Chapter 18

Income Taxes

Prepared by:
Dragan Stojanovic, CA
Rotman School of Management, University of Toronto
 Income Taxes

Current Future/Deferred Income Tax Loss Presentation, IFRS /

Income Income Taxes Carryover Benefits Disclosure, and Private
Taxes •Tax basis •Introduction to tax Analysis Entity GAAP
•Accounting •Future income tax losses •Balance sheet Comparison
income and liabilities •Loss carryback presentation •Comparison
taxable income •Future income tax illustrated •Income and other chart
•Calculation of assets •Loss carryforward statement •Looking ahead
taxable income •Income tax illustrated presentation
•Calculation of accounting objectives •Carryforward with •Disclosure
current income •Multiple differences valuation allowance requirements
taxes illustrated •Review of future •Analysis
•Tax rate income tax asset •Outstanding
considerations account conceptual
questions

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 Income Taxes

Current Future/Deferred Income Tax Loss Presentation, IFRS /

Income Income Taxes Carryover Benefits Disclosure, and Private
Taxes •Tax basis •Introduction to tax Analysis Entity GAAP
•Accounting •Future income tax losses •Balance sheet Comparison
income and liabilities •Loss carryback presentation •Comparison
taxable income •Future income tax illustrated •Income and other chart
•Calculation of assets •Loss carryforward statement •Looking ahead
taxable income •Income tax illustrated presentation
•Calculation of accounting objectives •Carryforward with •Disclosure
current income •Multiple differences valuation allowance requirements
taxes illustrated •Review of future •Analysis
•Tax rate income tax asset •Outstanding
considerations account conceptual
questions

3
 Fundamentals
Accounting income (per GAAP) ≠ Taxable
income (per Income Tax Act)

Accounting income → Income tax expense

(current and future)

Taxable income → Income tax payable and

current income tax expense

Income tax expense ≠ Income tax payable

4
 Accounting Income and
Taxable Income:
Reconciliation of Accounting Income
and Taxable Income:

Accounting income
± differences
= Taxable income

Taxable income × current tax rate =

taxes payable and current income tax expense

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 Future Tax Liability Example
Chelsea Inc. - 2010

Accounting Tax

Revenue $130,000 $100,000

Expenses 60,000 60,000

Income $ 70,000 $ 40,000

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

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 Future Tax Liability Example
Chelsea Inc.

2010 2011 2012

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 @
$ 16,000 $ 36,000 $ 32,000
40%
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 Permanent, Timing, and
Temporary Differences
• Taxable income is determined by starting with
accounting income and adjusting it for
permanent and reversible (or timing)
differences in the year

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Permanent 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-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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Summary of Permanent Differences

Sources of PERMANENT DIFFERENCES

Some items are recorded but never

in books on tax return

are never but recorded

Other items
recorded in books on tax return

No future tax effects

for permanent differences
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 Reversible Differences
• Are treated the same for books and tax—but in
different periods.
• Relate to income statement differences
• Cause the balance of a temporary difference to
change from period to period
• Originating timing difference
– Cause of the initial difference (e.g. the $30,000
non taxable revenue in 2010 in Chelsea
example)
• Reversing timing difference
– Causes a temporary difference to decrease (e.g.
the $20,000 and $10,000 amounts taxed in 2011
and 2012 in Chelsea example) 11
 Calculation of Current Income
Taxes
Two methods:
1. Taxes payable method
• Allowed under PE GAAP
• Current Income Taxes
= Taxable income x Tax rate
2. Future income taxes method
• Called balance sheet liability method in IFRS
• Required by IFRS and option under PE GAAP
• Starts with Current Income Taxes and
• Adjusts for future (or “deferred”) income tax
assets and liabilities,
• To also get future (or “deferred”) income tax
expense
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 Terminology
• PE GAAP and IFRS use different terminology for the
asset and liability approach to income taxes
• Under PE GAAP
– 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 balance sheet liability
method
– Related tax accounts are called deferred income tax
assets, deferred income tax liabilities, and deferred
income tax expense
• As a result, you will see the terms “future” and “deferred” used
interchangeably.
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 Income Taxes

Current Future/Deferred Income Tax Loss Presentation, IFRS /

Income Income Taxes Carryover Benefits Disclosure, and Private
Taxes •Tax basis •Introduction to tax Analysis Entity GAAP
•Accounting •Future income tax losses •Balance sheet Comparison
income and liabilities •Loss carryback presentation •Comparison
taxable income •Future income tax illustrated •Income and other chart
•Calculation of assets •Loss carryforward statement •Looking ahead
taxable income •Income tax illustrated presentation
•Calculation of accounting objectives •Carryforward with •Disclosure
current income •Multiple differences valuation allowance requirements
taxes illustrated •Review of future •Analysis
•Tax rate income tax asset •Outstanding
considerations account conceptual
questions

14
 Temporary Differences

= accumulated timing differences

= difference between book value of an
asset or 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 Differences

• …a taxable temporary difference (i.e. will be

added to accounting income in calculating
taxable income in the future), giving rise to a
future tax liability.

