Tax Slides

7/29/2019 Tax Slides

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Prepared by:Patricia Zima, CA

Mohawk College of Applied Arts and Technology

Chapter 18Chapter 18Income Taxesncome Taxes


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Accounting for Income Taxesccounting for Income TaxesCurrentCurrent

Income TaxesIncome Taxes

Introduction toIntroduction to

financial reportingfinancial reportingfor income taxesfor income taxes

AccountingAccounting

income and taxableincome and taxable

incomeincome

Calculation ofCalculation oftaxable incometaxable income

Calculation ofCalculation of

current incomecurrent income

taxestaxes

The Asset-The Asset-

Liability MethodLiability Method

DifferentialDifferential

reportingreporting

ConceptualConceptual

questionsquestions

ComprehensiveComprehensive

Illustration ofIllustration ofinterperiod taxinterperiod tax

allocationallocation

Future IncomeFuture Income

TaxesTaxes

Tax basisTax basisFuture income taxFuture income tax

liabilitiesliabilities

Future income taxFuture income tax

assetsassets

MultipleMultipledifferencesdifferences

illustratedillustrated

Tax rateTax rate

considerationsconsiderations

Uncertain taxUncertain taxpositionspositions

Accounting forAccounting for

Income Tax LossIncome Tax Loss

Carryover BenefitsCarryover BenefitsIntroduction to taxIntroduction to tax

losseslossesLoss carrybackLoss carryback

illustratedillustratedLoss carryforwardLoss carryforward

illustratedillustrated

Carryforward withCarryforward withvaluationvaluation

allowanceallowanceReview of FutureReview of Future

Income Tax AssetIncome Tax Asset

accountaccount

PerspectivesPerspectives

BalanceBalance

sheetsheet

presentationpresentationIncomeIncome

statementstatement

presentationpresentation

OtherOther

disclosuresdisclosuresAnalysisAnalysis

InternationalInternational


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FundamentalsundamentalsAccounting income (per GAAP) Taxable

income (per Income Tax Act)

Accounting income Income tax expense(current and

future)

Taxable income Income tax payable andcurrent income tax expense

Income tax expense Income tax payable


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Accounting Income andccounting Income andTaxable Income:axable Income:Reconciliation of Accounting Income

and Taxable Income:

Accounting income

differences

= Taxable income

Taxable income current tax rate =

taxes payable andcurrentincome tax expense


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Future Tax Liability Exampleuture Tax Liability ExampleChelsea Inc. - 2008helsea Inc. - 2008Accounting Tax

RevenueRevenue $130,000$130,000 $100,000$100,000

ExpensesExpenses 60,00060,000 60,00060,000

IncomeIncome $ 70,000$ 70

,000 $ 40,000$ 40

,000

Tax @ 40%Tax @ 40% $ 28,000$ 28,000 $ 16,000$ 16,000


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Future Tax Liability Exampleuture Tax Liability ExampleChelsea Inc.helsea Inc.2008 2009

Accounting IncomeAccounting Income $70,000$70,000 $70,000$70,000

Adjust for revenueAdjust for revenuetaxable in futuretaxable in futureperiodperiod

(30,000)

(30,000) 20,00020,000

Taxable IncomeTaxable Income $ 40,000$ 40

,000 $ 90,000$ 90

,000

Tax payable @ 40%Tax payable @ 40% $ 16,000$ 16,000 $ 36,000$ 36,000

2010

$70,000$70,000

10,00010,000

$ 80,000$ 80

,000

$ 32,000$ 32

,000


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Permanent, Timing, andermanent, Timing, andTemporary Differencesemporary Differences Taxable income is determined by starting with

accounting income and adjusting it for

permanentand timing differences in the year The accounting for future tax liabilities and

future tax assets (on the balance sheet) isbased on the tax impact of the accumulatedtiming differences = temporary differences


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Permanent Differences - Examplesermanent Differences - Examples Items, recognized on income statement, but

never for income tax purposes:

Non-tax-deductible expenses (e.g. fines, golf

dues, expenses related to non-taxablerevenue)

Dividends from taxable Canadian corporations

Items, recognized for tax purposes, but not for

financial accounting purposes:

Depletion allowance of natural resources inexcess of cost


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Summary of Permanent Differencesummary of Permanent DifferencesSources of PERMANENT DIFFERENCESSources of PERMANENT DIFFERENCES

Some itemsSome items are recordedare recordedin booksin books

but neverbut neveron tax returnon tax return

Other itemsOther items are neverare never

recorded in booksrecorded in booksbut recordedbut recordedon tax returnon tax return

No future tax effectsNo future tax effectsfor permanent differencesfor permanent differences


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Timing Differencesiming Differences Are treated the same for books and taxbut in

different periods.

Relate to income statement differences

Cause the balance of a temporary difference tochange from period to period

Originating timing difference

Cause of the initial difference (e.g. the $30,000non taxable revenue in 2008 in Chelseaexample)

Reversing timing difference

Causes a temporary difference to decrease(e.g. the $20,000 and $10,000 amounts taxed in2009 and 2010 in Chelsea example)


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Temporary Differencesemporary Differences= accumulated timing differences

= difference between book value of an assetor liability and its tax value

Is either a deductible temporary difference(i.e. will be deducted from accounting income

in calculating taxable income in the future),giving rise to a future tax asset, OR


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Temporary Differencesemporary Differences a taxable temporary difference (i.e. will be

added to accounting income in calculating

taxable income in the future), giving rise to afuture tax liability.


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Future Tax Asset anduture Tax Asset andFuture Tax Liability - SourcesFuture Tax Liability - Sources Future tax accounts on the balance sheet may

be a: Future tax liability, or

Future tax asset Future tax liability arises if the future recovery of

an asset, or future settlement of a liability, that isreported on the balance sheet will result in

paying future income taxes Future tax asset arises if the recovery of an

asset or settlement of a liability results in futureincome tax reductions or benefits


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Future Tax Liabilityuture Tax LiabilityIs it a Liability?s it a Liability? Sometimes dismissed by analysts

Meets

CICA Handbook, Section 1000definition of a liability:

1. Results from a past transaction

2. It is a present obligation

3. It represents a future sacrifice


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Future Tax Liability Exampleuture Tax Liability ExampleChelsea Inc. - 2008helsea Inc. - 2008Books Tax

Accounts receivable $30,000 0

Income reported

in 2008 $70,000 $40,000

Tax rate = 40%

Future Income tax liability

(30,000 x 40%) 12,000

Income tax payable

(40,000 x 40%) 16,000

Income Tax Expense (total) 28,000


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Chelsea Inc. example continuedhelsea Inc. example continued2009 2010

Future taxableFuture taxable

amountsamounts

$20,000$20,000 $10,000$10,000

Future tax rateFuture tax rate 40%40% 40%40%

Future incomeFuture incometax liabilitytax liability

$ 8,000$ 8,000 $ 4,000$ 4,000

Total

$30,000$30,000

40%40%

$ 12,000$ 12,000


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Recording Journal Entriesecording Journal Entries e.g. Chelsea Inc. -2008e.g. Chelsea Inc. -2008Journal Entries:

Current Income Tax Expense 16,000Income Tax Payable 16,000

Future Income Tax Expense 12,000Future Income Tax Liability 12,000


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Future Income Tax Liabilityuture Income Tax LiabilityNet Assets reported End of 2008 End of 2009

Accounts receivable (inAccounts receivable (inassets)assets)

$30,000$30,000 $10,000$10,000

Future income tax liability (inFuture income tax liability (inliabilities)liabilities)

12,00012,000 4,0004,000

Net assets reportedNet assets reported $ 18,000$ 18,000 $ 6,000$ 6,000

Note: Balance sheet reflectsNote: Balance sheet reflectseventual cash impact ofeventual cash impact ofrecovering the A/Rrecovering the A/R


