Calculation and Presentation of Income Tax Expense

11.3 Calculation and Presentation of Income Tax Expense

Introduction

Income tax expense is a critical component of financial reporting, reflecting the cost of income taxes that a company expects to pay on its taxable income. For accountants and financial analysts, understanding how to calculate and present income tax expense is essential for accurate financial analysis and compliance with accounting standards. This section delves into the components of income tax expense, including current and deferred tax, and how they are reported on the income statement.

Understanding Income Tax Expense

Income tax expense is comprised of two main components:

1. Current Tax Expense: This represents the amount of income taxes payable to tax authorities for the current period, based on taxable income.
2. Deferred Tax Expense: This arises from temporary differences between the accounting income reported on the financial statements and the taxable income reported to tax authorities. Deferred taxes can result in either deferred tax assets or deferred tax liabilities.

Current Tax Expense

Calculation of Current Tax Expense

The current tax expense is calculated by applying the statutory tax rate to the taxable income for the period. Taxable income is determined by adjusting accounting income for permanent and temporary differences.

• Permanent Differences: These are differences between accounting income and taxable income that will never reverse. Examples include non-deductible expenses and tax-exempt income.
• Temporary Differences: These are differences that will reverse over time, such as depreciation differences between accounting and tax purposes.

Example of Current Tax Calculation

Consider a company with an accounting income of $500,000. The statutory tax rate is 30%. The company has $20,000 in non-deductible expenses and $10,000 in tax-exempt income.

1. Calculate Taxable Income:

   • Accounting Income: $500,000
   • Add: Non-deductible Expenses: $20,000
   • Less: Tax-exempt Income: $10,000
   • Taxable Income: $510,000

2. Calculate Current Tax Expense:

   • Taxable Income: $510,000
   • Tax Rate: 30%
   • Current Tax Expense: $510,000 × 30% = $153,000

Deferred Tax Expense

Understanding Deferred Taxes

Deferred taxes arise from temporary differences between the carrying amount of an asset or liability in the financial statements and its tax base. These differences result in deferred tax assets or liabilities.

• Deferred Tax Assets: These arise when taxable income is greater than accounting income due to temporary differences, leading to future tax deductions.
• Deferred Tax Liabilities: These occur when accounting income is greater than taxable income, resulting in future taxable amounts.

Calculation of Deferred Tax

Deferred tax is calculated by identifying temporary differences and applying the tax rate to these differences. The deferred tax expense or benefit is the change in the deferred tax asset or liability from the beginning to the end of the period.

Example of Deferred Tax Calculation

Assume a company has a temporary difference of $50,000 due to accelerated depreciation for tax purposes. The statutory tax rate is 30%.

1. Calculate Deferred Tax Liability:

   • Temporary Difference: $50,000
   • Tax Rate: 30%
   • Deferred Tax Liability: $50,000 × 30% = $15,000

2. Deferred Tax Expense:

   • If the deferred tax liability increased from $10,000 to $15,000 during the period, the deferred tax expense is $5,000.

Presentation of Income Tax Expense on the Income Statement

The income tax expense reported on the income statement includes both current and deferred tax components. It is presented as a single line item, but detailed disclosures are required in the notes to the financial statements.

Example of Income Statement Presentation

Income Before Tax: $500,000
Income Tax Expense:
   - Current Tax: $153,000
   - Deferred Tax: $5,000
Total Income Tax Expense: $158,000
Net Income: $342,000

Disclosure Requirements

Under IFRS and ASPE, companies must disclose the following in their financial statements:

1. Reconciliation of Accounting Income to Taxable Income: A reconciliation showing the relationship between accounting profit and taxable profit, including the impact of permanent and temporary differences.
2. Components of Income Tax Expense: A breakdown of current and deferred tax expense.
3. Deferred Tax Assets and Liabilities: The nature and amounts of deferred tax assets and liabilities, including any valuation allowances.
4. Tax Rate Reconciliation: A reconciliation of the statutory tax rate to the effective tax rate, explaining significant differences.

Practical Considerations and Challenges

Valuation Allowances

A valuation allowance is required if it is more likely than not that some or all of the deferred tax asset will not be realized. This involves significant judgment and consideration of future taxable income.

Changes in Tax Rates

Changes in statutory tax rates affect the measurement of deferred tax assets and liabilities. Companies must adjust their deferred tax balances in the period of the change, impacting the deferred tax expense.

International Considerations

For Canadian companies with international operations, additional complexities arise from different tax jurisdictions and rates. Transfer pricing, foreign tax credits, and double taxation agreements are important considerations.

Real-World Application

Consider a Canadian technology company with operations in the United States. The company must account for differences in Canadian and U.S. tax rates and regulations. This involves calculating deferred taxes for differences in depreciation methods and recognizing foreign tax credits for taxes paid in the U.S.

Conclusion

Understanding the calculation and presentation of income tax expense is crucial for accurate financial reporting and compliance with accounting standards. By mastering these concepts, you will be better equipped to analyze financial statements and make informed decisions.

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