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INTERMEDIATE ACCOUNTING

TENTH CANADIAN EDITION

Kieso • Weygandt • Warfield • Young • Wiecek • McConomy

• Weygandt • Warfield • Young • Wiecek • McConomy CHAPTER 18 Income Taxes Prepared by:

CHAPTER 18 Income Taxes

Prepared by:

Lisa Harvey, CPA, CA

Rotman School of Management, University of Toronto

CHAPTER

18

INCOME TAXES

After studying this chapter, you should be able to:

Understand the importance of income taxes from a business perspective.

Explain the difference between accounting income and taxable income, and calculate taxable income and current income taxes.

Explain what a taxable temporary difference is, determine its amount, and calculate deferred tax liabilities.

Explain what a deductible temporary difference is, determine its amount, and calculate deferred tax assets.

Prepare analyses of deferred tax balances and record deferred tax expense.

Explain the effect of multiple tax rates and tax rate changes on income tax accounts, and calculate

current and deferred tax amounts when there is a change in substantively enacted tax rates.

Account for a tax loss carryback.

Account for a tax loss carryforward, including any note disclosures.

Explain why the Deferred Tax Asset account is reassessed at the statement of financial position date, and account for the deferred tax asset with and without a valuation allowance account.

Identify and apply the presentation and disclosure requirements for income tax assets and liabilities, and apply intraperiod tax allocation.

Identify the major differences between ASPE and IFRS for income taxes.

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Income Taxes

Income Taxes Current Income Taxes • Accounting income and taxable income • Calculation of taxable income

Current Income Taxes

Accounting

income and

taxable income

Calculation of taxable income

Calculation of

current income

taxes

Deferred/Future Income Taxes

Deferred tax

liabilities

Deferred tax assets

Income tax

accounting

objectives and

analyses of

temporary

deductible

differences

Tax rate

considerations

Income Tax Loss Carryover Benefits

Loss carryback illustrated

Loss carryforward illustrated

Review of deferred tax asset account

Presentation, Disclosure, and Analysis

Statement of financial position presentation

Income and other statement presentation

Disclosure

requirements

Analysis

Outstanding

conceptual

questions

• Analysis • Outstanding conceptual questions Income Taxes from a Business Perspective IFRS/ASPE

Income Taxes from a Business

Perspective

IFRS/ASPE

Comparison

Comparison of

IFRS and ASPE

Looking ahead

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Income Taxes from a Business Perspective

A major consideration for new companies is the tax rate that will be paid on its profits

Corporations file income tax returns that

are administered by the Canada Revenue

Agency (CRA)

The purpose is to raise money to support

government operations

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Income Taxes

Income Taxes Income Taxes from a Business Perspective Current Income Taxes • Accounting income and taxable

Income Taxes from a Business

Perspective

Current Income Taxes

Accounting

income and

taxable income

Calculation of taxable income

Calculation of

current income

taxes

Deferred/Future Income Taxes

Deferred tax

liabilities

Deferred tax assets

Income tax

accounting

objectives and

analyses of

temporary

deductible

differences

Tax rate

considerations

Income Tax Loss Carryover Benefits

Loss carryback illustrated

Loss carryforward illustrated

Review of deferred tax asset account

Copyright © John Wiley & Sons Canada, Ltd.

Presentation, Disclosure, and Analysis

Statement of financial position presentation

Income and other statement presentation

Disclosure

requirements

Analysis

Outstanding

conceptual

questions

IFRS/ASPE

Comparison

Comparison of

IFRS and ASPE

Looking ahead

Analysis • Outstanding conceptual questions IFRS/ASPE Comparison • Comparison of IFRS and ASPE • Looking ahead

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Accounting and Taxable Income

Accounting income (or profit) is a pre-tax concept

Determined according to IFRS or ASPE

Objective is to provide useful information to users of

the financial statements

Taxable income is a tax accounting term

Determined according to the Income Tax Act and

Regulations

Used to determine income tax payable

• Therefore, accounting income ≠ taxable income

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Accounting Income and Taxable Income

