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In: Accounting

"Calculating Current and Deferred Income" There are six steps in calculating the current and deferred income...

"Calculating Current and Deferred Income"

There are six steps in calculating the current and deferred income tax expense or benefit components of a company’s income tax provision. Identify one of the six steps and describe the step in detail, explaining the issues that should be considered in that step and how it is computed.

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Expert Solution

(1) This six steps in calculating the current and deferred income tax expense are the folllowing.

  1. Identify at each balance sheet date all differences between the book basis and the tax basis of assets and liabilities.
  2. Eliminate step 1 differences that will have no future tax consequence (that is, eliminate permanent differences).
  3. Separate the remaining differences (temporary differences) into those that will result in future tax deductions and those that will result in future taxable income.
  4. Multiply temporary differences that will result in future taxable income by the enacted income tax rate expected to apply in the future period of the taxable income. Show the result as a deferred tax liability on the balance sheet.
  5. Multiply temporary differences that give rise to future tax deductions by the enacted income tax rate expected to apply in the future periods of the deductions. Under U.S. GAAP, include this item in deferred tax assets; see step 6, next. Under IFRS, include this item in deferred tax asset only if it is probable that the firm will be able to realize the benefit of the future tax deduction.
  6. Under U.S. GAAP, assess the likelihood that the firm will realize the benefits of deferred tax assets in the future. If the firm is “more likely than not” (that is, the probability exceeds 50 percent) to realize the benefits, then deferred tax assets equal the amount in step 5 above. If the firm has a realization probability of less than 50 percent, then the firm must reduce the deferred tax asset by a valuation allowance (similar in concept to an allowance for uncollectible accounts receivable). The deferred tax asset valuation allowance reduces the deferred tax asset to the amount the firm expects to realize in tax savings in the future.

(2) Benefit components of a company’s income tax provision.

Current income tax or benefit: represents income tax payable or refundable in current year
Deferred income tax expense or or benefit: represents amount necessary to adjust BS liabilities or rec for future inc tax pay or refundable that results from current or prior year transactions.

(3)  The issues that should be considered in that step are the following.

     

  1. temporary differences originating or reversing during the current period (illustrated in the Burns example in the textbook);
  2. changes in income tax rates expected to apply in future periods when temporary differences reverse (illustrated in the next section); and

changes in the valuation allowance for Deferred Tax Assets under U.S. GAAP


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