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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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Copyright 2007 John Wiley & Sons Canada, Ltd.Copyright 2007 John Wiley & Sons Canada, Ltd.All rights reserved. Reproduction or translation ofAll rights reserved. Reproduction or translation ofthis work beyond that permitted by Access Copyrightthis work beyond that permitted by Access Copyright(The Canadian Copyright Licensing Agency) is(The Canadian Copyright Licensing Agency) is
unlawful. Requests for further information should beunlawful. Requests for further information should beaddressed to the Permissions Department, Johnaddressed to the Permissions Department, JohnWiley & Sons Canada, Ltd. The purchaser may makeWiley & Sons Canada, Ltd. The purchaser may makeback-up copies for his or her own use only and notback-up copies for his or her own use only and notfor distribution or resale. The author and thefor distribution or resale. The author and thepublisher assume no responsibility for errors,publisher assume no responsibility for errors,
omissions, or damages caused by the use of theseomissions, or damages caused by the use of theseprograms or from the use of the informationprograms or from the use of the informationcontained herein.contained herein.
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