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 Future Tax Asset and
Future Tax Liability - Sources
• Future tax accounts on the balance sheet may
be a:
– Future income (or “deferred”) tax liability, or
– Future income (or “deferred”) tax asset

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 Future Tax Asset and
Future Tax Liability - Sources
• Future tax liability
– When the future recovery of an asset, or future
settlement of a liability, that is reported on the
balance sheet will result in paying future income
taxes
– Arises from taxable temporary differences
• Future tax asset
– When the recovery of an asset or settlement of a
liability results in future income tax reductions or
benefits
– Arises from deductible temporary differences
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 Future Tax Liability Example
Chelsea Inc. - 2010
Books Tax
Accounts receivable $30,000 0
Income reported
in 2010 $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
2011 2012 continued
Total
Future taxable
$20,000 $10,000 $30,000
amounts

Future tax rate 40% 40% 40%

Future income
$ 8,000 $ 4,000 $ 12,000
tax liability

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 Recording Journal Entries
– e.g. Chelsea Inc. -2010

Journal Entries:

Current Income Tax Expense 16,000

Income Tax Payable 16,000

Future Income Tax Expense 12,000

Future Income Tax Liability 12,000

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 Future Income Tax Liability

End of End of
Net Assets reported
2010 2011
Accounts receivable (in
$30,000 $10,000
assets)
Future income tax liability
12,000 4,000
(in liabilities)
Net assets reported $ 18,000 $ 6,000
Note: Balance sheet
reflects eventual cash
impact of recovering the
A/R
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 Future Tax Asset – Example

• Cunningham Inc. sells microwave ovens with

a 2 year warranty
• In 2011, estimated warranty expense is
$500,000
• Actual warranty costs are $300,000 in 2012
and $200,000 in 2013

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 Future Income Tax Asset:
Example

Books Tax
Warranty liability $500,000 0

Tax rate = 40%

Future Income tax asset
(500,000 x 40%) 200,000
Income tax payable (assumed)
(Taxable Income x 40%) 600,000
Income Tax Expense (total) 400,000
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 Future Income Tax Asset:
Example
Journal 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 is

made up of a current tax expense of $600,000
and a future income tax benefit of $200,000
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 Future Income Tax Asset:
Example

In subsequent years (2012 and 2013):

- warranty expense of $500,000 deducted for tax, but
not for books
- Income taxes payable reduced by $500,000 × 40%
= $200,000
- Entry in future, therefore:
Income tax expense$x
Future income tax asset $ 200,000
Income taxes payable $x − 200,000

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 Valuation of Future Income Tax
Asset
• Income tax assets and liabilities meet the
conceptual framework conditions for
recognition as “asset” or “liability”
• Future income tax assets must be reviewed
at year end to ensure they are not reported at
more than recoverable amount
– This depends on whether taxable income will
be earned in the future, against which
temporary differences can be deducted

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 Income Tax Expense

= total of current tax expense (or benefit) and future

tax expense (or benefit)

Current income tax expense (or benefit)

= income taxes payable/receivable, based on
taxable income for current year

Future income tax expense (or benefit)

= amount of adjustment needed to the future
income tax asset/liability account on the balance
sheet
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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) at the balance sheet date

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 Future Tax Rates

• The effect of future tax rate changes should

be immediately recognized on all future tax
accounts
• Rate changes are treated as an adjustment
to the future income tax expense/benefit
• Accounting standards prohibit discounting of
future income tax assets and liabilities
• IFRS requires separate disclosure of future
tax expense or benefit due to a change in tax
rates

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 Future Tax Rate - example
Hostel Corp. had the following at end of 2009:
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 2011,
2012 and 2013)
Tax rate 40%
Future tax liability 1,200,000
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 Future Tax Rate - example
Assume a new income tax rate is enacted from
40% to 35%, effective January 1, 2012
• Recalculate Future tax liability as follows:
2011 $1,000,000 x 40% = $400,000
2012 $1,000,000 x 35% = $350,000
2013 $1,000,000 x 35% = $350,000
Total $1,100,000
Required Adjusting Entry:
Future Income Tax Liability100,000
Future Income Tax Benefit 100,000
(1,200,000 - 1,100,000)
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 Income Taxes

