9.1 Current and deferred income tax accounting
3 min read•august 16, 2024
Income tax accounting is a crucial aspect of financial reporting, balancing current and future tax impacts. It involves recognizing temporary and between book and taxable income, using estimated tax rates and enacted laws.
Current taxes reflect immediate consequences, while deferred taxes represent future effects of today's transactions. The liability method focuses on , comparing tax bases to carrying amounts and adjusting for changes in rates or laws.
Income Tax Accounting Principles
Fundamental Concepts and Objectives
Top images from around the web for Fundamental Concepts and Objectives
Accounting Concepts - Clipboard image View original
Is this image relevant?
Income Tax Accounting | Boundless Accounting View original
Is this image relevant?
Why It Matters: Completing the Accounting Cycle | Financial Accounting View original
Is this image relevant?
Accounting Concepts - Clipboard image View original
Is this image relevant?
Income Tax Accounting | Boundless Accounting View original
Is this image relevant?
1 of 3
Top images from around the web for Fundamental Concepts and Objectives
Accounting Concepts - Clipboard image View original
Is this image relevant?
Income Tax Accounting | Boundless Accounting View original
Is this image relevant?
Why It Matters: Completing the Accounting Cycle | Financial Accounting View original
Is this image relevant?
Accounting Concepts - Clipboard image View original
Is this image relevant?
Income Tax Accounting | Boundless Accounting View original
Is this image relevant?
1 of 3
- Income tax accounting recognizes, measures, and reports tax consequences of business transactions in financial statements
- Reflects current and future tax effects of events recognized in financial statements or tax returns
- Follows accrual basis accounting recognizing tax effects when transactions occur (not when cash exchanges hands)
- Involves temporary and permanent differences affecting the relationship between book income and taxable income
- Requires use of estimated tax rates and consideration of enacted tax laws as of the date
- Applies principle of conservatism particularly in recognition of deferred tax assets
Key Components and Considerations
- Temporary differences impact timing of taxable income recognition (depreciation methods, warranty expense recognition)
- Permanent differences permanently impact taxable income (fines, penalties, tax-exempt interest)
- Estimated tax rates based on expected future tax rates when temporary differences reverse
- Tax laws and regulations considered include those enacted or substantively enacted
- Conservatism principle leads to careful evaluation of realizability
Current vs Deferred Taxes
Current Income Taxes
- Represent income taxes payable or recoverable for the current period's taxable profit or loss
- Based on taxable income for the current year calculated using tax rules
- Reflect immediate tax consequences of transactions and events
- Calculated by applying applicable tax rate to current year's taxable income
- May differ from due to timing differences and permanent differences
- Reported as a current liability or asset on the balance sheet
Deferred Income Taxes
- Amounts of income taxes payable or recoverable in future periods
- Arise from temporary differences between book income and taxable income
- Represent future tax effects of transactions recognized in current financial statements
- Deferred tax assets reduce future tax payments (tax loss carryforwards, deductible temporary differences)
- Deferred tax liabilities increase future tax payments (taxable temporary differences)
- Measured using expected tax rates when differences reverse
- Reported as non-current assets or liabilities on the balance sheet
Liability Method for Income Tax
Fundamentals of the Liability Method
- Also known as balance sheet approach focusing on temporary differences
- Compares tax bases of assets/liabilities to their carrying amounts in financial statements
- Measures deferred tax assets/liabilities using enacted tax rates expected when realized/settled
- Requires reassessment and adjustment of deferred tax balances each reporting date
- Considers tax planning strategies management expects to implement
- Recognizes changes in deferred taxes from rate/law changes in income from continuing operations
Valuation Allowances and Tax Planning
- Establishes valuation allowances to reduce deferred tax assets to realizable amounts
- More likely than not standard used to assess need for
- Considers all available evidence both positive (taxable income in carryback years) and negative (cumulative losses in recent years)
- Tax planning strategies evaluated for probability of implementation and impact
- Examples of tax planning strategies accelerating taxable income or deferring deductions
- Valuation allowance adjustments impact income tax expense in the period of change
Income Tax Expense & Payable Calculation
Components of Income Tax Expense
- Calculated as sum of current tax expense and deferred tax expense/benefit
- Current tax expense determined by applying tax rate to taxable income
- Deferred tax expense/benefit from changes in deferred tax asset/liability balances
- calculated by dividing total income tax expense by pre-tax financial income
- Reconciliation between statutory and effective tax rates required in disclosures
- Explanation of significant rate differences (permanent differences, tax credits, foreign operations)
Income Tax Payable Determination
- Represents actual taxes owed to tax authorities based on tax return
- May differ from income tax expense reported in financial statements
- Calculated considering various tax credits and deductions
- Impacts of operations in multiple tax jurisdictions considered
- Estimated tax payments and withholdings reduce final tax payable amount
- Reported as current liability if due within one year or non-current if beyond
Key Terms to Review (18)
ASC 740: ASC 740 is the accounting standard that governs the recognition, measurement, presentation, and disclosure of income taxes in financial statements. This standard establishes how companies should account for current and deferred income taxes, ensuring that tax positions are reported accurately and transparently. By applying ASC 740, businesses can determine the tax implications of their operations and financial transactions, facilitating better financial reporting and compliance with tax regulations.
Balance Sheet: A balance sheet is a financial statement that summarizes a company’s assets, liabilities, and shareholders' equity at a specific point in time. It provides a snapshot of what a company owns and owes, helping stakeholders assess the financial health and stability of the business. This statement is essential for understanding a company’s capital structure and financial position.
