ACC 318 Module 4 Project One Example

Why the Tax Bill and the Tax Expense Differ: Deferred Taxes at a Composite Trampoline Park Chain

[Student Name]

Southern New Hampshire University

ACC 318: Intermediate Accounting II

Project One

[Instructor Name]

[Date]

The organization, setting and figures below are a composite written as a model document. No real employer, client, colleague or patient is described.

Why the Tax Bill and the Tax Expense Differ: Deferred Taxes at a Composite Trampoline Park Chain

Introduction

The trampoline park chain earned $5,200,000 before income taxes on its books this year, yet its tax returns will show taxable income of only $3,470,000. Neither number is wrong. GAAP and the tax code measure income for different purposes and on different schedules, and ASC 740 requires the company to report tax expense that reflects both the tax it owes now and the tax consequences of differences that will reverse later (Kieso et al., 2019). This project identifies the differences, computes current and deferred taxes, evaluates a deferred tax asset that may never be used, reconciles the effective rate and shows the presentation. All years are taxed at one blended federal and state rate, 25 percent.

Identifying the Differences

Table 1. Differences Between Book and Taxable Income

The fine and the meals will never be deducted, so they raise taxable income this year and every year they recur, and they have no deferred tax effect. The depreciation difference arises because the company took bonus depreciation on $3.2 million of new attractions, deducting most of the cost immediately for tax while depreciating it over eight years for books. In later years book depreciation will exceed tax depreciation, producing taxable amounts, so the difference creates a deferred tax liability. The memberships work the other way. Annual passes sold in December are taxed when the cash is received but recognized as revenue over the coming year for books, so the company has already paid tax on revenue it will report later, which creates a deferred tax asset.

Current and Deferred Taxes

Table 3. Deferred Tax Changes This Year

The Oklahoma Loss Carryforward

The company's two Oklahoma parks are held in a separate subsidiary that files its own state return. It has a state net operating loss carryforward that would reduce future Oklahoma tax by $120,000, recorded as a deferred tax asset. The tax standard asks a blunt question about any deferred tax asset: will there be enough future taxable income to use it? If the answer is probably not, an allowance offsets the asset (Financial Accounting Standards Board, 1992). The negative evidence is strong: the subsidiary has lost money in each of its three years, and one of its two parks is under review for closure. The positive evidence, a new lease signed for a third park, is a plan rather than a result. On balance, realization is not more likely than not, so the company records a full $120,000 valuation allowance, which increases deferred tax expense.

Total Tax Expense, Entry and Rate Reconciliation

Total income tax expense is current tax of $867,500 plus deferred tax of $450,000 plus the valuation allowance of $120,000, or $1,437,500. The entry debits Income Tax Expense for $1,437,500 and Deferred Tax Asset for $150,000, and credits Income Taxes Payable for $867,500, Deferred Tax Liability for $600,000 and Valuation Allowance for $120,000.

Table 4. Rate Reconciliation

The temporary differences do not appear in the reconciliation because deferred tax accounting already records their tax effect in the year the income is reported. Only items that change the total tax ever paid on this year's income, permanent differences and changes in the allowance, move the effective rate away from 25 percent.

Presentation

Since 2015 every deferred tax balance sits in the noncurrent section, and offsetting is allowed only inside one taxpayer and one taxing authority. The federal and Texas balances net to a deferred tax liability of $450,000 for this year's changes. The Oklahoma subsidiary's $120,000 asset and its $120,000 allowance net to zero and cannot be offset against the parent's liability. The notes should disclose the components of tax expense, the significant temporary differences, the carryforward and its expiration, and the reasons for the valuation allowance.

What the Numbers Say

Graham et al. (2012) note that the tax accounts are among the most judgment-laden in financial statements and that the valuation allowance in particular gives managers room to shift income between years. That is a reason to document the allowance carefully: if the Oklahoma parks turn profitable, releasing the allowance will lower tax expense in that year, and users will want to know it came from evidence rather than a target. For now, the 27.6 percent effective rate tells the owners and the private equity investor that most of the gap between book and cash taxes is timing, not savings. The $600,000 deferred liability will come due as bonus depreciation runs out.

That timing has cash consequences the owners should plan for. Bonus depreciation lowered this year's tax payment by about $600,000, but as the attractions continue to be depreciated on the books with little tax depreciation left, taxable income will exceed book income and cash taxes will rise. If the chain keeps opening parks and buying new attractions, fresh bonus depreciation will keep pushing the liability out, which is why growing companies often carry deferred tax liabilities for many years. If growth stops, the reversal arrives, and cash taxes will exceed tax expense for several years.

Conclusion

The chain owes $867,500 in current tax on taxable income of $3,470,000, but reports total tax expense of $1,437,500, including $450,000 of net deferred tax and a $120,000 valuation allowance. The effective rate of 27.6 percent reconciles to the 25 percent statutory rate through nondeductible items and the allowance. The deferred liability from bonus depreciation is the largest item and will reverse over the next several years.

References

Financial Accounting Standards Board. (1992). Accounting for income taxes (Statement of Financial Accounting Standards No. 109). Author.

Graham, J. R., Raedy, J. S., & Shackelford, D. A. (2012). Research in accounting for income taxes. Journal of Accounting and Economics, 53(1-2), 412-434. https://doi.org/10.1016/j.jacceco.2011.11.006

Kieso, D. E., Weygandt, J. J., & Warfield, T. D. (2019). Intermediate accounting (17th ed.). Wiley.