15.1 Current Income Taxes Payable

When a company completes a fiscal year, it will produce a set of financial statements. In most jurisdictions, the financial statements will be the starting point for the income tax calculation. A corporate tax return will usually start with the net income before taxes or accounting profit taken directly from the company’s income statement. This amount will then be subject to a number of adjustments until the final result, the taxable profit or taxable income, is determined. It is on this taxable profit that the corporate income tax will then be levied.

There are a number of reasons that taxation authorities require adjustments to the accounting profit before levying the tax. As we have seen in previous chapters, there are several areas in accounting standards where significant judgments or estimations are required. As taxation regulations are written into laws, the authorities need to create more certainty in interpretation to enable enforcement. Thus, some types of subjectively determined amounts that are acceptable under IFRS may not be considered appropriate for tax calculation purposes. Another reason is the need for consistency. Although IFRS allows companies the flexibility to choose among different acceptable accounting policies, taxation authorities are more concerned with fairness and transparency, which often requires a higher level of consistency in treatment of certain types of transactions. A third reason is the desire of governments to use the taxation system as a tool to achieve policy goals. For example, if a government wanted to encourage investment in a specific industry sector, it could allow certain tax incentives to those companies that invest in the property, plant, and equipment required for those particular industry activities. These incentives may create a difference in the way accounting profit and taxable profit are calculated.

Regardless of the reasons for the differences, the accountant’s objective is to properly record the appropriate income tax expense and outstanding income tax liability at the end of the year. The simplest way to do this is to take the amount of tax owing, as determined on the corporate tax return, and record it. Let’s look at an example to see how this would work.

Assume that for financial statement purposes, a company reports revenue from a long-term contract on the basis of services rendered, which results in $30,000 net revenue per year over a two-year period. As well, assume that no cash is received until the end of the second year, and that the taxation authorities tax this revenue at a rate of 20% only when the cash is received. Thus, no tax would be payable in the first year, and $12,000 () tax would be payable in the second year. If we simply record the tax expense when the taxation authority assesses it, the company’s income statement would look like this:

This is clearly not a satisfactory result, as the income tax expense has not been properly matched to the revenue that created it. This approach, sometimes referred to as the taxes payable method, is not allowed under IFRS due to this improper matching. It is, however, allowed under ASPE, which will be discussed further in the Appendix.

To properly convey the economic substance of the transactions, the income tax expense should be $6,000 per year, which would result in net income of $24,000 per year. This result would properly show how the reported income is attracting a tax liability, even though the actual levy of the taxes does not occur until year 2. Thus, in year 1, the company has created a deferred tax liability that will not need to be paid until year 2. It is these deferred tax amounts that create complications in accounting, and as such, we need to understand their nature in more detail.