To determine taxable income, companies

prepare a reconciliation of accounting income to

taxable income:

Accounting income

± differences

Taxable income

income: Accounting income ± differences Taxable income • Taxable income × current tax rate = taxes

Taxable income × current tax rate = taxes

payable and current income tax expense

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Accounting and Taxable Income - Example

2014

Accounting

Tax

Revenue

$130,000

$100,000

Expenses

60,000

60,000

Income

$ 70,000

$ 40,000

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Accounting and Taxable Income - Example

 

2014

2015

2016

Accounting Income

$70,000

$70,000

$70,000

Adjust for revenue taxable in future

(30,000)

20,000

10,000

period

Taxable Income

$ 40,000

$ 90,000

$ 80,000

Tax payable (25%)

$ 10,000

$ 22,500

$ 30,000

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Reversing and Permanent Differences

Taxable income is determined by starting

with accounting income and adjusting it for reversing/temporary and permanent

differences in the year

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Reversing/Temporary Differences

Reversing differences are treated the same for

books and tax but in different periods

Relate to income statement differences

The balance of a temporary difference changes

from period to period

Originating timing difference

Cause of the initial difference (e.g. the $30,000 non taxable revenue in 2014 in Chelsea example)

Reversing timing difference

Causes a temporary difference to decrease (e.g. the

$20,000 and $10,000 amounts taxed in 2015 and

2016 in Chelsea example)

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Permanent Differences

Some items

Other items

Permanent Differences Some items Other items are recorded in books are never recorded in books No
Permanent Differences Some items Other items are recorded in books are never recorded in books No

are recorded in books

are never

recorded in books

No future tax effects for permanent differences

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but never on tax return

but recorded

on tax return

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Permanent Differences

Items recognized for financial accounting purposes but never for income tax purposes:

Non-tax-deductible expenses (e.g. fines, golf dues, expenses related to non-taxable revenue)

Dividends from taxable Canadian corporations

Items recognized for tax purposes but not for financial accounting purposes:

Depletion allowance of natural resources in excess of

cost

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Calculation of Current Income Taxes

Two methods:

1. Taxes payable method

Allowed under ASPE

Current Income Taxes = Taxable income x Tax rate

2. Asset and liability approach

Required by IFRS and option under ASPE

Starts with Current Income Taxes and

- Adjusts for future/deferred income tax assets and liabilities

- Recognizes a future/deferred income tax expense

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Terminology

ASPE and IFRS use different terminology for the asset

and liability approach to income taxes

Under ASPE

This method is called the future income taxes method

Related tax accounts are called future income tax assets, future income tax liabilities, and future income tax expense

Under IFRS

This method is called the temporary difference approach

Related tax accounts are called deferred tax assets, deferred tax liabilities, and deferred tax expense

As a result, you will see the terms future and deferred

used interchangeably

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Income Taxes

Income Taxes Current Income Taxes • Accounting income and taxable income • Calculation of taxable income

Current Income Taxes

Accounting

income and

taxable income

Calculation of taxable income

Calculation of

current income

taxes

Deferred/Future Income Taxes •Deferred tax liabilities •Deferred tax assets •Income tax accounting objectives
Deferred/Future
Income Taxes
•Deferred tax
liabilities
•Deferred tax assets
•Income tax
accounting
objectives and
analyses of
temporary
deductible
differences
•Tax rate
considerations

Income Tax Loss Carryover Benefits

Loss carryback illustrated

Loss carryforward illustrated

Review of deferred tax asset account

Presentation, Disclosure, and Analysis

Statement of financial position presentation

Income and other statement presentation

Disclosure

requirements

Analysis

Outstanding

conceptual

questions

• Analysis • Outstanding conceptual questions Income Taxes from a Business Perspective IFRS/ASPE

