Summary Intermediate accounting.

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ISBN-10 047061630X ISBN-13 9780470616307
326 Flashcards & Notes
10 Students
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This is the summary of the book "Intermediate accounting.". The author(s) of the book is/are Donald E Kieso, Jerry J Weygandt, Terry D Warfield. The ISBN of the book is 9780470616307 or 047061630X. This summary is written by students who study efficient with the Study Tool of Study Smart With Chris.

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Summary - Intermediate accounting.

  • 1.1 Accounting for income taxes

  • Identify temporary or permanent differences: 

    The MACRS depreciation system is used for tax purposes, and the straight-line depreciation method is used for financial reporting purposes for some plant assets.

    This is a temporary difference that will result in future taxable amounts and, therefore, usually give rise to a deferred income tax liability.

  • Identify temporary or permanent difference. A landlord collects some rents in advance. Rents received are taxable in the period when they are received. 

    This is a temporary difference that will result in future deductible amounts.

  • 1.1.1 Book versus tax reporting

  • Why do companies need to provide financial information?

    Companies need to provide financial information to the investment community that provides a clear picture of present and potential tax obligations and tax benefits.

  • Corporations must file income taxes returns following the guidelines developed by the appropriate taxing authority. So what do they calculate?

    They calculate taxes payable based upon tax regulations and income tax expense based upon IFRS. The amount reported as tax expense will often differ from the amount of taxes payable to the tax authority.

  • Explain straight-line depreciation as well as accelerated depreciation and there connection to book/tax-reporting.

    For tax purposes, company uses accelerated depreciation. 

    For book (IFRS) reporting purposes, company uses straight-line depreciation for fixed assets.

    Straight-line depreciation: simpliest and most commonly used method.

    Purchase price- salvage value/ total estimated life in years of the item --> constant depreciation expense.

    Accelerated depreciation: Write off more in first years and less in last years. Biggest benefit --> tax benefit --> By writing more assets against revenue, companies report lower revenues and thus pay less taxes.

  • What is accrual accounting?

    Records income when it is earned or expenses, when they occured --> when actual transaction completed/item sold/work done, the corresponding amount will appear in the books even though payment has not yet been received.

    For financial reporting (book) purposes, companies use accrual accounting.

  • What is cash-based accounting?

    Records revenue when cas is received and records expenses when cash is paid. For tax purposes better, because using accrual accounting you show as if you have earned more than you actually did --> leading to higher revenue, higher taxes!

  • How are income taxes classified in the balance sheet?

    In the balance sheet, income taxes are classified as current liability.

  • Why do temporary differences occur?

    The difference between the amounts can happen when there are temporary differenes between the amounts reported for tax purposes and those reported for book purposes. (Including different use of accrual and cash-based accounting)

  • Why does management of large listed companies have a high incentive to report IFRS income as high as possible?

    Positive effect on bonus

    Positive effect on stock price

    Positive effect on performance evaluation

    At the same time, companies want the tax burden to be as low as possible: report low taxable income; but: less flexibility compared with IFRS reporting.

  • How would you describe tax-planning-strategy?

    An action that meets certain criteria and that a company implements to realize a tax benefit for an operating loss or tax credit carryforward before it expires. Companies consider tax-planning strategies when assessing the need for and amount of a valuation allowance for deferred tax assets.

  • Identify differences between pretax financial income and taxable income.

    Companies compute pretax financial income (or income for book purposes) in accordance with generally accepted accounting principles. They compute taxable income (or income for tax purposes) in accordance with prescribed tax regulations.

    Differences may exist for example, in the timing of revenue recognition and the timing of expense recognition.

  • 1.1.3 Temporary differences and deferred taxes

  • What are temporary differences?

    A temporary difference is the difference between the tax basis of an asset or liability and its reported amount in the financial statements that will result in taxable amounts or deductible amounts in future years.

    Temporary differences occur because financial accounting and tax accounting are inconsistent when determining when to record items of revenue and expense.

