Financial Accounting:
Liabilities & Equities (FA3)
Module 6
Audio lecture presented by:
Barbara M. Wyntjes, B.Sc., CGA
FA3 Module 6
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Part 1:
Accounting for
Income Tax
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Introduction
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Intraperiod and interperiod
Permanent and temporary differences
Accounting methods
Income tax credits
Operating losses for tax purposes
Disclosure
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Intraperiod Tax Allocation
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Total income tax expense reported
according to the nature of the income,
gains, and losses giving rise to the tax
Income Statement:
 Continuing operations
 Discontinued operations (net of tax)
 Extraordinary gains or losses (net of tax)
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Intraperiod Tax Allocation
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Three calculations of income tax expense
Continuing operations
Discontinued operations
 Extraordinary gains or losses
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Intraperiod Tax Allocation
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Statement of Changes to Retained Earnings:
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Capital transactions
Restatements of prior periods (correction
of errors or changes in accounting policy)
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Assignment A15-1
Req’d 1
See Chapter 15, page 965
And handout 1, page 1
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Assignment A15-1
Req’d 2
See Chapter 15, page 965
And handout 1, page 1
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Part 2:
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Taxable vs Accounting Income
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The difference arises from two types of
sources:
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permanent differences
temporary differences
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Taxable vs Accounting Income
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Permanent differences:
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Items of revenue, expense, gains, or
losses that are reported for either
accounting or tax purposes but never
enter into the computation of both
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Taxable vs Accounting Income
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Examples
 Income
 Expenses
No problem
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Taxable vs Accounting Income
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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
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Lead to timing differences
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Taxable vs Accounting Income
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Temporary differences:
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Determined by comparing accounting
balance sheet carrying values with tax
values (a balance sheet approach)
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Taxable vs Accounting Income
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Timing differences:
 Determined by examining current year
differences between accounting and
taxable income (an income statement
approach)
 Deferral Method
 Current method = Liability Method
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Taxable vs Accounting Income
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Example:
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CCA versus amortization
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Taxable vs Accounting Income
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Example:
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Cash basis versus revenue recognition
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Warranty expense versus paid
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Unearned revenue
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Conceptual Issues
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There are three basic underlying issues:
 The extent of the allocation
 Discounting
 The measurement method
The range of temporary differences to which
interperiod tax allocation is applied
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Extent of Allocation
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The three basic options are:
1. Tax payable method - no allocation
2. Comprehensive method - full allocation
3. Partial allocation
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Taxes Payable Method
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The amount of taxes assessed in each year
is the income tax expense for that year
Income tax expense = current income tax
Corresponds with actual cash outflow
Not an obligation as do not owe now
Differential reporting
Problems
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Comprehensive Allocation Method
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The objective is to recognize the income tax
effect of every item when that item is
recognized in accounting net income
(according to GAAP).
Match revenue and expense to income tax
impact
Tax effects of all temporary differences are
allocated, regardless of the timing or
likelihood of their reversal
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Partial tax Method
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Alternatives that falls between the two
extremes of no allocation and full allocation
Interperiod income tax allocation is applied
to some types of temporary differences but
not to all (likely to reverse out in near future)
Not for recurring or uncertain reversal
Problems
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Discounting
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Future monetary assets and liabilities are
discounted (consistency)
Difficulties – estimates and timing
Do not discount
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Measurement Issue
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Interest rate to use
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Current tax rate – arose at
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Expected/enacted rate
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Deferral Method
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Records the future tax impacts by using the
corporation’s effective average tax rate in
the year that the temporary difference first
arose.
Income Statement approach - focuses on
best matching of revenue and expenses.
Does not meet definition of assets and
liabilities.
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Liability Method
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Records the future tax impacts by using the
tax rate that will be in effect in the year of
reversal (expected/enacted)
The future tax impact is recorded on the
balance sheet and is updated as the tax rate
changes (Balance Sheet approach)
FIT amounts meets definition of assets and
liabilities
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Liability Method
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More volatile Net Income
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More consistent
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Future Income Tax Liability
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From the perspective of the firm
Taxable temporary differences: taxable to
the firm in the future = FIT liability
Income tax expense not equal to tax payable
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Future Income Tax Liability
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Example:
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Accounting Income > taxable income
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Amortization expense $20,000
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CCA $30,000
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Future Income Tax Asset
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From the perspective of the firm
Deductible temporary differences: deductible
to the firm in the future = FIT asset
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Future Income Tax Asset
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Example:
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Accounting Income < taxable income
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Unearned revenue
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Prepaid
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Future Income Tax
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Future income tax assets and liabilities are
classified as current assets/liabilities or non current
Net amounts
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Income Tax Expense
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Calculation of income tax expense
1.
Calculate tax payable.
2.
Calculate the change in future income
tax.
3.
Combine 1 and 2 to obtain tax
expense.