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Future Tax Assetuture Tax AssetIs it an Asset?s it an Asset? Meets all necessary criteria from CICA

Handbook, Section 1000:

1.It will contribute to future net cash flows2.Access to benefits are controlled by the

entity

3.It results from a past transaction or event


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Future Tax Asset Example:uture Tax Asset Example: Cunningham Inc. sells microwave ovens with

a 2 year warranty

In 2008, estimated warranty expense is$500,000

Actual warranty costs are $300,000 in 2009and $200,000 in 2010


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Recording Journal Entriesecording Journal Entries e.g. Cunningham Inc. -2008e.g. Cunningham Inc. -2008Journal Entries:

Current Income Tax Expense 600,000

Income Tax Payable 600,000

Future Income Tax Asset 200,000

Future Income Tax Expense 200,000

The total income tax expense of $400,000 ismade up of a current tax expense of $600,000and a future income tax benefit of $200,000


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Future Tax Asset exampleuture Tax Asset exampleIn subsequent years (2009 and 2010):

- warranty expense of $500,000 deducted fortax, but not for books

- Income taxes payable reduced by $500,000 40% = $200,000

- Entry in future, therefore:

Income tax expense $xFuture income tax asset $ 200,000

Income taxes payable $x 200,000


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Valuation of Future Income Tax Assetaluation of Future Income Tax Asset Must be reviewed at year end to ensure

future income tax asset is not reported at

more than recoverable amount Recognized to extent that it is more likely

than not that the asset will be realized in thefuture

This depends on whether taxable income willbe earned in the future, against whichtemporary differences can be deducted


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Income Tax Expensencome Tax Expense= total ofcurrent tax expense (benefit) and

future tax expense (benefit)

Current income tax expense (benefit)

= income taxes payable/receivable, based ontaxable income for current year


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Future Tax Expense: Exampleuture Tax Expense: ExampleExample 1:

Future tax asset before adjustment 1,000 dr.

Future tax asset determined to be 2,400 dr.

Entry:

Future income tax asset 1,400Future income tax benefit 1,400


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Future Tax Expense: Exampleuture Tax Expense: ExampleExample 2:

Future tax asset before adjustment 1,000 dr.

Future tax asset determined to be 200 dr.

Entry:

Future income tax expense 800Future income tax asset 800


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Future Tax Ratesuture Tax Rates CICA Handbook, Section 3465

Should use the enacted rate (or substantivelyenacted) at the balance sheet date (i.e. the

rates that are expected to apply when the taxassets are realized or the tax liabilities aresettled)


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Future Tax Ratesuture Tax Rates The effect of future tax rate changes should

be immediately recognized on all future taxaccounts

Rate changes are treated as an adjustment tothe future income tax expense/benefit

CICA Handbook 3465 prohibits the

discounting of future income tax assets andliabilities


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Future Tax Rate - exampleuture Tax Rate - exampleHostel Corp. had the following at end of 2007:Property, plant, and equipment:

Net book value (NBV) = $4,000,000

Tax value (Undepreciated

capital cost, UCC) = 1,000,000

Taxable temporary difference = 3,000,000

(to reverse by $1,000,000 each year in 2009,

2010 and 2011)

Tax rate 40%

Future tax liability 1,200,000


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Future Tax Rate - exampleuture Tax Rate - exampleAssume a new income tax rate is enacted from

40% to 35%, effective January 1, 2010 Recalculate Future tax liability as follows:

2009 $1,000,000 x 40% = $400,000

2010 $1,000,000 x 35% = $350,0002011 $1,000,000 x 35% = $350,000

Total $1,100,000

Required Adjusting Entry:

Future Income Tax Liability 100,000

Future Income Tax Benefit 100,000

(1,200,000 - 1,100,000)


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The amount reported is the tax calculatedfrom the loss

May be carried back three years, or forward

for the next twenty years When applying the carry back, it is usually

applied to the oldest available year first

The benefit of a tax loss carryforward isrecorded (i.e. booked) if it is more likely thannot that taxable income will be earned infuture periods to apply it against

Tax Loss Carryback andax Loss Carryback andCarryforwardarryforward


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Tax Loss Carryforwardax Loss CarryforwardCan you recognize (book) the tax benefit of aloss carryforward?

