a. Book income, or pretax financial income is a financial reporting term. It also is often referred to as income before taxes, income for financial reporting purposes, or income for book purposes. Companies determine pretax financial income according to GAAP. (KIESO) Companies choose to report pretax financial income in order to disclose the information to their shareholders and investors.
The number in ZAGG’s statement of operation for fiscal 2012 is $23,898.00, which is book income.
The difference between book income and taxable income is quite significant because book income is determined using GAAP, whereas taxable income is determined after consulting the IRS code. Also the difference would be that for financial reporting, companies use the full accrual method to report revenues, whereas for tax purposes, they used modified cash basis.
b. i. There are some differences between taxable income and pretax financial income that are permanent. Permanent tax differences result from items that (1) enter into pretax financial income but never into taxable income, (2) enter into taxable income but
never into pretax financial income.
In the United States the examples of permanent differences would be accounting for meals and entertainment, municipal bond interest, penalties and fines, as well as purchase of life insurance for employees.
ii. Temporary tax difference is the difference between the tax basis of an asset or liability and its reported carrying amount in the financial statements, which will result in taxable amounts or deductible amounts in future years. However, they are called
temporary because such differences eventually smooth out.
An example of temporary would be difference in depreciation method, for example, a company would use straight-line depreciation for book purposes, and for tax purposes it would use a more accelerated method.
iii. Statutory tax rate is the tax rate imposed by law; in this case it is 35%.
iv. Effective tax rate is the average rate of tax that a corporation actually pays. It is always be lower than statutory tax rate.
c. Deferred tax expense is the increase in the deferred tax liability balance from the beginning to the end of the accounting period. Big question that comes up is why a company reports deferred income taxes as part of their total income tax expense.
Deferred income tax expense is deferred portion of income tax that is reported on the income statement. A company reports their deferred income taxes as part of their total income tax expense to make it more transparent and accurate.
d. Explain what deferred income tax assets and deferred income tax liabilities represent.
Give an example of a situation that would give rise to each of these items on the balance sheet.
A deferred tax asset is the deferred tax consequence attributable to deductible temporary differences. If tax expense is smaller than current income tax liability it is a deferred tax asset.
If a company encounters loss, it usually uses that loss in order to lower taxes in the following years, so in that sense the loss would give a rise of a deferred tax asset.
Deferred tax liability is the deferred tax consequence as a result of discrepancy in the book value and after-tax asset or liability. If tax expense were higher than current tax liability, the difference would be the deferred tax liability. Temporary difference causes future liabilities, so the company usually records a deferred tax liability, which will be the increase in future tax payable.
e. Explain what a deferred income tax valuation allowance is and when it should be recorded. A Company usually creates a valuation allowance for deferred tax asset if it can predict that they will not realize a portion of an asset. This amount is evaluated and updated in the end of each accounting in order to comply with tax laws. The tax effect of any valuation allowance used to offset the deferred tax asset can also impact the
estimated annual effective rate. (Steven Bragg, Accounting Tools)
f. i. Using information in the first table in Note 8, show the journal entry that ZAGG recorded for the income tax provision in fiscal 2012?
Income Tax Expense 9,393
Net Deferred Tax Asset 8,293
Income Tax Pay 17,686
ii. Using the information in the third table in Note 8, decompose the amount of “net deferred income taxes” recorded in income tax journal entry in part f. i. into its deferred income tax asset and deferred income tax liability components.
iii. The second table in Note 8 provides a reconciliation of income taxes computed using the federal statutory rate (35%) to income taxes computed using ZAGG’s effective tax rate.
Income Tax Expense 9,393
Deferred Tax Asset 8,002
Deferred Tax Liab 291
Income Tax Pay 17,686
Calculate ZAGG’s 2012 effective tax rate using the information provided in their income statement. What accounts for the difference between the statutory rate and ZAGG’s effective tax rate?
ETR = Tax Expense / Pretax Income = 9,393 / 23,898 = 0.393 = 39.3%
Statutory rate x = 8,364
iv. According to the third table in Note 8 – Income Taxes, ZAGG had a net deferred income tax asset balance of $13,508,000 at December 31, 2012. This balance appears in Current DTT totaling $6,912, and in Noncurrent Deferred Income Tax and equals $6,596.