1. Powerpoint slides by: Copyright © 2003 McGraw-Hill Ryerson Limited, Canada Michael L. Hockenstein  Commerce Department Vanier College Intermediate Accounting Thomas H. Beechy Schulich School of Business, York University Joan E. D. Conrod Faculty of Management Dalhousie University

2. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-2 Accounting for Corporate Income Taxes Chapter 16

3. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-3 Intraperiod Tax Allocation  Intraperiod tax allocation : the disaggregation of the components of income tax according to the nature of the income, gains, and losses giving rise to the tax

4. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-4 Intraperiod Tax Allocation (cont.)  The total income tax expense must be allocated to: continuing operations discontinued operations extraordinary gains and losses capital transactions restatements of prior periods (that is, those due to changes in accounting policy and correction of errors from prior periods)

5. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-5 Intraperiod Tax Allocation (cont.)  The taxes allocated to the first three items all appear on the income statement  The taxes relating to extraordinary items and discontinued operations need not be separately disclosed; these items can simply be reported net of tax  The income tax expense relating to continuing operations must be separately disclosed, however, including the portion that is for deferred taxes

6. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-6 Example of Intraperiod Tax Allocation  Assume the following facts: a corporation reports net income before income taxes and extraordinary items of $1,000,000 taxable income is the same as pretax accounting income the company has an extraordinary loss of $200,000 before tax; this amount is deductible for tax purposes the tax rate is 40%

7. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-7 Example of Intraperiod Tax Allocation (cont.)  The income tax expense will be $320,000, determined as follows: - Operating income, before taxes$1,000,000 - Extraordinary loss (200,000) - Taxable income$ 800,000 - Tax rate  40% - Income tax payable$ 320,000

8. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-8 Example of Intraperiod Tax Allocation (cont.) Income before income taxes and extraordinary items$1,000,000 Provision for income tax expense (400,000) Income before extraordinary items$ 600,000 Extraordinary item: Loss due to xxxx [Note Y]$(200,000) Less applicable income tax benefit 80,000 (120,000) Net income$ 480,000

9. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-9 Example of Intraperiod Tax Allocation (cont.) Income tax expense320,000 Income tax payable320,000

10. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-10 Provision or Expense?  Provision for income tax expense : the expense (or recovery) of income tax charged to the income statement

11. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-11 Differences Between Taxable and Accounting Income  The difference between taxable income and accounting income arises from two types of sources: permanent differences and temporary differences  Permanent differences : items of revenue, expense, gains, or losses that are reported for accounting purposes but never enter into the computation of taxable income  Permanent differences also include those rare items that enter into taxable income but are never included in accounting income

12. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-12 Differences Between Taxable and Accounting Income (cont.)  Temporary differences : wherein an item of revenue, expense, gain, or loss arises in determining accounting income in one period and for taxable income in another period; determined by comparing accounting balance sheet carrying values with tax values (a balance sheet approach)

13. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-13 Differences Between Taxable and Accounting Income (cont.)  Timing differences : wherein an item of revenue, expense, gain, or loss arises in determining accounting income in one period and for taxable income in another period; determined by examining current year differences between accounting and taxable income (an income statement approach)

14. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-14 Exhibit 16-1

15. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-15 Exhibit 16-1 (cont.)

16. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-16 Conceptual Issues in Interperiod Tax Allocation  There are three basic underlying issues: the extent of the allocation the measurement method discounting

17. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-17 Extent of Allocation  Extent of allocation refers to the range of temporary differences to which interperiod tax allocation is applied  The three basic options are: no allocation---the tax payable method full allocation---the comprehensive method partial allocation

18. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-18 Extent of Allocation (cont.)  The tax payable method : the amount of taxes assessed in each year is the income tax expense for that year - income tax expense = current income tax  Comprehensive allocation method : the tax effects of all temporary differences are allocated, regardless of the timing or likelihood of their reversal

19. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-19 Extent of Allocation (cont.)  Partial allocation is a “family” of alternatives that falls between the two extremes of no allocation and full allocation  Partial allocation : interperiod income tax allocation is applied to some types of temporary differences but not to all

20. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-20 Measurement Method  When the effects of temporary differences are measured, should the tax rate be: the rate in effect at the time that the temporary difference first arises, or the rate that is expected to be in effect when the temporary difference reverses?  This is the measurement method issue

21. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-21 Measurement Method (cont.)  Deferral method : records the future tax impacts by using the corporation’s effective average tax rate in the year that the temporary difference first arises, or originates  Liability (or accrual) method : records the future tax impacts by using the tax rate that will be in effect in the year of reversal  The future tax impact is recorded on the balance sheet as a liability, and is updated as the tax rate changes

22. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-22 Discounting  If the deferred tax balances are discounted, interest is imputed on the balance each year, using the same rate as was used for discounting  The income tax expense on the income statement would therefore include: the discounted present value of the future tax impact of temporary differences that originated in the current period

23. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-23 Discounting (cont.) the interest on the balance at the beginning of the year plus or minus adjustments to the ending balance for tax rate increases or decreases less drawdowns that occurred during the current period due to reversal of the temporary difference

24. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-24 Effective Tax Rate  One objective of interperiod income tax allocation is to reflect in net income the effective tax rate that the corporation is paying  The effective tax rate: the ratio of the income tax expense (including the tax expense relating to temporary differences) divided by the pretax net income

25. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-25 Effective Tax Rate (cont.)  Financial analysts often calculate the effective tax rate as the ratio of current income taxes (that is, without including the tax expense or benefit related to temporary differences) to pretax net income  The CICA Handbook speaks of the “income tax rate” [CICA 3465.92(c)] in a context that includes the effects of temporary differences  The CICA Handbook requires that public companies provide a reconciliation between the effective and statutory rate

26. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-26 Future Income Tax Assets  Future income taxes are not discounted  Future income tax assets and liabilities are classified as current assets/liabilities if the temporary differences relate to current assets or liabilities  Future income tax balances that relate to long-term assets and liabilities are reported separately from other long-term assets and liabilities

27. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-27 Future Income Tax Assets (cont.)  Future income tax assets arise from: write-downs of inventory or other assets for accounting purposes, tax deduction at the time of sale deferred executive compensation treated as an expense for accounting purposes, tax deduction when paid warranty costs estimated and charged to income at the time of sale

28. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-28 Balance Sheet Presentation  When future income tax assets are reported on a balance sheet in which current and long-term assets and liabilities are segregated, they must be classified as either current or long term  The classification is current if the temporary differences that give rise to the future income taxes are current assets or current liabilities

29. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-29 Disclosure: General Recommendations  The general recommendations for disclosure of the components of the provision for income tax expense are as follows: The amount of income tax expense or benefit that is included in net income before discontinued operations and extraordinary items should be reported separately in the income statement (excluding taxes relating to discontinued operations, extraordinary items, capital transactions, and retroactive adjustments, which should be included with the appropriate item); income tax expense should not be combined with other items of expense [CICA 1520.03(m)]

30. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-30 Disclosure: General Recommendations (cont.) The amount of income tax expense that is attributable to future income taxes should be disclosed, either on the face of the statements (i.e., in the income statement or cash flow statement) or in the notes [CICA 3465.91(b)] The amounts of income tax expense that relate to each of discontinued operations, extraordinary items, and capital transactions should be disclosed [CICA 3465.91(c),(d),(e)]

31. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-31 Reconciliation of Effective Tax Rates  Two general categories of causes for variations in the tax rate: permanent differences, which cause items of income and/or expense to be reported in accounting income that are not included in taxable income differences in tax rates, due to: - different tax rates in different tax jurisdictions, - special taxes levied (and tax reductions permitted) by Canada Customs and Revenue Agency - changes in tax rates relating to temporary differences that will reverse in future periods

32. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-32 Exhibit 16-5

33. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-33 Exhibit 16-6

34. Copyright © 2003 McGraw-Hill Ryerson Limited, Canada   16-34 Exhibit 16-7