  • What are future deductible amounts?

    Deferred tax asset. 

    An asset on a company's balance sheet that may be used to reduce any subsequent period's income tax expense as a result of deductible temporary differences.

    Often associated with a loss carryforward: 

    These future deductible amounts cause taxable income to be less than pretax financial income as result of temporary differences.

  • What are future taxable amounts?

    Deferred tax liability. 

    Represents an increase in taxes payable in future years as a result of taxable temporary differences existing in the end of the current year.

  • Name two components of income tax expense.

    Current tax expense (=amount of income taxes payable for that period) and deferred tax expense (=increase in taxes payable).

  • Explain the connection between probability and future deductible amounts.

    It must be applied that there is more than a 50% probability that the company will have positive accounting income in the next fiscal period befpre the tax asset can be applied.

  • A company should reduce a deferred tax asset if it is probable that it will not realize some portion or all of the deferred tax asset. How is the reduction applied?

    A company should reduce a deferred tax asset to its expected realizable value by a valuation allowance if it is more than likely than not that it will not realize some portion or all of the deferred tax asset. 

    Increasing the valuation allowance increases deferred income tax expense.

  • Income tax expense is greater than income tax payable if?

    Deferred tax assets decrease and deferred tax liabilities increase.

  • Income tax expense is smaller than income tax payable if?

    Deferred tax assets increase and deferred tax liabilities decrease.

  • What does 'originating timing difference' mean?

    Initial difference between the book basis and tax basis of an asset or liability --> when the difference first arises

  • When assessing criteria for accounting for uncertain tax positions in the financal statements, which criteria amongst others are applicable in accordance with IAS 12 Income Taxes?

    'More-likely-than-not'- criterion and the amount should not be discounted for the valuation.

  • When does reversing difference occur?

    A reversing difference occurs when a temporary difference that originated in prior periods is eliminated and the related tax effect is removed from the tax account.

  • When is a deferred tax asset recognized?

    A deferred tax asset is recognized for all deductible temporary differences. However, a deferred tax asset should be reduced if, based on all available evidence, it is probable that some portion or all of the deferred tax asset will not be realized.

  • What does a loss carryback provision permits?

    The loss carryback provision permits a company to carry a net operating loss back two years and receive refunds for income taxes paid in those years. The loss must be applied to the second preceeding year first and then to the preceeding year.

  • What does a loss carryforward permit?

    The loss carryforward permits a company to carry forward a net operating loss twenty years, offsetting future taxable income. 

    The loss carryback can be accounted for with more certainty because the company knows whether it had taxable income in the past; such is not the case with income in future.

  • Describe the purpose of a defrred tax asset valuation allowance.

    A deferred tax asset should be reduced by a valuation allowance if, based on all available evidence, it is more likely than not (a level of likelihood that is at least slightly more than 50%) that it will not realize some portion or all of the deferred tax asset. 

    The company should carefully consider all available evidence, both positive and negative, to determine whether, based on the weight of available evidence, it needs a valuation allowance.

  • Describe the presentation of income tax expense in the income statement.

    Significant components of income tax expense should be disclosed in the income statement or in the notes to the financial statements. The most commonly encountered components are the current expense (or benefit) and the deferred expense (or benefit).

  • Describe various temporary differences.

    (1) revenue or gains that are taxable after recognition in financial income

    (2) expenses or losses that are deductible after recognition in financial income

    (3) revenues or gains that are taxable before recognition in financial income

    (4) expenses or losses that are deductible before recognition in financial income

  • Explain the effect of various tax ates and tax rate changes on deferred income taxes.

    Companies may use tax rates other than the current rate only after enactment of the future tax rates.

    When a change in the tax rate is enacted, a company should immediately recognize its effect on the deferred income tax accounts. The company reports the effects as an adjustment to income tax expense in the period of the change.

