1. Ch.18 Accounting Income and Tax Income
Introduction to Income Taxes
Textbook: Intermediate Accounting Income Taxes 13th Canadian Edition, Volume 2Authors: Kieso, Weygandt, Warfield, Wiecek, McConomyChapter Focus: Income TaxesNote: Slide deck contains animations. Disable if necessary.
Learning Objectives (Chapter 18)
After studying this chapter, you will able to:
Understand the significance of income taxes in business contexts, including their effect on financial decision-making and reporting.
Differentiate between accounting income and taxable income; calculate taxable income, current income taxes, and recognize the timing of tax payments.
Identify taxable and deductible temporary differences; determine their amounts, deferred tax assets, and liabilities to assess future tax impacts.
Analyze deferred tax balances meticulously, ensuring accurate recording of deferred tax expenses to reflect true financial position.
Understand the impact of varying tax rates and rate changes on income tax accounts; articulate methods for calculating tax amounts affected by changes in enacted tax rates and their effects on deferred taxes.
Account for the benefits of tax loss carryover, including note disclosures that enhance clarity to stakeholders about potential future benefits.
Discuss the reasons for reassessing the Deferred/Future Tax Asset account; articulate accounting treatment with or without a valuation allowance considering market conditions.
Describe presentation and disclosure requirements for income tax assets and liabilities within financial statements, and apply intraperiod tax allocation effectively.
Identify key differences in accounting treatment for income taxes between ASPE and IFRS while presenting upcoming changes relevant to stakeholders.
Income Taxes from a Business Perspective
Corporations are mandated by the Income Tax Act and provincial legislation to file accurate income tax returns reflecting their financial activities.
It is crucial to recognize that Generally Accepted Accounting Principles (GAAP) methodologies often diverge from tax laws; frequently, there is a substantial difference between pre-tax accounting income and taxable income due to adjustments and timing differences.
Under Accounting Standards for Private Enterprises (ASPE), companies have the option to employ a taxes payable approach, wherein the tax expense reported equals taxes payable, leading to simplified accounting processes.
Accounting Income vs. Taxable Income
Accounting Income:
Also referred to as “income before taxes” or “accounting profit.”
This figure is computed per IFRS or ASPE guidelines and aims to deliver relevant information that supports decision-making for financial statement users.
Taxable Income:
Known as “income for tax purposes” and calculated in accordance with the Income Tax Act and associated regulations.
It involves methodically adjusting accounting income for differences such as non-deductible expenses or tax credits to derive the accurate taxable income figure.
Differences Between Accounting and Taxable Income
Temporary Differences:
These differencing conditions occur when revenues or gains are recognized or taxable prior to or after they are reflected in accounting income.
For example: Certain expenses may be deductible from taxable income before they are recorded as expenses in accounting income, leading to timing differences in tax effects.
Permanent Differences:
These are items in accounting income that are completely excluded from taxable income, or conversely, inclusions in taxable income that do not affect accounting profit.
Since they do not reverse in future periods, they do not result in deferred tax implications and must be carefully documented.
Key Concepts for Accounting Income
Understanding Differences: It is essential to comprehend why accounting income diverges from taxable income due to differing regulatory rules.
Reconciliation: Critical for determining the adjustments needed to reconcile the disparate segments of income.
Tax Expense Calculation: Must report both current and deferred tax expenses through precise journal entries to ensure compliance.
Housekeeping Requirements: Include thorough reviews of tax rate changes, implications of carrybacks or carryforwards, and necessary disclosures to provide transparency.
Reconciliation of Accounting to Taxable Income
Formula:
Taxable Income Calculation:Accounting Income (from income statement) + Permanent Differences + Temporary Differences = Taxable Income
Journal Entries:
Current Tax Entry:
Debit Current Income Tax Expense (CITExp).
Credit Current Income Tax Payable (CITP).
Calculate Deferred Taxes:
Debit Deferred Tax Expense.
Debit Deferred Tax Asset.
Credit Deferred Tax Payable (or record the benefit).
Types of Differences
Permanent Differences:
These are added or deducted directly from accounting income, with no need for future adjustments; includes specific allowances such as for meals, capital gains, and certain tax-exempt income.
Temporary Differences:
Adjustments that reflect timing differences; recognized in one period with intentions to reverse the effects in a future period, impacting the financial statements effectively.
Examples of Tax Implications
Revenue Recognition: The timing of revenue recognition for tax purposes may differ; taxable income may arise only when cash is received, which contrasts with accrual accounting practices.
Tax Accounting: Accrued expenses are managed on a cash basis for taxing units, affecting the overall financials of the tax entity.
Calculating Taxable Income: Example
A hypothetical company reports accounting income over the years 2023-2025, involving differences such as royalties, insurance premiums, warranty costs leading to necessary adjustments in reported income.
Deferred Tax Accounting
Deferred tax assets and liabilities emerge from temporary differences, impacting future taxable relations.
Deferred Tax Liability: Established from taxable temporary differences anticipated to reverse in following periods, creating a future tax obligation.
Deferred Tax Asset: Developed from deductible temporary differences, providing future tax benefits.
Tax Base of Assets and Liabilities
The tax base crucially determines the amounts deductible for assets upon realizations of profitability.
Discrepancies between the tax base and carrying amounts generate temporary differences, necessitating adequate accounting treatment.
Income Tax Loss Carryover Benefits
Tax legislation allows for loss carrybacks and carryforwards to alleviate future taxable income projections.
Carrybacks: Permit entities to apply losses to previous taxable incomes, yielding tax refunds for earlier accounting periods.
Carryforwards: Enable companies to apply losses against future taxable income for a period extending up to 20 years, optimizing tax strategies.
Conclusion
Regular reviews and adjustments of deferred tax accounts are vital to ensuring the accuracy and reliability of financial statements related to income taxes.
Understanding the dynamics of accounting for income taxes not only aids in compliant reporting but also supports informed business decisions and strategic financial planning considering evolving accounting standards and tax laws.