Current tax liability: Current tax liability refers to the amount of income tax a company is obligated to pay for the current tax year, based on its taxable income. This liability is a crucial aspect of financial reporting and reflects a company's financial obligations resulting from its earnings, impacting cash flow and overall financial health.
Deductible expenses: Deductible expenses are costs that can be subtracted from a taxpayer's gross income to determine taxable income, reducing the overall tax liability. These expenses must be ordinary and necessary for the operation of a business or for the production of income, as defined by tax laws. Understanding deductible expenses is crucial for accurately calculating current and deferred income tax obligations.
Deferred Tax Asset: A deferred tax asset is an accounting item that represents a company’s future tax benefits, which arise from overpayment of taxes or the carrying forward of losses. This asset indicates that the company has paid more taxes than it owes and can reduce future tax liabilities when it recognizes these benefits in future periods. Understanding deferred tax assets is crucial for grasping how current tax obligations may differ from reported income due to temporary differences.
Effective Tax Rate: The effective tax rate is the average rate at which an individual or corporation is taxed on their taxable income, calculated as the total tax expense divided by the taxable income. This rate reflects the true economic burden of taxation on a taxpayer and can provide insights into the efficiency of a company's tax strategy. Understanding this rate is crucial as it relates to current and deferred income taxes, the impact of temporary differences, the recognition and measurement of deferred tax assets and liabilities, and how these elements are presented and disclosed in financial statements.
IFRS 12: IFRS 12 is an International Financial Reporting Standard that outlines the disclosure requirements for interests in other entities, including subsidiaries, joint arrangements, and associates. This standard aims to provide transparency in financial statements regarding the nature and risks associated with these interests, which directly influences how current and deferred income tax is accounted for and presented in financial reports.
Income Statement: An income statement is a financial document that summarizes a company's revenues, expenses, and profits or losses over a specific period, showing how much money the business made or lost. This statement is crucial for understanding a company's financial performance, as it reveals how effectively management generates profit and controls costs, providing insight into operational efficiency and profitability.
Income Tax Expense: Income tax expense refers to the amount of income tax that a company recognizes as an expense in its financial statements during a specific period. This expense represents the estimated tax liability based on taxable income, reflecting the cost of conducting business within a tax period. The calculation of income tax expense takes into account both current and deferred tax components, ensuring that all tax implications related to income are appropriately recorded.
IRS Guidelines: IRS guidelines are the regulations and rules set forth by the Internal Revenue Service that govern how income tax should be reported, calculated, and paid by individuals and corporations. These guidelines provide clarity on current and deferred income tax accounting, ensuring compliance with tax laws and helping entities understand how to treat different types of income, deductions, and credits.
Permanent Differences: Permanent differences are discrepancies between taxable income and accounting income that will not be reversed in future periods. These differences arise due to specific items that are either recognized for accounting purposes but not for tax purposes, or vice versa, such as certain types of income that are exempt from taxation. Understanding these differences is crucial as they influence the effective tax rate and the overall financial reporting of a company.
Tax audit: A tax audit is an examination of an individual or organization's financial records by tax authorities to ensure compliance with tax laws and regulations. It serves to verify the accuracy of tax returns and the legitimacy of claims made, often leading to adjustments in reported income, deductions, and credits if discrepancies are found. Tax audits play a crucial role in the broader framework of current and deferred income tax accounting by impacting how entities recognize their tax liabilities and the timing of their tax payments.
Tax credit: A tax credit is an amount of money that taxpayers can subtract directly from the taxes they owe to the government. This reduces the overall tax liability on a dollar-for-dollar basis, making tax credits a powerful tool for individuals and businesses to lower their tax bills and incentivize certain behaviors or investments.
Tax loss carryforward: A tax loss carryforward is a provision that allows a business or individual to use a net operating loss from one year to offset taxable income in future years. This mechanism helps to smooth out tax liabilities over time by enabling entities to reduce future taxable income with past losses, thus resulting in potential tax savings. The carryforward period typically extends for a specific number of years, during which the losses can be applied against future profits.
Tax Provision: A tax provision is an accounting entry that reflects a company's current and deferred tax liabilities or assets, representing the amount of income tax expense that the company expects to pay or recover in the future. This entry is essential for preparing financial statements, as it impacts both the income statement and balance sheet by ensuring that tax obligations are accurately reflected in the company's financial position.
Tax Reconciliation: Tax reconciliation is the process of comparing and aligning the income tax expense recognized in financial statements with the actual tax liability owed to tax authorities. This process ensures that any differences between the two are identified, analyzed, and reconciled, which is particularly important in the context of both current and deferred income tax accounting. Accurate tax reconciliation helps organizations maintain compliance with tax regulations and provides insights into effective tax planning.
Temporary differences: Temporary differences are the differences between the carrying amount of an asset or liability in the balance sheet and its tax base that will result in taxable or deductible amounts in future periods. They arise due to variations in the recognition of income and expenses for financial reporting purposes versus tax purposes, influencing both current and deferred income tax accounting.
Valuation Allowance: A valuation allowance is a reserve set against deferred tax assets to reduce them to the amount that is more likely than not to be realized. This concept is crucial in assessing the realizability of deferred tax assets, ensuring that companies only recognize those assets they expect to utilize in the future. It reflects the potential uncertainty surrounding the future taxable income that may be available to absorb these deferred tax assets.