Accounting for income taxes – Financial Statement presentation

Introduction:

Income tax is one of the major aspects for the corporations, firms as well as individuals. It is compulsory for the corporations to file the income tax return as per the guidelines of Internal Revenue Service. In the financial reports, the corporates mentions pretax financial income which is referred as income before taxes and it is computed as per GAAP, whereas taxable income is the income on which tax is calculated.

Income tax accounting focuses on recognizing the amount of taxes payable or refundable for the current year. It also helps in recognizing deferred tax liability and assets for future tax consequences.

Deferred Tax and its accountability:

Deferred Taxes represents company’s tax liability that is postponed to future period. Deferred tax is the result of tax laws that allow companies to write off the expenses before they are recognized and thus creates deferred tax liability. (Cheung, joseph k. 1989)

Deferred tax arises due to timing difference. Timing difference is the difference between the carrying value of an asset or liability recognized in the books of account and actual amount attributed to that asset or liability for tax laws.

Deferred Taxes Example

For federal tax purpose, assets are depreciated at a higher rate than they are depreciated in the books of accounts and thus create a deferred tax.

Deferred Tax Liability

Deferred tax liability generally arises where company receives tax relief in advance for an accounting expense or income is not taxed until its received.

Example of Deferred Tax Liability

A company claims acceleration rate of depreciation in tax returns while in books charges depreciation at different rate

A company makes pension contribution and is allowed deduction on paid basis while for accounting purpose, deduction is determined on actuarial valuation.

Deferred Tax Assets

Deferred Tax asset arises where a tax relief is received after an expense is deducted for accounting purpose in earlier years.

Example of Deferred Tax Asset

A company may accrue expenses in relation to provision for bad debt but for tax purposes deduction will be allowed when provision is utilized.

A company is able to carry forward the tax losses to reduce future taxable income.

Example of Deferred Tax Asset and Deferred Tax Liability

A company purchases an asset for $10,000 which is depreciated on a straight-line basis of five years for accounting purposes. While for tax purpose, company claims depreciation at 25% per year. The applicable rate of corporate income tax is assumed to be 35%

How to calculate deferred tax ?Calculating Deferred Taxes

  Purchase Year 1 Year 2 Year 3 Year 4

Accounting value $10,000 $8,000 $6,000 $4,000 $2,000

Tax value $10,000 $7,500 $5,625 $4,219 $3,164

Taxable/(deductible) temporary difference $0 $500 $375 ($219) ($1,164)

Deferred tax liability/(asset) at 35% $0 $175 $131 ($77) ($407)

How deferred taxes are presented on the balance sheet?

Deferred Taxes on Balance sheet

Deferred Tax Asset are found on the balance sheet under Current Assets and is dealt as per US GAAP, IFRS and UK GAAP

Deferred Tax Liability are found on the balance sheet under Current Liabilities and is dealt as per US GAAP, IFRS and UK GAAP

Deferred income tax

Deferred income tax referred to the income tax liability recorded on the balance sheet that results from the income already earned or expenses not booked for tax purposes. The difference that arises between tax on accounting income and tax as per financial income is termed as deferred income tax (Cheung, joseph k. 1989)

Financial statement presentation:

When presenting the income taxes in the financial statements then the company first needs to classify that is the particular amount related to asset or liability and is current or not current in nature.

There are several aspects in income tax accounting that needs to be presented in the income statement of the corporation like:

Current tax expense or benefit.

Deferred tax expense or benefit

Investment tax credits.

Government grants

The benefits of operating loss carryforwardsTax expense that results from allocating tax benefits either directly to paid-in capital or to reduce goodwill or other noncurrent intangible assets of an acquired entity.

Adjustments of a deferred tax liability or asset for enacted changes in tax laws or rates or a change in the tax status of a company.

Adjustments of the beginning-of-the-year balance of a valuation allowance because of a change in circumstances that causes a change in judgment about the realizability of the related deferred tax asset in future years.

With the income tax presentation in the income statement one is able to assess the quality of earnings, predicting the future cash flows, predicting the loss caryyforwards, (Kieso, weygandt & warfield, 2012),

When presenting the income taxes in balance sheet a strong focus on given in the classification of deferred taxes and their classification as non current and current and asset and liability.

Income taxes in Apple Inc:

Deferred tax assets and liabilities reflect the effects of tax losses, credits, and the future income tax effects of temporary differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases and are measured using enacted tax rates that apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. (Apple, 10-K report, 2012)

Conclusion:

The tax expense income related to profit from ordinary activities shall be presented on the face of the income statement. International Accounting Standards requires certain exchange differences to be recognised as income or expense but does not specify where such differences should be presented in the income statement. Accordingly, where exchange differences on deferred foreign tax liabilities or assets are recognised in the income statement, such differences may be classified as deferred tax expense (income) if that presentation is considered to be the most useful to financial statement users. (Fleming, Damon M. 2011)

The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods

References:

Apple 10-K report, 2012 from: http://files.shareholder.com/downloads/AAPL/2383281926x0xS1193125-12-444068/320193/filing.pdfNurnberg, Hugo, (2010), a note of financial reporting of depreciation and income tax, Journal of Accounting Research. Autumn, Vol. 7 Issue 2, p257-261.Cheung, joseph k. (1989), In nature of Deferred income tax, Contemporary Accounting Research. Spring1989, Vol. 5 Issue 2, p625-641. 17p.

Fleming, Damon M. (2011), Accounting for Income taxes: A misfit on converge of standards, Strategic Finance. May2011, Vol. 92 Issue 11, p49-53. 5p.

Kieso, weygandt & warfield, (2012), Intermediate Accounting, 14th edition