Income Taxes from a Business

Perspective

IFRS/ASPE

Comparison

Comparison of

IFRS and ASPE

Looking ahead

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Temporary Differences

Temporary differences are:

Accumulated timing differences

The difference between book value of an

asset or liability and its tax base or basis

The tax base of an asset or liability is similar to a measurement attribute

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Temporary Differences

There are two types of temporary differences:

1. Taxable temporary differences (i.e. will be

added to accounting income in calculating

taxable income in the future)

2. Deductible temporary differences (i.e. will be

deducted from accounting income in

calculating taxable income in the future)

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Deferred Tax Liabilities and Deferred Tax Assets

Deferred tax liabilities

Future tax consequences of a taxable temporary differences

Deferred tax assets

Future tax consequences of a deductible temporary difference

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Deferred Tax Liabilities - Example

Accounts receivable

Tax rate = 25%

Carrying Value

$30,000

Tax Base

-0-

Income tax payable = $10,000

Deferred tax liability at the end of 2014: $7,500*

*(30,000 x 25%)

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Deferred Tax Liabilities - Example

 

2015

2016

Total

Future

     

taxable

$20,000

$10,000

$30,000

amounts

Future tax

     

rate

25%

25%

25%

Future

     

income tax

$ 5,000

$ 2,500

$7,500

liability

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Deferred Tax Liabilities - Example

Journal Entries in 2014:

Current Income Tax Expense 10,000

Income Tax Payable

Deferred Tax Expense

Deferred Tax Liability

10,000

7,500

7,500

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Deferred Tax Assets Example

Cunningham Inc. sells microwave ovens with a 2 year warranty

In 2015, estimated warranty expense is

$500,000

Actual warranty costs are $300,000 in 2016 and $200,000 in 2017

Income tax payable for 2015 is $600,000

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Deferred Tax Assets Example

Warranty liability

Tax rate = 25%

Carrying Amount

$500,000

Tax Base

-0-

Deferred tax asset at the end of 2015: $125,000* *(500,000 x 20%)

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Deferred Tax Assets Example

Journal Entries for 2015:

Current Income Tax Expense 600,000

Income Tax Payable

600,000

Deferred Tax Asset

125,000

Deferred Tax Expense/Benefit

125,000

The total income tax expense of $475,000 is made

up of a current tax expense of $600,000 and a deferred tax benefit of $125,000

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Income Tax Accounting Objectives

1. Recognize the amount of tax that is payable or refundable for the current year 2. Recognize tax effects in the same

accounting period as the related

transactions and events

Referred to as interperiod tax allocation

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Future Tax Rates

Should use the rates that are expected to apply when the tax assets are realized or the tax liabilities are settled

i.e., the enacted rate or substantively enacted

rate

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Revision of Future Tax Rates

The effect of future tax rate changes should be immediately recognized on all deferred tax accounts

Recorded as an adjustment to the deferred tax

expense/benefit

IFRS requires separate disclosure of future tax expense or benefit due to a change in tax rates

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Revision of Future Tax Rate -

Example

Given:

Hostel Corp. had the following at end of 2014:

$3,000,000 of excess capital cost allowance (CCA)

Deferred tax liability of $900,000 ($3,000,000 x 30%)

Temporary difference is expected to reverse equally in

2015, 2016 and 2017 ($1,000,000 per year)

Assume a new income tax rate is enacted from 30% to 25%, effective January 1, 2016

Calculate the adjustment to the deferred tax liability and provide the required journal entry

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Revision of Future Tax Rate -

Example

Adjustment to the deferred tax liability:

2015

$1,000,000 x 30% = $300,000

2016

$1,000,000 x 25% = $250,000

2017

$1,000,000 x 25% = $250,000

Total

$800,000

Journal entry:

Deferred Tax Liability

Deferred Tax Benefit

*($900,000 - $800,000)

100,000*

100,000

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Income Taxes

Income Taxes Current Income Taxes • Accounting income and taxable income • Calculation of taxable income

