Accounts receivable

"DTA" if the item causes an increase in deferred Effect - DTL

tax assets
"DTL" if the item causes an increase in deferred
tax liabilities Classification - Current
"Perm" if the item is a permanent difference
"None" if the item is not one of the above

Are originating or future reversing

temporary differences used in Future reversing temporary differences
determining the change in deferred tax are used.
accounts?

More profit will be recognized under completed contract in year three

At the end of year one, Cody Co. reported a profit on a partially completed
construction contract by applying the percentage-of-completion method.
By the end of year two, the total estimated profit on the contract at
completion in year three had been drastically reduced from the amount
estimated at the end of year one.
Consequently, in year two, a loss equal to one-half of the year-one profit
was recognized. Cody used the completed-contract method for income tax
purposes and had no other contracts.
According to FASB Statement No. 109, Accounting for Income Taxes, the
year-two balance sheet should include a deferred tax asset and or liability
for tax purposes than will be recognized under percentage-of-
completion in year three for accounting purposes. The entire profit
will be recognized under completed contract (tax purposes) in year
three. But a portion of income has already been recognized for
accounting purposes before year three. Therefore, less income will be
recognized in year three for accounting purposes.
Consequently, at the end of year two, there is a future taxable
difference because future taxable income will exceed future pre-tax
accounting income. Taxable differences give rise to deferred tax
liabilities.

Bad debt expense (allowance method for the

books)

"DTA" if the item causes an increase in deferred tax Effect - DTA

assets
"DTL" if the item causes an increase in deferred tax Classification - Current
liabilities
"Perm" if the item is a permanent difference
"None" if the item is not one of the above

Effect - DTA

Classification - Both current and

noncurrent

Categorizing Temporary Differences
A. Originating/Reversing
Categorizing Temporary Differences
B. Future Differences
Categorizing Temporary Differences
Examples of Taxable Temporary
Differences
Categorizing Temporary Differences
Two Categories
Categorizing Temporary Differences
Two Categories Continued
A. Originating/Reversing --
1. When an item causing a temporary difference
first occurs, the difference is called an
originating difference.
2. In later years, the difference attributable to
the item is called the reversing difference.
B. Future Differences --
The classification of temporary differences is
based on the future reversal rather than the
originating amount because deferred tax asset
and liability balances reflect the future tax
consequences of transactions that have already
occurred.
D. Examples of Taxable Temporary
Differences --
(future taxable income > future pretax
accounting income):
C. Two Categories --
For purposes of interperiod tax allocation and recording the annual income tax accrual entry, temporary
differences are classified into two categories.
1. The first category, called Taxable Temporary Differences, involves differences that initially cause a
postponement in the payment of taxes.
a. In the year of origination, the item causes taxable income to decline relative to pretax accounting
income.
b. When the item reverses, the item
causes future taxable income to exceed pretax accounting income. This is why these differences are
called taxable differences. They increase taxable income relative to pretax accounting income in the
future.
c. Future taxable differences give rise to deferred tax liabilities.
2. The second category, called Deductible Temporary Differences,
involves differences that initially cause a prepayment of taxes.
a. In the year of origination, the item causes taxable income to
increase relative to pretax accounting income.
b. When the item reverses, the item causes future taxable income to
be less than pretax accounting income. This is why these differences
are called deductible differences. They reduce taxable income relative
to pretax accounting income in the future.
c. Future deductible differences give rise to deferred tax assets.
Completed contract method for tax,
percentage of completion method for
the books
"DTA" if the item causes an increase in
deferred tax assets
"DTL" if the item causes an increase in
deferred tax liabilities
Deductible After Recognized for the
Books
Deductible Before Recognized for the
Books
Define "deductible difference".
Define "deductible temporary
differences".
Effect - DTL
Classification - Current
Deductible After Recognized for the
Books --
Expenses or Losses that are Deductible
after they are Recognized in Financial
Income
Deductible Before Recognized for the
Books
-- Expenses or Losses that are
Deductible before they are Recognized
in Financial Income
A temporary difference that causes
future taxable income to be less than
future book income is what type of
temporary difference.
Differences that initially cause a
prepayment of taxes.
 A current temporary difference that
Define "deferred tax asset". causes current book income to be less
than taxable income.