Current Future/Deferred Income Tax Loss Presentation, IFRS /

Income Income Taxes Carryover Benefits Disclosure, and Private
Taxes •Tax basis •Introduction to tax Analysis Entity GAAP
•Accounting •Future income tax losses •Balance sheet Comparison
income and liabilities •Loss carryback presentation •Comparison
taxable income •Future income tax illustrated •Income and other chart
•Calculation of assets •Loss carryforward statement •Looking ahead
taxable income •Income tax illustrated presentation
•Calculation of accounting objectives •Carryforward with •Disclosure
current income •Multiple differences valuation allowance requirements
taxes illustrated •Review of future •Analysis
•Tax rate income tax asset •Outstanding
considerations account conceptual
questions

33
 Tax Loss Carryback and
Carryforward

• The amount reported is the tax calculated from 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 is recorded
(i.e. booked) if it is more likely than not that taxable
income will be earned in future periods to apply it
against

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 Tax Loss Carryback

• Refile prior year’s tax returns, reduce prior

taxable incomes with current year’s loss
• Claim back taxes previously paid:
Income Tax Refund Receivable xx
Current Income Tax Benefit xx
• If loss still remains, carry it forward

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 Tax Loss Carryforward
Can you recognize (book) the tax benefit of a
loss carryforward?
•If 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), then recognize tax benefit as an asset:

Future Income Tax Asset xx

Future Income Tax Benefit xx

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 Tax Loss Carryforward
(Cont’d)
• 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)

Assuming tax benefit was recognized as a

Future 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
(Cont’d)

• If benefit was not “booked” and company does

generate taxable income in the future and uses the
unrecognized losses to reduce taxable income:
Income tax payable xx
Current income tax benefit xx

• Separate disclosure of the tax benefit from realization

of unrecorded loss carryforward is not required under
PE GAAP, 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 PE GAAP (but not
permitted under IFRS)
• Assuming a $150,000 loss carryforward where it is
unlikely 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 60,000
Allowance to Reduce Future Income Tax
Asset to Expected Realizable Value 60,000
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 Carryforward with Valuation
Allowance (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 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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 Income Taxes

Current Future/Deferred Income Tax Loss Presentation, IFRS /

Income Income Taxes Carryover Benefits Disclosure, and Private
Taxes •Tax basis •Introduction to tax Analysis Entity GAAP
•Accounting •Future income tax losses •Balance sheet Comparison
income and liabilities •Loss carryback presentation •Comparison
taxable income •Future income tax illustrated •Income and other chart
•Calculation of assets •Loss carryforward statement •Looking ahead
taxable income •Income tax illustrated presentation
•Calculation of accounting objectives •Carryforward with •Disclosure
current income •Multiple differences valuation allowance requirements
taxes illustrated •Review of future •Analysis
•Tax rate income tax asset •Outstanding
considerations account conceptual
questions

42
 Balance Sheet Presentation
• Under IFRS
– All deferred tax assets and liabilities are recorded as
noncurrent
• Under PE GAAP
– Future tax asset or liability is classified as current or
noncurrent 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 43
 Intraperiod Tax Allocation
• Income tax expense is reported with its
related item, such as discontinued operations,
other comprehensive income, 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 future
income taxes
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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
– Unrealized holding gain of $25,000 on investment
accounted for at FV-OCI
• Prepare the journal entries to record current and
future tax expenses

45
 Intraperiod Tax Allocation:
Example
Current Income Tax Expense
(discontinued operations) 241,500
Current Income Tax Benefit
(continuing operations) 175,000
Income Tax Payable 66,500

Calculations:
• income of 690,000 x 35% = 241,500 expense
• loss of 500,000 x 35% = 175,000 benefit
46
 Intraperiod Tax Allocation:
Example

Future Income Tax Expense (OCI) 8,750

Future Income Tax Liability 8,750

Calculations:
• 25,000 x 35% = 8,750

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 Disclosure Requirements

• IFRS has more extensive disclosure requirements than

PE GAAP, 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

48
 Analysis

• Extensive disclosure help users asses

quality of earnings, as well as assist in
better prediction of future cash flows

49
Outstanding Conceptual Issues

• Asset-liability method (or balance sheet liability

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 future tax assets

50
 Income Taxes

Current Future/Deferred Income Tax Loss Presentation, IFRS /

Income Income Taxes Carryover Benefits Disclosure, and Private
Taxes •Tax basis •Introduction to tax Analysis Entity GAAP
•Accounting •Future income tax losses •Balance sheet Comparison
income and liabilities •Loss carryback presentation •Comparison
taxable income •Future income tax illustrated •Income and other chart
•Calculation of assets •Loss carryforward statement •Looking ahead
taxable income •Income tax illustrated presentation
•Calculation of accounting objectives •Carryforward with •Disclosure
current income •Multiple differences valuation allowance requirements
taxes illustrated •Review of future •Analysis
•Tax rate income tax asset •Outstanding
considerations account conceptual
questions

51
 Looking Ahead

• Additional changes are expected as IASB

and FASB revisit the income tax standard

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 COPYRIGHT

Copyright © 2010 John Wiley & Sons Canada, Ltd.

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