2. 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.

3. Income Taxes 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
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

4. 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
L01

5. Income Taxes 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
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

6. 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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7. Accounting Income and Taxable Income
To determine taxable income, companies prepare a reconciliation of accounting income to taxable income:
Accounting income
± differences
Taxable income
Taxable income × current tax rate = taxes payable and current income tax expense
L02

8. Accounting and Taxable Income - Example
2014
Accounting
Tax
Revenue
$130,000
$100,000
Expenses
60,000
Income
$ 70,000
$ 40,000
L02

9. Accounting and Taxable Income - Example
2014
2015
2016
Accounting Income
$70,000
Adjust for revenue taxable in future period
(30,000)
20,000
10,000
Taxable Income
$ 40,000
$ 90,000
$ 80,000
Tax payable (25%)
$ 10,000
$ 22,500
$ 30,000
L02

10. 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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11. 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)
L02

12. Permanent Differences
Some items
are recorded
in books
but never
on tax return
Other items
are never
recorded in books
but recorded
on tax return
L02
No future tax effects
for permanent differences

13. 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
L02

14. Calculation of Current Income Taxes
Two methods:
Taxes payable method
Allowed under ASPE
Current Income Taxes = Taxable income x Tax rate
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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15. 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
L02

16. Income Taxes 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
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

17. 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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18. Temporary Differences
There are two types of temporary differences:
Taxable temporary differences (i.e. will be added to accounting income in calculating taxable income in the future)
Deductible temporary differences (i.e. will be deducted from accounting income in calculating taxable income in the future)
L03/L04

19. Deferred Tax Liabilities and Deferred Tax Assets
Future tax consequences of a taxable temporary differences
Deferred tax assets
Future tax consequences of a deductible temporary difference
L03/L04

20. Deferred Tax Liabilities - Example
Carrying Value Tax Base
Accounts receivable $30,
Tax rate = 25%
Income tax payable = $10,000
Deferred tax liability at the end of 2014: $7,500*
*(30,000 x 25%)
L03

21. Deferred Tax Liabilities - Example
2015
2016
Total
Future taxable amounts
$20,000
$10,000
$30,000
Future tax rate
25%
Future income tax liability
$ 5,000
$ 2,500
$7,500
L03

22. Deferred Tax Liabilities - Example
Journal Entries in 2014:
Current Income Tax Expense 10,000
Income Tax Payable ,000
Deferred Tax Expense ,500
Deferred Tax Liability ,500
L03

23. 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
L04

24. Deferred Tax Assets – Example
Carrying Amount Tax Base
Warranty liability $500,
Tax rate = 25%
Deferred tax asset at the end of 2015: $125,000*
*(500,000 x 25%)
L04

25. 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
L04

26. Income Tax Accounting Objectives
Recognize the amount of tax that is payable or refundable for the current year
Recognize tax effects in the same accounting period as the related transactions and events
Referred to as interperiod tax allocation
L05

27. 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
L06

28. 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
L06

29. 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
L06

30. Revision of Future Tax Rate - Example
Adjustment to the deferred tax liability: 2015 $1,000,000 x 30% = $300, $1,000,000 x 25% = $250, $1,000,000 x 25% = $250,000 Total $800,000 Journal entry: Deferred Tax Liability 100,000* Deferred Tax Benefit 100,000 *($900,000 - $800,000)
L06

31. Income Taxes 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
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

32. 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)
L07

33. 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 xx
Current Tax Benefit xx
If a tax loss still remains, carry it forward
L07

34. Tax Loss Carryforward To record the 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 xx
Deferred Tax Benefit xx
To record the use of a recognized tax loss carryforward:
Deferred tax expense xx
Deferred tax asset xx
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35. 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
L08

36. 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
L08

37. 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 ,000*
Deferred Tax Benefit ,000
Deferred Tax Expense ,000
Allowance to Reduce Future Income Tax
Asset to Expected Realizable Value ,000
*(150,000 x 20%)
L08

38. 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
L08

39. 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
L09

40. Income Taxes 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
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

41. 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
L10

42. 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
L10

43. 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
L10

44. Intraperiod Tax Allocation - Example
Assume the following information for Copy Doctor Inc.:
Tax rate of 25%
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
L10

45. Intraperiod Tax Allocation - Example
Current Income Tax Expense (discontinued operations) 172,500* Current Income Tax Benefit (continuing operations) 125,000** Income Tax Payable 47,500 *income of 690,000 x 25% = 172,500 expense **loss of 500,000 x 25% = 125,000 benefit
L10

46. Intraperiod Tax Allocation - Example
Deferred Tax Expense (OCI) 6,250 Deferred Tax Liability 6,250 Calculations: 25,000 x 25% = 6,250
L10

47. 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
L10

48. Analysis
Extensive disclosure help users assess quality of earnings as well as assist in better prediction of future cash flows
L10

49. 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
L10

50. Income Taxes 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
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

51. Looking Ahead
Additional changes are expected as the result of current and future IASB projects
L11

52. COPYRIGHT
Copyright © 2013 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.