An item of revenue or expense that, over

the total life of the item, will affect
pretax accounting income and taxable
Define "temporary difference". income in the same total amount but will
be recognized in different amounts in
any given year for financial reporting and
tax purposes.

"DTA" if the item causes an increase in

deferred tax assets
Effect -
"DTL" if the item causes an increase in
deferred tax liabilities
"Perm" if the item is a permanent difference
Classification -
"None" if the item is not one of the above

Dunn Co.'s 2005 income statement reported $90,000 income before provision for income The tax liability is 30% of taxable income.
taxes.
To compute the provision for federal income taxes, the following 2005 data are provided: Pre-tax accounting income $90,000
Plus advance rent (taxable, but not included in pre-tax accounting income)
Rent received in advance $16,000
$16,000 Less municipal bond income (this is included in pre-tax accounting income, but is not
Income from exempt municipal bonds taxable)
20,000 ($20,000)
Depreciation deducted for income tax purposes in excess of depreciation reported for Less depreciation for tax in excess of depreciation for the books
financial-statement purposes (10,000)
10,000 Equals taxable income
Enacted corporate income tax rate $76,000
30% Times tax rate
x .30
If the alternative minimum tax provisions are ignored, what amount of current federal Equals income tax liability
income tax liability should be reported in Dunn's December 31, 2005 balance sheet? $22,800

Estimated warranty expense

"DTA" if the item causes an increase in deferred Effect - DTA

tax assets
"DTL" if the item causes an increase in deferred Classification - Both current and
tax liabilities noncurrent
"Perm" if the item is a permanent difference
"None" if the item is not one of the above

Example: Deductible After Recognized
for the Books
Example: Deductible Before Recognized
for the Books
Example: Relationship Between Pretax
Accounting Income and Taxable Income
Examples: Nature of Temporary
Differences
Examples of Deductible Temporary
Differences
Example: An example of this type of
difference involves the recognition of
warranty expense. For financial reporting
purposes, warranty expense is usually
estimated and recognized in the year the
related merchandise is sold. For tax
purposes, warranty expense is
recognized in the year the defective
Example: An example of this type of difference is
depreciation recorded for income tax purposes. For
financial reporting purposes, depreciation is
recorded over the estimated useful life of an asset.
For tax purposes, depreciation is recorded over
shorter time frames called recovery periods. In
addition, for tax purposes, an accelerated
depreciation method is typically employed.
Example:
The four temporary differences in the previous examples are repeated below, along with additional information for
Year 1.
Year 1 Information Pretax accounting income $100,000
Fines and penalties 9,000
Municipal bond interest received 14,000
Depreciation deduction 16,000
Depreciation expense recognized for books 10,000
Taxable installment sales 0
Installment sales revenue recognized for books 6,000
Warranty deduction 1,000
Warranty expense recognized for books 8,000
Taxable service revenue 22,000
Service revenue recognized for books 10,000
Computation of taxable income: Balance sheet account:
Pretax accounting income $100,000
Plus nondeductible fines and penalties 9,000
Less nontaxable municipal bond interest received (14,000)
Excess of tax over book depreciation (6,000) Equipment book value
Excess of book over tax sales revenue (6,000) Installment receivable
Excess of book over tax warranty expense 7,000 Warranty liability
Excess of tax over book service revenue 12,000 Unearned revenue
T bl i $102 000
Example:A firm provides services for a client for a fee of $4,000.
The service is provided near the end of the year. The client is
expected to remit the fee early the following year. For financial
accounting purposes, the $4,000 of revenue is recognized in the
year the service is provided but for tax purposes is taxable in
the year the fee is received. Over the two years, both systems
recognize the same amount of revenue. The temporary difference
of $4,000 originated in the first year, and reversed in the second.
At the end of the first year, the firm has a future difference of
$4,000. That is the basis for the recorded deferred tax account
at the end of the first year.
Examples of Deductible Temporary
Differences --
(future taxable income < future pretax
accounting income)

