15.10 Chapter Summary

LO 1: Explain the relationship between taxable profit and accounting profit and calculate current taxes payable.

Tax authorities apply certain rules in the calculation of taxable profit that differ from accounting rules. Taxable profit will, therefore, not always equal accounting profit. It is common to use accounting profit as the starting point for the calculation of taxable profit, and once taxable profit is determined, the appropriate tax rate is applied to calculate current taxes payable.

LO 2: Explain what permanent and temporary differences are and describe the deferred tax effects of those differences.

A temporary difference occurs when an income or expense item is recognized in a different reporting period for tax purposes than for accounting purposes. This is not the same as a permanent difference, which is an item that is included in one type of reporting (tax or accounting) but never the other. Permanent differences affect current taxes but have no effect on future taxes. Temporary differences, on the other hand, will have an effect on future accounting periods when the temporary difference reverses. Temporary differences can be either taxable (i.e., they increase the future tax payable) or deductible (i.e., they decrease the future tax payable).

LO 3: Calculate the deferred tax effects of temporary differences and record the journal entries for current and deferred taxes.

When a temporary difference is identified, the deferred tax asset or liability is calculated by multiplying the amount of the difference by the tax rate expected to be in effect when the difference reverses. Current taxes are recorded as a debit to current tax expense and a credit to current taxes payable. The deferred tax expense or income for the year will be determined by comparing the current year’s deferred tax asset/liability balance to the previous year’s deferred tax asset/liability balance. Deferred taxes will create either a debit to deferred tax asset or a credit to deferred tax liability. A deferred tax asset will create a credit on the income statement described as deferred tax income, while a deferred tax liability will result in a debit on the income statement described as deferred tax expense.

LO 4: Determine the effect of changes in tax rates and calculate current and deferred tax amounts under conditions of changing rates.

Current taxes should always be calculated at the rate currently in effect. Deferred taxes are calculated at the rate expected to be in effect when the temporary difference reverses. This will be based on the rates in effect or substantively enacted at the reporting date. If a future tax rate changes after the deferred tax amount has already been recorded, then the deferred tax amount must be adjusted for the effect of the rate change. This adjustment is prospective and, thus, prior periods are not adjusted. The effect of the rate change needs to be disclosed separately from the other components of deferred tax expense.

LO 5: Analyze the effect of tax losses and determine the appropriate accounting of those losses.

Current tax losses can often be carried back or carried forward and applied against taxable profits for other years. When losses are carried back, a receivable and a tax income amount will be established based on the rates in effect in the previous years. When losses are carried forward, a determination must be made whether the future realization of these losses is probable or not. If it is not probable, then no amount is recorded until such time as the benefit of the loss is actually realized, resulting in no deferred tax asset being carried on the balance sheet. If it is, in fact, probable, then a deferred tax asset and deferred tax income amount is recognized based on the rate expected to be in effect when the loss is utilized. In the future year when the loss is utilized, the deferred tax asset is eliminated and a deferred tax expense is recorded.

LO 6: Explain the rationale for the annual review of deferred tax assets and describe the effects of this review.

A fair degree of uncertainty exists around the future benefits that can be derived from tax losses. The benefit of a tax loss can only be realized if there is sufficient taxable profit, or reversals of taxable temporary differences, in the future. Although the criteria for recognition may be met in one accounting period, circumstances can change in a later period, creating doubt about the amount that can be realized. As such, a review of deferred tax assets is required at every reporting period to determine if the recognition criteria still holds true. If it doesn’t, then the deferred tax asset needs to be partially or fully derecognized and an expense recorded. If a previously unrecorded tax loss now meets the probability criteria, then the benefit and asset will be recorded in the current year.

LO 7: Prepare the presentation of income tax amounts on the balance sheet and income statement and explain the disclosure requirements.

Current taxes payable should be disclosed as a current liability, and deferred tax assets or liabilities should be disclosed as non-current items. Note that different rules apply under ASPE. The components of deferred tax should be disclosed as well as a description of temporary differences. Unrecognized tax losses should be disclosed as well as the effect of tax rate changes, and a reconciliation of the statutory and effective tax rates needs to be disclosed as well.

LO 8: Explain the key differences between the treatment of income taxes under IFRS and ASPE.

Under IFRS, companies can only use the deferred tax approach, whereas under ASPE, companies can choose either the taxes payable method or the future income taxes method. Under IFRS, a deferred tax asset can only be recognized if future realization is probable, while under ASPE, the realization must be more likely than not. As well, ASPE allows the use of a valuation allowance. Under IFRS, all deferred tax balances are classified as non-current, whereas under ASPE, the classification will depend on the underlying, asset, liability, or temporary difference. There are differences in disclosure requirements and terminology as well.