This course is the third course in the five-course Financial Reporting Specialization. This course begins with a discussion of current liabilities and contingencies and continues with long-term debt and bonds. The course next explores accounting model for leases, both lessees and lessors, and a discussion on deferred tax assets and liabilities. Participants will learn the latest accounting standards including the new accounting model for leases effective for public companies in 2019 and private companies in 2020.
Introduction to Deferred Taxes
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Из курса от партнера University of Illinois at Urbana-Champaign
Accounting Analysis II: Measurement and Disclosure of Liabilities
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Module 6: Deferred Taxes Part 1
In this module, you will be introduced to deferred taxes. You will learn the differences between deferred tax assets/deferred tax liabilities and tax refunds receivable/taxes payable. Temporary and permanent tax differences and net operating loss (NOL) carrybacks and carryforwards are described. The module also includes discussion of intraperiod tax allocation and the effect of changes in tax rates.
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John HeppClinical Assistant Professor of Accountancy
Department of Accountancy
Welcome. In this module we're going to talk about deferred taxes,
one of the more complicated topics in accounting.
So in this lesson,
we'll start with an introduction to the broad topic.
So income taxes is topic 740 in the Accounting Standards Codification,
and it addresses the accounting and reporting for the effects of income taxes
that result from entity's activities during the current and preceding years.
What does that mean? It means we're going to have something that
used to be called timing differences,
a difference in timing between when
a certain expense or revenue affects gap income and affects taxable income.
Now we don't use the word timing difference anymore, we've changed that.
It's now called the temporary difference some 25 years ago,
but the concept is still the same,
that you're having a difference between the timing of
recognizing tax expense for gap purposes and for taxable purposes.
So up until now,
we've discussed liabilities that are obligations of the firm.
Current liabilities are easy.
Those are the amounts in that they're generally known,
they're accrual, it's basic accounting, it's pretty straightforward.
The longer term debt got a little bit more complicated.
It often involves present value measurements,
it involves effective interest rates where it's a little bit more complicated to measure.
So deferred taxes are different.
The amounts are seldom known with certainty due to
the nature of tax laws and uncertain timing.
So deferred taxes too are not measured at fair value,
nor are they measured at discounted present value.
So they're an odd duck in that regard.
There's good reasons for why they aren't,
we'll discuss those later when we talk about uncertain tax positions.
So for those reasons, it's often difficult to conceptualize,
to get a firm grasp about why the accounting is being done in a particular way.
So I consider it though to be a reconciliation between taxes payable,
which is based upon the IRS rules if you're in the United States,
or whatever taxing authority is determining the rules.
It could be a state authority,
it could be another authority in a different country that taxes people based on income.
It's a difference between taxes
payable and the GAAP measure of income and the related tax expense,
which is based upon GAAP income and not
necessarily on the amount of income taxes you're willing to pay.
So, in order to work in this field,
it's necessary to know something about
both in order to prepare and audit the deferred tax entries.
So this is a case where you really need close cooperation
usually between tax accountants and auditors for example.
So there are two objectives of tax accounting.
One, is to recognize the amount of taxes payable.
This is coming from the IRS rules or the other tax authority rules,
and you're going to recognize the current tax payable or
refundable based upon the results of preparing your tax return.
The second is to recognize deferred tax liabilities and assets for
the future consequences that could be incurred
based upon your GAAP recognition of income or expense.
If that seems a little difficult to grab a hold of,
don't feel bad, we will be talking
about this quite a bit though throughout the course of this lesson.
Now, not all events have tax consequences. Some don't.
Some items will never be taxed or taxable.
Certain revenues are exempt from taxation.
This could be dividends received, non-taxable bond interest.
Other items are never deductible.
Some goodwill is never deductible for example.
You may have differences in the timing or you may have
differences of whether it's taxable or not taxable at all.
Now, this used to be called permanent differences and so you'll still hear
a lot of people refer to them as permanent differences in practice.
Now the FASB doesn't actually use that term in ASC 740,
so you won't find it there but you will hear people refer to it from time to time.
So the basic requirement here is to recognize
a tax liability or asset for the estimated taxes payable.
So you look at your tax return, do I owe money?
I'm going to recognize a liability.
Am I getting money back from the tax authorities? That will be an asset.
And then the second part is to recognize
a deferred tax liability or asset for estimated future tax effects
that would be attributable to temporary differences
and carryforwards used to be attributable
to previously recognized items in the financial statements according to GAAP.
So here are some relationships that is important to consider to keep in mind
when we're doing this tax expense and the GAAP financial statements.