Examples of Deductible Temporary
Differences
Examples of Taxable Temporary
Differences
Examples of Taxable Temporary
Differences
Installment Sales
Example: Some Temporary Differences
Example: Taxable Before Recognized for
the Books
Example:1. Warranty expense. On sales for Year 1, the firm recognizes $8,000 of estimated warranty
expense. Also during Year 1, $1,000 was spent servicing warranty claims. The firm can deduct only the
$1,000 on its Year 1 tax return because tax law limits the deduction to the actual cost of claims service. At
the end of Year 1, the firm has a $7,000 future deductible difference. Next year, when the remaining
claims are serviced, the firm's taxable income will fall by $7,000 relative to pretax accounting income.
The future temporary difference is found in the warranty liability, which has a balance of $7,000, the
amount of future claims expected.
2. Revenue received in advance. During Year 1, the firm collected $22,000 in advance of providing its
services to customers. By the end of the year, the firm had performed $10,000 worth of service. The full
$22,000 is taxable in Year 1 but only $10,000 of revenue is recognized in the income statement. At the
end of Year 1, the firm has a $12,000 deductible difference. Next year, when the remaining service is
provided, the firm's pretax accounting income will increase $12,000 with no effect on taxable income.
Future taxable income will be less than pretax accounting income.
The future temporary difference is found in the unearned revenue account, which has a balance of
$12,000, the amount of paid services yet to be provided.
Example:
For financial reporting and tax purposes, depreciation on a plant asset purchased Year 1 will be:
Year Book Depreciation Tax Depreciation
1 $10,000 $16,000
2 10,000 9,000
3 10,000 5,000
Totals $30,000 $30,000
At the end of Year 1, the firm has a future taxable difference of $6,000, the difference between
depreciation for Years 2 and 3 under the two systems. ($20,000 - $14,000). At the end of Year 1, the firm
knows that its future taxable income will exceed pretax accounting income by $6,000 because of
transactions that have occurred through the end of Year 1.
At the end of Year 1, the tax basis of the asset is the book value for tax purposes and equals $14,000
(cost of $30,000 - $16,000 depreciation in Year 1). The net book value for balance sheet purposes is
$20,000 ($30,000 - $10,000). The difference between the two book value amounts is the future
temporary difference of $6,000.
Example:
During Year 1, a firm sells $6,000 worth of goods on the installment basis. For financial
reporting purposes, the firm uses the point-of-sales method to record revenue and
recognizes the entire $6,000 in Year 1. For tax purposes, the firm uses the installment
method, which postpones revenue recognition until cash is received. No cash is received
in Year 1 on the sale and the firm has no tax liability for this amount.
At the end of Year 1, the firm has a future taxable difference of $6,000. In a later year, when
cash is received, the firm's taxable income will exceed pretax accounting income by
$6,000 because of transactions that have occurred through the end of Year 1.
The future temporary difference is found on the balance sheet in the Installment
Receivable account, which has a balance of $6,000, the amount not yet collected.
Example:
1. An example of this type of difference involves the use of the Installment Sales Basis of
Accounting for income tax purposes. The accrual basis of accounting is used by the entity
for financial reporting purposes, while a version of the cash basis, the Installment Sales
Basis, is used for income tax purposes. The net installment accounts receivable at year-
end reflects the future temporary difference.
2. The use of the equity method to recognize income from investments in equity securities
is another example. The equity method is used for financial reporting purposes, and the
amount of income reported on the income statement corresponds to the percentage of
stock owned in the investee multiplied by the reported earnings of the investee.
Investment income recognized for tax purposes will be equal to the dividends received in
a given year (after the dividends received deduction, if applicable).
Example: An example of this type of difference involves the recognition of rent revenue or
subscription revenue. For financial reporting purposes, the rent revenue or subscription
revenue is recognized in the year that it is earned. For tax purposes, the rent revenue or
subscription revenue is recognized in the year that the related cash payment is received.
The unearned subscription revenue account reflects the future temporary difference.
On September 1, 20x7, the Dolphin Company rented a vacant warehouse to the Raider
Company. The lease term was one year, from September 1, 20x7 through August 31, 20x8.
The warehouse annual rental fee was $24,000, which was paid in full on September 1, 20x7.
For financial reporting purposes, $8,000 rental revenue will be reported in 20x7, and
$16,000 rental revenue will be reported in 20x8. For tax purposes, the entire $24,000 will
be reported on the 20x7 tax return. The total rent revenue is the same under the two
systems of reporting but the timing of recognition is different in each year affected. At the
end of 20x7, the $16,000 balance in unearned rent (a liability) equals the future temporary
difference to reverse in 20x8.
Excess of statutory depletion over cost depletion

