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Chris Green, CPA, is auditing Rayne Co.'s 2013 financial statements. For the year ended December...

Question:

Chris Green, CPA, is auditing Rayne Co.'s 2013 financial statements. For the year ended December 31, 2013, Rayne is applying GAAP for income taxes. Rayne's controller, Dunn, has prepared a schedule of all differences between financial statement and income tax return income.

Dunn believes that as a result of pending legislation, the enacted tax rate at December 31, 2013, will be increased for 2014. Dunn is uncertain which differences to include and which rates to apply in computing deferred taxes. Dunn has requested an overview of GAAP from Green.

Prepare a brief memo to Dunn from Green that identifies the objectives of accounting for income taxes, defines temporary differences, explains how to measure deferred tax assets and liabilities, and explains how to measure deferred income tax expense or benefit.

Deferred Tax Assets and Liabilities

Deferred tax assets are to be recorded on the assets side of the balance sheet to reduce the future taxable income. Deferred tax liabilities are to be recorded on the liabilities side of the balance sheet about future tax payments to be made to tax authorities.

Answer and Explanation:

Objectives for accounting of income taxes:

  • helps businesses determine income tax expense, refund or payable to be recorded for the current year
  • helps businesses recognize deferred tax and deferred tax liabilities and record them in balance sheet for appropriate reporting to users of financial statements.

Temporary difference is a difference in the amount of pre-tax income recorded in the books of accounts and income as per income tax. Difference can arise because of different treatment of income and expenses by GAAP, as well as income tax rules.

How to measure deferred tax liabilities (DTL) and deferred tax assets (DTA):

DTA and DTL arises because of timing difference in the treatment of income and expense in the GAAP and income tax. When the timing difference leads to extra tax payments in the current year (which could be set off in the next year's), it is regarded as DTA, while the deferred payments to future years leads to creation of DTL.

Steps for recording and measuring amount of deferred and current income tax:

  • Determine taxable income
  • Determine tax rate
  • Determine tax payable
  • Determine temporary difference in treatment of various income and expense figures
  • Apply tax rates on each temporary difference, which shall be taxable in the future to determine deferred tax liabilities
  • Apply tax rates of each temporary difference, which shall be tax deductible in the future to determine deferred tax assets

Learn more about this topic:

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Interperiod Tax Allocation: Permanent & Temporary Differences

from Accounting 202: Intermediate Accounting II

Chapter 8 / Lesson 4
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