Current Income Taxes

Accounting

income and

taxable income

Calculation of taxable income

Calculation of

current income

taxes

Deferred/Future Income Taxes

Deferred tax

liabilities

Deferred tax assets

Income tax

accounting

objectives and

analyses of

temporary

deductible

differences

Tax rate

considerations

Income Tax Loss Carryover Benefits

Loss carryback illustrated

Loss carryforward illustrated

Review of deferred tax asset account

Presentation, Disclosure, and Analysis

Statement of financial position presentation

Income and other statement presentation

Disclosure

requirements

Analysis

Outstanding

conceptual

questions

• Analysis • Outstanding conceptual questions Income Taxes from a Business Perspective IFRS/ASPE

Income Taxes from a Business

Perspective

IFRS/ASPE

Comparison

Comparison of

IFRS and ASPE

Looking ahead

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Income Tax Loss Carryover Benefits

Tax law permits the use tax losses to offset

taxable income in other years

May be carried back three years (loss carryback) or forward for the next twenty years (loss

carryforward)

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Tax Loss Carryback

When applying the loss carryback, it is usually applied to the oldest available year first

• Prior year’s tax returns are refiled, reducing prior taxable income with the current year’s loss

To record the tax loss carryback:

Income Tax Receivable Current Tax Benefit

xx

xx

If a tax loss still remains, carry it forward

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Tax Loss Carryforward

A tax loss carryforward can only be recognized if:

It is more likely than not (i.e., probable) that benefit will be

realized (i.e. company will generate taxable income in the future to apply loss against)

To record the tax loss carryforward:

Deferred Tax Asset Deferred Tax Benefit

xx

xx

To record the use of a recognized tax loss

carryforward:

Deferred tax expense Deferred tax asset

xx

xx

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Tax Loss Carryforward

If future 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

carryforward in notes to the financial statements

Disclose the amounts and expiry dates of

unrecognized income tax assets related to

the carryforward of unused tax losses

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Tax Loss Carryforward (Cont’d)

If the tax loss carryforward was not recognized but the

company does generate taxable income in the future and

uses the unrecognized losses:

Taxable income, current tax expense and income tax payable are reduced in the year that the tax loss carryforward is used

Separate disclosure of the tax benefit from realization of

unrecorded loss carryforward is not required under ASPE, but is required under IFRS if it makes up a major component of tax expense

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Carryforward with Valuation Allowance

This approach permitted under ASPE (but not permitted

under IFRS)

Assuming a 20% tax rate and a $150,000 loss carryforward where it is unlikely that benefit will be realized in the future:

Deferred Tax Asset 30,000*

Deferred Tax Benefit Deferred Tax Expense

30,000

30,000

Allowance to Reduce Future Income Tax

Asset to Expected Realizable Value *(150,000 x 20%)

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30,000

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Carryforward with Valuation Allowance

The second entry indicates that the company cannot conclude that it is more likely than not that the company will

benefit from the tax loss in the future

The financial statements would be the same whether the allowance method is

used or the future income tax asset is not

recognized at all

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Review of Deferred Tax Asset Account

Like all assets, deferred tax assets must be reviewed at year end to ensure that the carrying amounts are appropriate

This depends on whether taxable income will be

earned in the future against which temporary

differences can be deducted

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Income Taxes

Income Taxes Current Income Taxes • Accounting income and taxable income • Calculation of taxable income

Current Income Taxes

Accounting

income and

taxable income

Calculation of taxable income

Calculation of

current income

taxes

Deferred/Future Income Taxes

Deferred tax

liabilities

Deferred tax assets

Income tax

accounting

objectives and

analyses of

temporary

deductible

differences

Tax rate

considerations

Income Tax Loss Carryover Benefits

Loss carryback illustrated

Loss carryforward illustrated

Review of deferred tax asset account

Presentation, Disclosure, and Analysis

Statement of financial position presentation

Income and other statement presentation

Disclosure

requirements

Analysis

Outstanding

conceptual

questions

• Analysis • Outstanding conceptual questions Income Taxes from a Business Perspective IFRS/ASPE