  • Relevant facts

    • The classification of deferred taxes under IFRS are always noncurrent. GAAP classifies deferred taxes based on the classification of the asset or liability to which it relates.
  • Indicate whether this belongs to temporary or permanent differences: costs of guarantees and warranties are estimated and accrued for financial reporting purposes.

    This is a temporary difference that will result in future deductible amounts and, therefore, will usually give rise to a deferrred income tax asset.

  •  

    Indicate whether this belongs to temporary or permanent differences: Installment sales of investments are accounted for by the accrual method for financial reporting purposes and the installment-sales method for tax purposes.

    This is a temporary difference that will result in future taxable amounts and, therefore, will usually give rise to a deferred income tax liability.

  •  

    Indicate whether this belongs to temporary or permanent differences: for some assets, straight-line depreciation is used for both financial reporting purposes and tax purposes, but the assets' lives are shorter for tax purposes.

    This is a temporary difference that will result in future taxable amounts and, therefore, will usually give rise to a deferred income tax liability.

     

  • Indicate whether this belongs to temporary or permanent differences: The tax return reports a deduction for 80% of the dividends received from US corporations. The cost method is used in accounting for the related investments for financial reporting purposes.

    This is a temporary difference that will result in future deductible amounts and, therefore, gives rise to a deferred income tax asset.

  • Indicate whether this belongs to temporary or permanent differences: Estimated losses on pending lawsuits and claims are accrued for books. These losses are tax-deductible in the period(s) when the related liabilities are settled.

    This is a temporary difference that will result in future deductible amounts and, therefore, gives rise to a deferrd income tax asset.

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How can errors occur?

Unintentional mathematical mistakes, mistakes in applying methods, intentional misuse or bias of information.

Why is there a need for discounted cash flows?

Cash to be received in the future has a cost. Alternative investments and price inflation reduce the value of those cash flows in current monetary terms (present value). That is why the cash flows are discounted, normally using a constant discount rate.

Describe two effects of time on a decision and its influence on alternative decisions.
  1. The decision commits resources for a lengthy period of time, and this commitment usually prevents taking another future opportunity.
  2. Management's flexibility to modify and investment as time and information unfold can affect alternative decisions.
Define fixed and variable overhead costs.

Variable overhead costs fluctuate with the level of business activity (increase with higher business activity and decrease with lower business activity) where fixed overhead mostly refer to rents, salaries and insurance.

What is cost-based transfer pricing?

When a company does not use market prices or negotiated prices to determine transfer price, it usually turns to cost-based transfer-pricing. The cost-based transfer price may be based upon:

  • Unit-level cost
  • Absorption cost
Describe sales variance analysis.

Sales are also subject to deviation from plans.

The two most common types of analysis focus on 

  1. sales revenue
  2. contribution margin

Once again the variance measures the difference between budgeted and actual amounts. But now a variance is favorable if actual exceeds budget.

Sales variances can be further divided into: 

  1. Sales-price
  2. Revenue sales-volume variances

Additional analyses can be carried out on: 

  1. Revenue-sales mix
  2. Revenue-sales quantity
  3. Revenue-market size
  4. Revenue-market-share variances.
How to allocate cost variances?

Generally, variances for direct and indirect costs are closed at the end of each period to the cost of goods sold account. Logically, those variances are also related to the ending inventories of materials, work-in-process and finished goods. The cost accounting standards board requires that part of any cost variance be assigned to the related inventories.

Distinguish between unfavorable and favorable variances in a standard costing system.

In a standard costing system: 

  • unfavorable variance are equal to underapplied overhead
  • favorable variances are equal to overapplied overhead

The sum of the overhead variances equals the under- and overapplied overhead cost of a period.

How can volume variances occur?

Results when standard hours allowed for actual output differs from the denominator activity.

What is budget variance?

A periodic measure to quantify the difference between budgeted and actual figures for a particular accounting category. A favorable budget variance refers to positive variances or gains; an unfavorable budget variance describes negative variance, meaning losses and shortfalls. Budget variances occur because forecasters are unable to predict the future with complete accuracy.