"DTA" if the item causes an increase in deferred tax Effect - Perm

assets
"DTL" if the item causes an increase in deferred tax
liabilities Classification - N/A
"Perm" if the item is a permanent difference
"None" if the item is not one of the above

Fines for violation of law

"DTA" if the item causes an increase in deferred Effect - Perm

tax assets
"DTL" if the item causes an increase in deferred
tax liabilities Classification - N/A
"Perm" if the item is a permanent difference
"None" if the item is not one of the above

For the year ended December 31, 2004, Mont Co.'s books showed income of
$600,000 before provision for income tax expense. To compute taxable
income for federal income tax purposes, the following items should be
noted:
Income from exempt municipal bonds $60,000
Depreciation deducted for tax purposes in excess of depreciation recorded
on the books $120,000
Proceeds received from life insurance on death of officer $100,000
Estimated tax payments 0
Enacted corporate tax rate 30%
Ignoring the alternative minimum tax provisions, what amount should Mont
report at December 31, 2004 as its current federal income tax liability?
The tax liability is the tax rate times taxable income = .30($600,000 - $60,000 -
$120,000 - $100,000) = $96,000.
The municipal- bond interest is tax exempt, but included in pre-tax
accounting income of $600,000 and therefore is subtracted when computing
taxable income.
The excess depreciation is also subtracted, because pre-tax accounting
income reflects only depreciation recorded for financial accounting
purposes.
The proceeds on life insurance are included in pre-tax accounting income,
but are not taxable and are therefore subtracted in computing taxable
income.

Installment sales (point of sale

recognition for books)
Effect - DTL
"DTA" if the item causes an increase in
deferred tax assets Classification - Both current and
"DTL" if the item causes an increase in noncurrent
deferred tax liabilities
"Perm" if the item is a permanent

List the two categories of temporary 1. Taxable Temporary Differences;

differences. 2. Deductible Temporary Differences.
Municipal bond interest
"DTA" if the item causes an increase in deferred
tax assets
"DTL" if the item causes an increase in deferred
tax liabilities
"Perm" if the item is a permanent difference
"None" if the item is not one of the above
Nature of Temporary Differences
Nature of Temporary Differences
Continued
Orleans Co., a cash-basis taxpayer, prepares accrual-basis financial
statements. Since 2002, Orleans has applied FASB Statement No. 109,
Accounting for Income Taxes. In its 2005 balance sheet, Orleans' deferred
income- tax liabilities increased compared to 2004.
Which of the following changes would cause this increase in deferred
income tax liabilities?
I. An increase in pre-paid insurance.
II. An increase in rent receivable.
III. An increase in warranty obligations.
Prepaid expenses
"DTA" if the item causes an increase in deferred
tax assets
"DTL" if the item causes an increase in deferred
tax liabilities
"Perm" if the item is a permanent difference
"None" if the item is not one of the above
Effect - Perm
Classification - N/A
A. In contrast with permanent differences
which never reverse over time, temporary
differences do reverse. The temporary
differences are actually timing differences.
These are the differences involved with the
process of interperiod tax allocation - the
recognition of deferred tax accounts.
1. The only difference between the two reporting systems (GAAP and tax) is
one of timing of recognition.
2. The concept of future temporary differences is one way to refer to the
underlying differences leading to the deferred tax accounts. Another is in
reference to an item's tax basis compared with its amount for financial
reporting purposes. For example, the cost of a plant asset is $100,000 and
for financial reporting the asset has been depreciated $15,000 through the
current balance sheet date (book value $85,000). The asset has been
depreciated $25,000 for tax purposes through the balance sheet date. For
tax purposes, this asset is said to have a tax basis of $75,000. The difference
between the book value and tax basis is $10,000, which also is the future
taxable difference. The $10,000 difference is the amount taht enters into the
computation of the deferred tax liability at the end of the current year.
B. I and II.
Correct!
Deferred tax liabilities are the future tax effects of future taxable temporary differences. Such differences cause future
taxable income to exceed future pre-tax accounting income.
I. An increase in pre-paid insurance implies that future accounting insurance expense will exceed future tax insurance
expense. Therefore, future taxable income will increase relative to future pre-tax accounting income. This increases
the deferred tax liability.
II. An increase in rent receivable implies that future tax-rent revenue will exceed future accounting-rent revenue. A
rent receivable is recorded when accounting-rent revenue is recognized before cash is received. Cash will be
received in the future, which will be recognized as rent revenue for tax, but no revenue will be recognized for
accounting. Therefore, again, future taxable income will increase relative to future pre-tax accounting income.
III. An increase in warranty obligations implies that future tax-warranty expense will exceed future accounting-
warranty expense. Accounting has recognized the warranty expense in the year of sale, whereas tax-warranty
expense is recognized in the year the repairs are made. This time, future taxable income will decrease relative to
future pre-tax accounting income. This increases the deferred tax asset, rather than the deferred tax liability.
Therefore, only I and II increase the deferred tax liability.
Effect - DTL
Classification - Current
Recognized estimated lawsuit loss for books

