

Current portion of the tax expense (or tax benefit).

  

Deferred portion of the tax expense (or tax benefit), with separate disclosure of amounts attributable to:

  

Portions that do not include the effect of separately disclosed amounts.

  

Operating loss carryforwards.

  

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Adjustments due to changes in tax laws or rates.

  

Adjustments to the beginning-of-the-year valuation allowance due to revised estimates.

  

Tax credits.

     To relate this to the income tax journal entries we've seen in the chapter, remember that the current portion of the tax expense is the credit to the income tax payable; the deferred portion of the tax expense is the credit or debit to deferred tax assets and liabilities (and perhaps valuation allowance).

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