Kleckner Company started operations in 2013. Although it has grown steadily, the company reported accumulatedoperating losses of \(450,000 in its first four years in business. In the most recent year (2017), Kleckner appears to haveturned the corner and reported modest taxable income of \)30,000. In addition to a deferred tax asset related to its net operatingloss, Kleckner has recorded a deferred tax asset related to product warranties and a deferred tax liability related to accelerateddepreciation. Given its past operating results, Kleckner has determined that it is not probable that it will realize any of thedeferred tax assets. However, given its improved performance, Kleckner management wonders whether there are any accountingconsequences for its deferred tax assets. They would like you to conduct some research on the accounting for recognitionof its deferred tax asset.

Instructions

Access the IFRS authoritative literature at the IASB website (http://eifrs.iasb.org/).(Click on the IFRS tab and then register for freeeIFRS access if necessary.) When you have accessed the documents, you can use the search tool in your Internet browser torespond to the following questions. (Provide paragraph citations.)

(a)Briefl y explain to Kleckner management the importance of future taxable income as it relates to the recognition ofdeferred tax assets.

(b)What are the sources of income that may be relied upon in assessing realization of a deferred tax asset?

(c)What are tax-planning strategies? From the information provided, does it appear that Kleckner could employ a taxplanningstrategy in evaluating its deferred tax asset?

Short Answer

Expert verified

a) The carry-forward of unused tax losses must be recorded as a deferred tax asset.

b) When assessing profitability, an entity must consider taxable profits, unused tax losses, tax planning opportunities, and other criteria.

c) Tax planning is an objective to create or increase taxable income.

Step by step solution

01

(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.

02

(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

03

(c) Explaining the tax-planning strategies.

“Tax planning opportunities are measures that will materially provide for creating or increasing assessable income over a specified period or assessing credit carryforwards.”In 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

Teri Hatcher Inc., in its first year of operations, has the following differences between the book basis and tax basis of its assets and liabilities at the end of 2016. Book Basis Tax Basis Equipment (net) \(400,000 \)340,000 Estimated warranty liability \(200,000 \) –0– It is estimated that the warranty liability will be settled in 2017. The difference in equipment (net) will result in taxable amounts of \(20,000 in 2017, \)30,000 in 2018, and \(10,000 in 2019. The company has taxable income of \)520,000 in 2016. As of the beginning of 2016, the enacted tax rate is 34% for 2016–2018, and 30% for 2019. Hatcher expects to report taxable income through 2019.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 will be reported on the balance sheet at the end of 2016.

The following information was disclosed during the audit of Elbert Inc. 1. Amount Due Year per Tax Return 2017 \(130,000 2018 104,000 2. On January 1, 2017, equipment costing \)600,000 is purchased. For financial reporting purposes, the company uses straight-line depreciation over a 5-year life. For tax purposes, the company uses the elective straight-line method over a 5-year life. (Hint: For tax purposes, the half-year convention as discussed in Appendix 11A must be used.) 3. In January 2018, \(225,000 is collected in advance rental of a building for a 3-year period. The entire \)225,000 is reported as taxable income in 2018, but \(150,000 of the \)225,000 is reported as unearned revenue in 2018 for financial reporting purposes. The remaining amount of unearned revenue is to be recognized equally in 2019 and 2020. 4. The tax rate is 40% in 2017 and all subsequent periods. (Hint: To find taxable income in 2017 and 2018, the related income taxes payable amounts will have to be “grossed up.”) 5. No temporary differences existed at the end of 2016. Elbert expects to report taxable income in each of the next 5 years. Instructions (a) Determine the amount to report for deferred income taxes at the end of 2017, and indicate how it should be classified on the balance sheet. (b) Prepare the journal entry to record income taxes for 2017. (c) Draft the income tax section of the income statement for 2017, beginning with “Income before income taxes.” (Hint: You must compute taxable income and then combine that with changes in cumulative temporary differences to arrive at pretax financial income.) (d) Determine the deferred income taxes at the end of 2018, and indicate how they should be classified on the balance sheet. (e) Prepare the journal entry to record income taxes for 2018. (f) Draft the income tax section of the income statement for 2018, beginning with “Income before income taxes.”

Youngman Corporation has temporary differences at December 31, 2017, that result in the following deferred taxes.

Deferred tax asset $24,000

Deferred tax liability 69,000

Indicate how these balances would be presented in Youngman’s December 31, 2017, statement of financial position.

The accounting records of Shinault Inc. show the following data for 2017 (its first year of operations).

1. Life insurance expense on officers was \(9,000.

2. Equipment was acquired in early January for \)300,000. Straight-line depreciation over a 5-year life is used with no salvage value. For tax purposes, Shinault used a 30% rate to calculate depreciation.

3. Interest revenue on State of New York bonds totaled \(4,000.

4. Product warranties were estimated to be \)50,000 in 2017. Actual repair and labor costs related to the warranties in 2017 were \(10,000. The remainder is estimated to be paid evenly in 2018 and 2019.

5. Gross profit on an accrual basis was \)100,000. For tax purposes, \(75,000 was recorded on the installment-sales method.

6. Fines incurred for pollution violations were \)4,200.

7. Pretax financial income was $750,000. The tax rate is 30%.

Instructions (a) Prepare a schedule starting with pretax financial income in 2017 and ending with taxable income in 2017. (b) Prepare the journal entry for 2017 to record income taxes payable, income tax expense, and deferred income taxes.

Rode Inc. incurred a net operating loss of \(500,000 in 2017. Combined income for 2015 and 2016 was \)350,000. The tax rate for all years is 40%. Rode elects the carryback option. Prepare the journal entries to record the benefits of the loss carryback and the loss carryforward. Rode expects to return to profitability in 2018.

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