Question

C 18-6

Interperiod Tax Allocation

LO 18.2 AICPA Adapted Chris Green, CPA, is auditing Rayne Co.'s 2016 financial statements. For the year ended December 31, 2016, 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, 2016, will be increased for 2017. 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.

Required:

1. 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.

Answer 1

Accounting for Income Taxes at the year end is a two step process which includes

1. Accounting for current income tax expense or benefit i.e amount owed to goverment
2. Accounting for deferred taxes which can be a benefit (Asset) or a liability

The Deferred taxes arise because the Tax regulations have a different recogniotion criteria of Assets and liabilities as comapred to US GAAP which gives rise to temporary difference between Tax base as per regulations vs US GAAP

How to Measure ?

The recognition of Deferred Tax as asset or liability depends upon whether the temporary difference is giving rise to a future taxable amount or a future deductible amount.In earlier case its an 'liability' while in latter case its an 'asset' and that depends upon whether the figure in question is a Asset or a liability in Balance sheet and the applicable tax rate is the rate applicable when the temporary difference is expected to reverse.

Now let's arrive at our example, the expected tax rate in 2017 is higher than prevailing which means the enacted tax rate for the year in which temporary differences arrising in YE 2016 is going to reverse i.e 2017 is going to be higher, therefore giving rise to a Future taxable amount i.e a Deferred Tax Liability

So, Deferred tax liability will be calculated using applicable tax rates of 2017 and recognised in FY 2016 as Non Current Liabilities.