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Part 3:
Assignment A15-8
Req’d 1
See Chapter 15, page 968
And handout 1, page 2
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Assignment A15-8
Req’d 2
See Chapter 15, page 968
And handout 1, page 2
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Assignment A15-8
Req’d 3
See Chapter 15, page 968
And handout 1, page 2
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Assignment A15-8
Taxes Payable Method
See Chapter 15, page 968
And handout 1, page 2
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Part 4:
Assignment A15-13
20X4
See Chapter 15, page 970
And handout 1, page 3
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Assignment A15-13
20X5
See Chapter 15, page 970
And handout 1, page 3
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Assignment A15-13
20X6
See Chapter 15, page 970
And handout 1, page 3
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Assignment A15-13
Schedule
See Chapter 15, page 970
And handout 1, page 3
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Part 5:
Assignment A15-29
20X1
See Chapter 15, page 976
And handout 1, pages 4-5
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Assignment A15-29
20X2
See Chapter 15, page 976
And handout 1, pages 4-5
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Assignment A15-29
20X3
See Chapter 15, page 976
And handout 1, pages 4-5
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Part 6:
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Investment Tax Credits
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Reductions of tax caused by capital
expenditure (DR income tax payable)
Flow-through method (CR income tax
expense)
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Investment Tax Credits
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Cost Reduction approach
The tax credit is recorded as a reduction to
capital assets or in a separate deferred
credit (contra account to asset).
It is amortized over the life of the asset.
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Tax Losses
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Tax loss = taxable loss on tax return
Corporation is entitled to offset the loss
against past and future taxable income:
 the loss can be carried back for three
years
 any remaining loss can be carried forward
for seven years (if meet criteria).
If the sum of the previous 3 years and next 7
years taxable income is less than the loss,
any remaining potential benefit is lost
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Tax Loss Carrybacks
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DR income taxes receivable and CR income
tax expense (recovery)
Tax is recovered at the rate at which it was
originally paid
If loss relates to discontinued/extraordinary,
allocate to proper area of income statement
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Tax Loss Carrybacks
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Advantages
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No requirement to apply sequentially
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Recovery maximization strategy
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Text Example
See pages 981 to 982
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Tax Benefit
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Is the present and future benefit that the
company will be able to realize from the tax
loss through a reduction of income taxes
paid to governments
Tax benefit = Tax loss x Tax rate
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Tax Loss Carryforwards
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Basic Principle – More likely than Not
Future benefits of tax loss carryforwards
should be recognized in the year of the loss
only if there is a greater than 50% probability
that the benefits will be realized.
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Tax Loss Carryforwards
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DR future income tax asset – carry forward
benefit (balance sheet account)
CR Income tax expense – recovery (income
statement account)
Use the rate that is enacted for the period in
the future if it is known (if not, current rate
used)
If the rate changes in the future, then the
benefit is adjusted based upon the change
in the rate
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Tax Loss Carryforwards
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Recorded loss carry forward benefit unlikely that the benefit will be used, then
the benefit should be written off resulting in
a decrease in the asset and an decrease in
net income
If initially unlikely but becomes more than
likely, than record it.
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Tax Loss Carryforwards
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Advantages
A loss carryforward recognition decreases
the apparent accounting loss
The income tax recovery is a credit entry in
the income statement, reducing the amount
of the reported loss
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Tax Loss Carryforwards
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Strong earnings history
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Loss from non-recurring cause
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Existing temporary differences (CCA)
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Tax Loss Carryforwards
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FA3 responsible to explain policy and impact
of that policy in the financial statements
(NOT for calculations)
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Policy Decisions:
1. Use the tax loss as a loss carryback or loss
carryforward
2. Claim CCA in the loss year (optional) – if
not, increase loss carryforward
3. Refile prior CCA – increase loss used as a
carryback.
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Policy Decisions:
4. Record tax loss carryforward – based on
likelihood (>50%)
5. Still a greater than 50% probability
6. Still a less than 50% probability
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Impact in Financial Statements
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Loss carry back
Reduces the loss in the current year
Increases assets on the balance sheet
(Income taxes receivable)
 Increases retained earnings by reducing
the amount of loss charged to retained
earnings in the period
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Impact in Financial Statements
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Recorded loss carry forward benefit
Recognizes an asset on the balance
sheet (Future income tax asset – LCF)
 Reduces the loss in the current year
 Results in an increased retained earnings
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Impact in Financial Statements
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Do NOT record loss carry forward benefit
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No effect on the current year’s statements
In the year the benefit is used, the income
taxes will be reduced (loss carryforward x
tax rate in effect during that year)
 Increase income and increase retained
earnings
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Impact in Financial Statements
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Draw down of carry forward benefit
 Reduce income taxes payable
 Reduce future income tax asset – LCF
 No effect on net income or retained
earnings - unless the benefit had to be
adjusted to compensate for a change in
tax rate
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Disclosure
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General recommendations for disclosure of
the components of the provision for income
tax expense:
 Continuing operations
 Discontinued operations, extraordinary
items and capital transactions
 Income tax expense should not be
combined with other items of expense
 Future income taxes
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Disclosure
Public companies must explain difference
between the effective tax rate (income tax
expense / pre-tax net income) and
statutory rate
 Loss carrybacks and carryforwards
should be segregated between continuing
operations and discontinued operations
 The amount and expiry of unrecognized
tax losses.
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Disclosure
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Cash Flow Statement: only the amounts
of taxes actually paid or received for the
year.
All allocations, whether for temporary
differences or for tax loss carryforwards,
must be adjusted out.
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Part 7:
Past Exam Questions:
See Module 6 Handout 2
FA3 Module 6
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Blueprint: 11-15%
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Multiple Choice and / or long answer
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Question 6a
See Module 6 Handout 2
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Question 6b
See Module 6 Handout 2
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Multiple Choice
i
See Module 6 Handout 2
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Multiple Choice
j
See Module 6 Handout 2
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Multiple Choice
k
See Module 6 Handout 2
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Multiple Choice
l
See Module 6 Handout 2
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Question 8
See Module 6 Handout 2
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End of presentation
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