2.11. Accounting for taxes – an overview

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Do curso por Moscow Institute of Physics and Technology

Core Concepts of Accounting – Numbers and People

7 classificações

Moscow Institute of Physics and Technology

Core Concepts of Accounting – Numbers and People

7 classificações

Curso 3 de 5 em Specialization Understanding Modern Finance

Whenever the word “accounting” is pronounced, it is immediately associated with the need to memorize endless boring numbers. However, it is the common financial statements that contain important information that provides inputs for valuation of investment projects. The only challenge is how to properly extract them. Accounting and finance are indeed intertwined. Sometimes people that are not experienced in the area even mix them up. But most often emphasis in accounting is on numbers. Still, the deep understanding of key accounting concepts helps reveal the interests and actions of people behind these numbers. And the human dimension of accounting adds invaluable insight in the potential of successful project implementation. This Course discusses core ideas and concepts of both financial and managerial accounting. It by no means pretends to be comprehensive to any extent. But, being rather an accounting overview, it focuses on the issues that are most relevant and important for effective valuation of investment projects. The learners will gain insight into the essence of accounting. They will be able to use the obtained knowledge and skills to successfully advance in their career at a financial institution, as well as in the area of financial management at non-financial businesses. To pursue a career in accounting, a more detailed study is strongly recommended.

Na lição

Operational Assets. Depreciation. Short-Term Investments. Long-Term Liabilities. Shareholders’ Equity. Some Tax Issues

Week 2 is devoted to long-term assets and liabilities. We start with operational assets and see the role of depreciation and amortization in financial accounting and compare it to the way depreciation is used in valuation of investment projects. Then we discuss how financial investments in securities – stocks and bonds – are treated in accounting dependent upon goals and time horizon of holding and/or issuing of these securities. You will see how financial concepts (present values) are used in accounting for bond premium/discount amortization. Finally, an overview of the accounting approach to taxes is provided. On an example, you will study the core idea of deferred taxes.

2.1. Operational assets – types and accounting approach13:17

2.2. Depreciation11:14

2.3. Depreciation tax shield8:53

2.4. Intangible assets – accounting and amortization7:22

2.5. Short-term investments in bonds10:19

2.6. Short-term investments in stocks12:33

2.7. Bonds (1) – parameters and accounting approach10:31

2.8. Bonds (2) – amortization of premium/discount13:34

2.9. Equity (1) – accounting for common and preferred stock11:37

2.10. Equity (2) – treasury stock and stock dividends12:15

2.11. Accounting for taxes – an overview9:11

2.12. Deferred taxes – an example8:32

Conheça os instrutores

Konstantin Kontor
Director and Professor of Finance and Strategy
American Institute of Business and Economics (AIBEc)

Well, we are approaching the end of the second week, and

in the final two episodes, I will say a few words about accounting for taxes.

Again, like I mentioned before,

this discussion by no means pretends to be comprehensive or deep.

We are just mentioning some things that sometimes are important to keep in mind.

But, like I said, tax accounting is an advanced part, and clearly,

those who would like to specialize in that should take some other courses.

Now, the question arises, why we talk about that at all?

So we talk about tax issues.

Now the story here is as follows.

That oftentimes in accounting

different procedures are allowed for the companies to report

for the need to show the income or for tax purposes.

Remember that when we talked about inventories,

we said that for quite some time people would use LIFO for tax purposes and

FIFO for income reporting, killing two birds with one stone.

Later it was prohibited to do so, but sometimes it is allowed.

And as a result, what happens is that over time there are some differences

between taxable income, and therefore,

what should be the tax expense derived from that, and what actually people pay.

Now, in general, that, like I said, is a very advanced topic.

So I will just show why that could happen and

what is the consistent approach to that.

So we're talking about differences.

So the problem is,

What should the tax

expense be?

Now, and like I said, because of these approach to treatment,

there may be some differences,

In recognition of certain revenues and

expenses with respect to taxes, and those may be permanent.

The example is, let's say, municipal bond

interest, which is by law tax deductible.

Or, what is more interesting for us, they may be temporary.

And what happens with this temporary,

that sometimes we may recognize some revenues or expenses for

income reporting purposes in one period, while for tax purposes in the other.

And that is the key, the core of the problem, if you will.

And in what follows, we will be studying these cases,

these small simplistic examples, just to keep this in mind.

Because whenever people hear something like deferred taxes,

they may be somewhat confused.

So this is the main story.

So we see that the differences

are differences in recognition,

Of revenues and expenses for

income and for tax purposes.

And again, our general principle here is matching.

And in what follows, I will show some examples of that.

Now let's take an example.

An example would go like this, this is a rent payment.

Now, the story goes as follows.

We have two years, let's say 2014 and then 2015.

And then the pretax income is $40,000 here and

$60,000 there.

So this is pretax income.

And let's say that the tax rate is 40%.

Now, see what happens.

The rent expense, Of $5,000,

It is reported for

income goals in 2014.

But for tax purposes, sort of paid, in,

I'll put like paid, in 2015.

And that results in a temporary deference.

Let's see what we mean here.

Let's start with year 2014.

So we, first of all, have income tax expense, what is it?

So it's 40%.

We take 40,000 pretax income, so it's $16,000 here.

This is 40% times 40k.

Now, we also have income tax payable.

Which in this case is higher, why is that?

Because this now, because we reported that in the previous year,

now it's 45,000, the base.

So this is 45,000 times 40%.

So income tax payable is $18,000.

So we see a mismatch, and

the mismatch is called deferred income tax.

So you can see that the block number, to be sure of that,

ends up ends meet, this is 2,000 here in debit side.

So this is what happened at the end of the year 2014.

Now, if we go to the next year.

So basically, at the end of the year 2014,

we have the rent payable, a liability,

that does not result in any tax things until the next year.

Now, let's see what happens in 2015.

Again, we have income tax expense,

and here we have income tax payable.

But now, see what happens.

Well, income tax expense, again, we have $60,000, so

we have $24,000 here.

But now, here we do not have $60,000,

we have $55, because 5 we have already reported.

So from 55 we take 40%, and here that becomes $22,000.

So you can see that combined that's the same amount,

18 plus 22 clearly is the same as 16 plus 24.

So here we, again, have this account deferred income tax,

that now has 2,000 on the credit side.

And you can see that, I'll put like this, sort of cancels out.

So if we had the accounts for

two years combined, we would not have had this difference at all,

but because we have to report that annually, we do.

So that shows to you what we have to do if reporting for

income and reporting for taxes occurs at different moments of time.

So that is sort of a simple episode.

And in the next one, we'll go a little further, and

study another case of deferred income taxes.

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