If more likely than not (i.e. a probability ofgreater than 50%) that benefit will be realized

(i.e. company will generate taxable income in thefuture to apply loss against), then recognize taxbenefit as an asset:

Future Income Tax Asset xx

Future Income Tax Benefit xx


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Tax Loss Carryforward (Contd)ax Loss Carryforward (Contd) Iffuture taxable income not likely (i.e. not

likely that benefit will be realized), then do not

record the tax benefit Instead, report existence of loss carryforwardin notes to the financial statements

Disclose the amounts and expiry dates of

unrecognized income tax assets related tothe carryforward of unused tax losses


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Tax Loss Carryforward (Contd)ax Loss Carryforward (Contd)Assuming tax benefit was recognized as aFuture Tax Asset, when co. applies the losses

against taxable income in the future:

Future income tax expense xx

Future income tax asset xx


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Tax Loss Carryforward (Contd)ax Loss Carryforward (Contd) If benefit was not booked and companydoes generate taxable income in the future

and uses the unrecognized losses toreduce taxable income:

Income tax payable xx

Current income tax benefit xx

Separate disclosure of the tax benefit fromrealization of unrecorded loss carryforwardis not required but is suggested


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Carryforward with Valuationarryforward with ValuationAllowancellowance Recommended by U.S. accounting standard This approach permitted in Canada

Assuming a $150,000 loss carryforward where it isunlikely that benefit will be realized in the future:

Future Income Tax Asset 60,000

Future Income Tax Benefit 60,000

(150,000 x 40%)

Future Income Tax Expense 60,000Allowance to Reduce Future Income Tax

Asset to Expected Realizable Value 60,000


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Carryforward with Valuationarryforward with ValuationAllowance (continued)llowance (continued) The second entry indicates that the company

cannot conclude that it is more likely than not

that the company will benefit from the tax lossin the future

The financial statements would be the samewhether the allowance method is used or the

future income tax asset is not recognized atall


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Intraperiod Tax Allocationntraperiod Tax Allocation Income tax expense is reported with itsrelated item, such as discontinued operations,

extraordinary item, other comprehensiveincome, adjustments to RE, etc.

Intraperiod Tax Allocation Tax expense is allocated within the financial

statements of the current period

Interperiod Tax Allocation Tax expense is allocated between years,

and results in the recognition of futureincome taxes


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Intraperiod Tax Allocationntraperiod Tax Allocation Assume the following information for Copy Doctor Inc.:

Tax rate of 35%

A loss from continuing operations of $500,000(tax benefit of 500,000 x 35% = 175,000)

An extraordinary taxable gain of $690,000 (taxexpense of 690,000 x 35% = 241,500)

The journal entry to record current taxes:

Current Income Tax Expense

(extraordinary item) 241,500Current Income Tax Benefit

(continuing operations) 175,000

Income Tax Payable 66,500


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Other disclosuresther disclosures Separate disclosure required for:

Current and future income taxes relating toequity

The amount and expiry date of unused taxlosses and reductions

The deductible temporary differences forwhich no future tax asset recognized

For public and other specified companies,additional disclosures required


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Differential Reportingifferential Reporting Available to organizations that

Are non-publicly accountable

Owners have unanimously consented Income tax reporting follows the taxes

payable basis:

Income tax expense (or benefit) = taxescurrently payable (or receivable)


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The Asset-Liability Methodhe Asset-Liability Method Asset-liability (sometimes referred to as the

liability approach) method objectives:

1. Recognize taxes payable (refundable)amount for the current year

2. Recognize future tax liabilities or assetsfor events (transactions) that have been

included in the current years financialstatements or tax returns


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Internationalnternational Current Canadian and international

standards are very similar

Both are based on the asset-liabilitymethod


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