十
Investment
Tools: Financial Statement Analysis: Liabilities
1.A: Analysis of Income Taxes
a: Define the key terms used in accounting for income taxes.
Tax return terminology:
1.
Taxable income: Income based upon IRS rules that determine taxes due.
2.
Taxes payable: The taxes due the government determined by taxable income and the
tax rate. This is also referred to as “current tax expense or benefit”.
3.
Income tax paid: Actual cash flow for income taxes, including payments or refunds for
other years.
4.
Tax loss carryforward: The current net taxable loss that is used to reduce taxable
income (thus taxes payable) in future years.
Financial reporting terminology:
1.
Pretax income: Income before income tax expense.
2. Income tax expense: The expense recognized on financial statements that includes
taxes payable and deferred income tax expense. Thus income tax expense is not just
what is owed as indicated on the tax returns.
3.
Deferred income tax expense: The difference in income tax expense and taxes
payable that results from changes in deferred tax assets and liabilities. Each
individual deferred item is expected to be paid (or recovered) in future years.
4.
Deferred tax asset: Balance sheet amounts related to the difference in tax expense
and taxes payable that are expected to be recovered from future operations.
5.
Deferred tax liability: Balance sheet amounts related to the difference in tax expense
and taxes payable that are expected to result in future cash outflow.
6.
Valuation allowance: Reserve against deferred tax assets based on the likelihood that
those assets will be realized.
7.
Timing difference: Results from a transaction being treated differently (timing or
amount) on the tax return and financial statements.
8.
Temporary difference: Differences between tax and financial reporting that will affect
taxable income when those differences reverse. Slightly broader than timing
differences.
b: Explain why and how deferred tax liabilities and assets are created.
A deferred tax asset occurs when taxable income exceeds pretax income and this difference
will reverse in the future. For example, pretax income includes an accrual for warranty
expense but warranty cost is not deductible for taxable income until the firm has made actual
expenditures to meet warranty claims.
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