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Chapter 19: Q1CRC (page 1110)

Kleckner Company started operations in 2013. Although it has grown steadily, the company reported accumulated operating losses of \(450,000 in its first four years in business. In the most recent year (2017), Kleckner appears to have turned the corner and reported modest taxable income of \)30,000. In addition to a deferred tax asset related to its net operating loss, Kleckner has recorded a deferred tax asset related to product warranties and a deferred tax liability related to accelerated depreciation.

Given its past operating results, Kleckner has established a full valuation allowance for its deferred tax assets. However, given its improved performance, Kleckner management wonders whether the company can now reduce or eliminate the valuation allowance. They would like you to conduct some research on the accounting for its valuation allowance.

Instructions

If your school has a subscription to the FASB Codification, go to http://aaahq.org/ascLogin.cfm to log in and prepare responses to the following. Provide Codification references for your responses.

  1. Briefly explain to Kleckner management the importance of future taxable income as it relates to the valuation allowance for deferred tax assets.
  2. What are the sources of income that may be relied upon to remove the need for a valuation allowance?
  3. What are tax-planning strategies? From the information provided, does it appear that Kleckner could employ a tax planning strategy to support reducing its valuation allowance?

Short Answer

Expert verified
  1. The carry-forward of unused tax losses must be recorded as a deferred tax asset.
  2. When assessing profitability, an entity must consider taxable profits, unused tax losses, tax planning opportunities, and other criteria.
  3. Tax planning is an objective to create or increase taxable income.

Step by step solution

01

Meaning of Income-tax

A business's tax responsibility to the government in which it operates is known as "income tax payable." A business's profits will determine the amount owed over a given period and the tax rates imposed. Tax payable is a debt that must be paid within the next 12 months. Thus, it is not considered a long-term responsibility but rather a current one.

02

(a) Explaining the importance of future taxable income.

IAS 12, paragraph 34, "A deferred tax asset shall be recorded for unused tax losses and unused tax credits to the extent future taxable profits will probably be available against which the unused tax losses and unused tax credits can be applied." Therefore, future taxable income is essential for boosting the amount recognized in the deferred tax asset.

03

(b) Explaining the sources of income that may be relied upon to remove the need for a valuation allowance.

This question is about the material in paragraph 36, which says, "An entity considers the following elements in determining the likelihood that taxable profit would be available against which the unused tax losses or unused tax credits can be applied."

  1. It would be prudent for the entity to ensure that it has sufficient temporary differences with the same tax authority and the taxable entity that will generate taxable amounts against which unused tax losses or unused tax credits can be used before they expire;
  2. When the unused tax loss or credit is likely to be eliminated by the company before generating a taxable profit.
  3. Unused tax losses stem from identifiable and unlikely to repeat reasons.

The deferred tax asset is not recognized since it is improbable that taxable earnings would be available to offset the utilized tax losses or tax credits.

04

(c) Explaining the tax-planning strategies.

鈥淭ax planning opportunities are measures that will materially provide for creating or increasing assessable income over a specified period or assessing credit carry forwards.鈥滻n some jurisdictions, for example, taxable profit can be made or raised by:

  1. Deciding whether interest income is taxed as received or as receivable
  2. Delaying the claim for certain taxable profit deductions;
  3. selling and maybe leasing back assets that have increased in value but whose tax base has not been modified to reflect this; and
  4. Selling a non-taxable asset (such as a government bond in some countries) to fund the acquisition of a taxable asset

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Most popular questions from this chapter

Addison Co. has one temporary difference at the beginning of 2017 of \(500,000. The deferred tax liability established for this amount is \)150,000, based on a tax rate of 30%. The temporary difference will provide the following taxable amounts: \(100,000 in 2018, \)200,000 in 2019, and $200,000 in 2020. If a new tax rate for 2020 of 20% is enacted into law at the end of 2017, what is the journal entry necessary in 2017 (if any) to adjust deferred taxes?

Meyer reported the following pretax financial income (loss) for the years 2015鈥�2019. 2015 $240,000 2016 350,000 2017 120,000 2018 (570,000) 2019 180,000 Pretax financial income (loss) and taxable income (loss) were the same for all the years involved. The enacted tax rate was 34% for 2015 and 2016, and 40% for 2017鈥�2019. Assume the carryback provision is used for the net operating losses. Instructions (a) Prepare the journal entries for the years 2017鈥�2019 to record the income tax expense, income taxes payable (refundable), and the tax effects of the loss carryback and loss carryforward, assuming that based on the weight of available evidence, it is more likely than not that one-fifth of the benefits of the loss carryforward will not be realized. (b) Prepare the income tax section of the 2018 income statement beginning with the line 鈥淚ncome (loss) before income taxes.鈥�

Nadal Inc. has two temporary differences at the end of 2016. The first difference stems from installment sales, and the second one results from the accrual of a loss contingency. Nadal鈥檚 accounting department has developed a schedule of future taxable and deductible amounts related to these temporary differences as follows. 2017 2018 2019 2020 Taxable amounts \(40,000 \)50,000 \(60,000 \)80,000 Deductible amounts (15,000) (19,000) \(40,000 \)35,000 \(41,000 \)80,000 As of the beginning of 2016, the enacted tax rate is 34% for 2016 and 2017, and 38% for 2018鈥�2021. At the beginning of 2016, the company had no deferred income taxes on its balance sheet. Taxable income for 2016 is $500,000. Taxable income is expected in all future years. Instructions (a) Prepare the journal entry to record income tax expense, deferred income taxes, and income taxes payable for 2016. (b) Indicate how deferred income taxes would be classified on the balance sheet at the end of 2016.

Presented below are two independent situations related to future taxable and deductible amounts resulting from temporary differences existing at December 31, 2017. 1. Mooney Co. has developed the following schedule of future taxable and deductible amounts. 2018 2019 2020 2021 2022 Taxable amounts \(300 \)300 \(300 \) 300 \(300 Deductible amount 鈥� 鈥� 鈥� (1,600) 鈥� 2. Roesch Co. has the following schedule of future taxable and deductible amounts. 2018 2019 2020 2021 Taxable amounts \)300 \(300 \) 300 \(300 Deductible amount 鈥� 鈥� (2,300) 鈥� Both Mooney Co. and Roesch Co. have taxable income of \)4,000 in 2017 and expect to have taxable income in all future years. The tax rates enacted as of the beginning of 2017 are 30% for 2017鈥�2020 and 35% for years thereafter. All of the underlying temporary differences relate to noncurrent assets and liabilities. Instructions For each of these two situations, compute the net amount of deferred income taxes to be reported at the end of 2017, and indicate how it should be classified on the balance sheet.

What is an uncertain tax position, and what are the general guidelines for accounting for uncertain tax positions?
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