Income Taxes from a Business

Perspective

IFRS/ASPE

Comparison

Comparison of

IFRS and ASPE

Looking ahead

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Statement of Financial Position

Presentation

Current income tax receivable or payable are reported separately from deferred/future income tax assets and

liabilities

They are reported as current

Shown on a gross basis unless there is a legal

right to offset

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Statement of Financial Position

Presentation

Deferred Tax Assets and Liabilities: IFRS

All deferred tax assets and liabilities are recorded as non-current

Deferred Tax Assets and Liabilities: ASPE

Future tax asset or liability is classified as current or non-current based on the classification of the underlying asset or liability

giving rise to the specific temporary difference

If the a future asset or liability is not related to specific asset or liability (e.g. expensed research costs deferred for tax purposes), classification is based on date that temporary difference is expected to reverse or tax benefit expected to be realized

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Income and Other Statement

Presentation

Income tax expense is reported with its related item such as discontinued operations, other comprehensive income, adjustments to Retained Earnings etc.

This is referred to as Intraperiod Tax Allocation

Results in the tax expense being allocated within the financial statements of the current period

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Intraperiod Tax Allocation - Example

Assume the following information for Copy Doctor Inc.:

Tax rate of 35%

A loss from continuing operations of $500,000

Income from discontinued operations of $900,000

($210,000 is not taxable)

Unrealized holding gain of $25,000 on investment

accounted for at FV-OCI

Prepare the journal entries to record current and future tax expenses

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Intraperiod Tax Allocation - Example

Current Income Tax Expense (discontinued operations) Current Income Tax Benefit

(continuing operations)

Income Tax Payable

172,500*

125,000**

47,500

*income of 690,000 x 25% = 172,500 expense

**loss of 500,000 x 25% = 125,000 benefit

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Intraperiod Tax Allocation - Example

Deferred Tax Expense (OCI)

Deferred Tax Liability

6,250

6,250

Calculations: 25,000 x 25% = 6,250

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Disclosure Requirements

IFRS has more extensive disclosure requirements

than ASPE, including:

Major components of income tax expense or benefits

Sources of both current and future taxes

Amount of current and future tax recognized in equity

Reconciliation of effective and statutory tax rates

Information about unrecognized future tax assets

Information about each type of temporary difference

and future tax asset or liability recognized on

statement of financial position

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Analysis

Extensive disclosure help users asses quality of earnings as well as assist in better prediction of future cash flows

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Outstanding Conceptual Issues

Asset-liability method (or temporary

difference approach) is considered most

conceptually sound method of income tax accounting

Significant conceptual questions remain

about:

Lack of discounting (and therefore, no

difference between short-term deferral and

long-term deferral)

Recognition of deferred tax assets

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Income Taxes

Income Taxes Current Income Taxes • Accounting income and taxable income • Calculation of taxable income

Current Income Taxes

Accounting

income and

taxable income

Calculation of taxable income

Calculation of

current income

taxes

Deferred/Future Income Taxes

Deferred tax

liabilities

Deferred tax assets

Income tax

accounting

objectives and

analyses of

temporary

deductible

differences

Tax rate

considerations

Income Tax Loss Carryover Benefits

Loss carryback illustrated

Loss carryforward illustrated

Review of deferred tax asset account

Presentation, Disclosure, and Analysis

Statement of financial position presentation

Income and other statement presentation

Disclosure

requirements

Analysis

Outstanding

conceptual

questions

IFRS/ASPE

Comparison

Comparison of

IFRS and ASPE

Looking ahead

IFRS/ASPE Comparison • Comparison of IFRS and ASPE • Looking ahead

Income Taxes from a Business

Perspective

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Looking Ahead

Additional changes are expected as the result of current and future IASB projects

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COPYRIGHT

Copyright © 2013 John Wiley & Sons Canada, Ltd. All

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information contained herein.

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