Chapter 16 Accounting for Income Taxes
DEFERRED TAX ASSETS AND DEFERRED TAX LIABILITIES
Fundamental Concepts
There are fundamental differences in the amount of income and expenses reported for GAAP and income tax purposes. The objective for GAAP reporting is to report the economic activities of the entity. The objective for income tax purposes is for the government to raise revenue. There are two terms that identify the types of income subject to tax under each reporting system.
1

Pretax financial income
Pretax financial income is the income determined using GAAP. It is the amount of income on which income tax is computed for financial statement purposed. It is formally presented in the income statement as income before income taxes. We normally refer to it is pretax income. 2

Taxable income
Taxable income is the income determined using Internal Revenue Code rules and regulations.
It is the amount of income on which the entity will actually pay income tax in the current accounting period.

Temporary Differences
Deferred taxes arise as a result of temporary difference between income tax expense and income tax payable. A temporary difference is the difference between the book value of an asset or liability and the tax basis of the same asset or liability. If the income tax expense in the income statement is larger than the current income tax liability the difference is called a deferred tax liability. If the income tax expense in the income statement is smaller than the current income tax liability the difference is called a deferred tax asset.
Deferred Tax Liabilities
A deferred tax liability is created as a result of the difference between the book value and the tax basis of an asset or liability. The difference creates a tax liability in future periods.
EXAMPLE: Spencer Company has pretax financial statement income for the current year of
$700,000. The company’s