"DTA" if the item causes an increase in deferred Effect - DTA

tax assets
"DTL" if the item causes an increase in deferred
tax liabilities Classification - Current
"Perm" if the item is a permanent difference
"None" if the item is not one of the above

A. Frequently, examination problems provide only one of the two income

measures. Also, some firms maintain only one set of records and adjust
pretax accounting income to derive taxable income. The adjustment process
is shown below:

Relationship Between Pretax Accounting Pretax accounting income $ xx

Plus and minus originating temporary differences xx
Income and Taxable Income Plus and minus permanent differences for the period xx
Equals taxable income $ xx

B. This approach simplifies the process of computing taxable income

because it focuses only on the differences between the two income
measures.

Some Temporary Differences

Some of the more frequently observed
temporary differences are listed and
Some Temporary Differences described below. In most cases, a
balance sheet account reflects the
amount of the difference to reverse in
the future.

(Start of CPAexcel Exam Questions)

B. An item is included in the calculation of net income in
When accounting for income taxes, a temporary difference occurs in which one year and in taxable income in a different year.
of the following scenarios?

A. An item is included in the calculation of net income, but is neither taxable
nor deductible.
B. An item is included in the calculation of net income in one year and in
taxable income in a different year.
C. An item is no longer taxable, owing to a change in the tax law.
D. The accrual method of accounting is used.
This answer describes one category of temporary
difference. In general, a temporary difference is one for
which the item's recognition takes place at a different
rate or time for financial reporting and the tax return.
However, the total impact of the item is the same over
its life, for both systems of reporting.

(Start of CPAexcel Flashcards)

Differences that initially cause a
postponement in the payment of taxes.
Define "taxable temporary differences".
(Start of CPAexcel Task Based simulation)

Straight-line depreciation for

financial reporting, MACRS for tax reporting Effect - DTL

"DTA" if the item causes an increase in deferred tax assets

"DTL" if the item causes an increase in deferred tax liabilities Classification - Noncurrent
"Perm" if the item is a permanent difference
"None" if the item is not one of the above

Taxable Before Recognized for the

Books --
Taxable Before Recognized for the
Books Revenues or Gains that are Taxable
before they are Recognized in Financial
Income

Tax receivable from net operating loss carryback

"DTA" if the item causes an increase in deferred tax Effect - None

assets
"DTL" if the item causes an increase in deferred tax
liabilities Classification - N/A
"Perm" if the item is a permanent difference
"None" if the item is not one of the above

True or False. Taxable temporary

differences are differences which cause True. They cause Deferred tax liabilities.
deferred tax liabilities.

Unearned revenue

"DTA" if the item causes an increase in deferred Effect - DTA

tax assets
"DTL" if the item causes an increase in deferred
tax liabilities Classification - Current
"Perm" if the item is a permanent difference
"None" if the item is not one of the above
Unrealized gain on trading securities

"DTA" if the item causes an increase in deferred Effect - DTL

tax assets
"DTL" if the item causes an increase in deferred
tax liabilities Classification - Current
"Perm" if the item is a permanent difference
"None" if the item is not one of the above

What temporary difference causes future

taxable income to exceed future book Taxable temporary difference.
income?

What type of deferred tax accounts do

They cause Deferred tax assets.
deductible temporary differences cause?

What type of differences are temporary

Taxable differences.
differences caused by depreciation?

What type of differences are temporary

differences caused by regular Deductible differences.
warranties?