It's going to be the sum of two different items.
First, the taxes payable,
the item from the tax return,
and then the deferred tax expense which is what
we'll be calculating now based upon temporary differences.
That deferred tax expense by the way could be positive or negative.
You could have something that's taxed earlier under
GAAP or that's taxed later under GAAP and IRS rules.
The beginning deferred taxes plus deferred tax expense,
plus or minus, will equal your ending deferred taxes.
And even the deferred taxes can be
an asset or a liability depending on how the difference worked between
the timing of recognition in GAAP and the timing of recognition
for determining taxes payable.
Now, if we have an asset,
that asset has to be realizable.
Usually an asset is a result of a loss in
a past period or previous period which might create some doubt as to
whether you're actually going to be able to realize
that amount in the future because in order to realize a tax asset,
you have to have taxable income in the future.
If you don't have taxable income in the future,
you'll never realize that asset.
So, if the tax is not probable of being recognized,
we're going to recognize a valuation allowance.
We're going to recognize a tax asset.
It's not that we are going to have
a recognition threshold and we won't recognize it at all,
we will recognize it but we will use a valuation allowance to reduce it net in
the financial statements if there's doubt about being able to realize that tax asset.
So, deferred taxes is one of those areas where we use
a valuation allowance as opposed to not recognizing the asset at all.
But the impact net is the same on the financial statements.
So in an ideal world,
temporary differences would be described as
this expected future consequences of
events that have been recognized in the financial statements et cetera.
However, when we illustrate temporary difference as if they were readily determinable,
the real world is not as simple.
You can't always just make up a schedule of each individual difference and use
that to calculate your deferred tax and expense, it becomes impracticable.
So applied literally, that concept that we have would be to
measure the tax impact of the future with and without the temporary differences.
What do we mean there? Well, you would calculate taxes payable or refundable in
future years including any reversing temporary differences and carryforwards,
and then do that same calculation again,
again for future years,
excluding any reversing temporary items,
and the difference would be your deferred tax amount.
And that way, you would have the correct tax rate,
for example, especially if you have graduated tax rates.
This would give you the exact figure.
That's rather difficult to do however,
that's not always practicable.
So taxes payables or refunds receivable,
they're a joint result of all the items in the return,
it's not always possible to look at a single item and sit there and go, "Here.
This is a tax effect from that single item."
The same applies to taxes that will be paid or refunded in future years,
only those events will occur in the future.
So, information about the future is always limited.
It's always difficult to audit the future.
So this is not an exact science.
So attribution of taxes to individual items and events,
it's sometimes arbitrary and except in the simplest situations,
it requires estimates and approximations.
So some of our examples that we're going to use to illustrate
the concepts will use simple situations,
but expect more complexity in real life.
So what is the convention?
Well, because a determination of the incremental difference
between a future income taxpayer cash flows
with and without reversing temporary difference and
carryforwards would be difficult in most situations,
the FASB decided, for practical reasons,
to measure deferred taxes using a tax rate convention.
So you would calculate your expected tax rate and use
that to measure your deferred tax asset or liability,
and then you would assess the need for a valuation allowance if you have a tax asset.
So there's a five step model that's typically employed and
this is straight out of the accounting standards codification.
You can go and look at it there if you would like and get
maybe a little bit more detailed description of it.
But first, you're going to identify the types and amounts of temporary differences and
the nature and amounts of all these operating loss and
tax credit carryforwards in the remaining carry forward period.
And then you'll measure
the total deferred tax liability for temporary differences using the applicable tax rate,
and then measure an asset for deductible temporary differences,
again using the applicable tax rate.
Then we'll measure the deferred tax assets for each type of tax credit carryforward.
Those are distinguishable.
Remember, a tax credit comes off of your total tax bill whereas a tax deduction
reduces the taxable amount of income but doesn't reduce the taxes directly.
And then, we'll reduce the deferred tax assets by evaluation allowance,
if it's more likely than not in other words,
the likelihood of more than 50 percent that some portion
or all of the deferred tax assets will not be realized.
And you need to do that by jurisdiction, by jurisdiction.
Because for example, you could have a subsidiary
in one country that's losing money and you won't
be able to realize the tax loss in that country whereas in other jurisdictions,
you may be able to recognize it because those are profitable.
So you have to look at it jurisdiction by jurisdiction, country by country,
even state by state sometimes within depending
on how taxable income is measured at the state level.
So, that wraps up our introduction.
We'll be going through each of these concepts that we've
discussed in greater detail in the following lessons.
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