FA3 - Lesson 6
Accounting for income tax
Lesson 6 deals with accounting issues related to measuring and
reporting income tax in the financial statements. Various
alternatives are reviewed, and then the lesson examines the
Canadian measurement and disclosure standards. Complications
caused by changes in tax rates are reviewed, as are the intricacies
of accounting for the benefit of a tax loss.
What is an intraperiod tax allocation?

Income tax expense must be allocated to:
 continuing operations,
 discontinued operations,
 extraordinary items, and
 retained earnings items.
Why are accounting income and taxable income
different?
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Permanent differences
Temporary differences
What is a permanent difference (PD)?


Items of revenue, expense, gains, or losses that
are reported for accounting purposes but never
enter into the computation of taxable income.
Also those rare items that enter into taxable
income but are never included in accounting
income.
What is a temporary difference (TD)?


Temporary differences arise when the tax basis
of an asset or liability is different from its carrying
value in the financial statements.
Or, components of accounting income entered
into the computation of taxable income, but in a
different period.
What is the objective of comprehensive interperiod
income tax allocation?


The objective of comprehensive interperiod
income tax allocation is to recognize the income
tax effect of every item when that item is
recognized in accounting net income.
Alternatives to comprehensive allocation are the
flow-through method and partial allocation.
How are the effects of TDs measured?


Using tax rates when the item originated (deferral
method).
Or, using tax rates expected when the item
reverses (liability or accrual method). The liability
or accrual method is Canadian GAAP.
What tax rate is used under the liability method?


Use the currently-enacted or substantiallyenacted rate that will apply in the period that the
temporary difference is expected to reverse.
Balances in FIT (Future Income Tax) are updated
annually to new tax rates.
How are future income taxes classified?



FIT is a current asset/liability if the temporary
differences are caused by a current asset or
liability.
FIT is long-term if caused by long-term assets or
liabilities.
Current FITs can be netted with other current
FITs. The same applies to non-current FITs.
How is income tax expense calculated?
1. Calculate tax payable.
2. Calculate the change in future income tax.
3. Combine 1 and 2 to obtain tax expense.
There is a table that aids the calculation of
item 2.
What is an investment tax credit?
Investment tax credits are reductions of tax
caused by capital expenditure.
 The tax credit is recorded as a reduction to
capital assets or in a separate deferred credit.
 It is amortized over the life of the asset.

What are the rules for tax losses?



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Tax losses may be carried back and offset
against taxable income in the three previous
years (LCB).
Tax receivables are based on the tax actually
paid.
Then, the tax loss may be carried forward for
seven years (LCF).
If the tax loss isn’t used within this period, it
expires.
Can you record the LCF in the year of the loss?

The 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.
What happens if the probability shifts in a later
year?


An unrecognized LCF can be set up in years
following the loss if the probability of realization
becomes greater than 50%.
If the likelihood shifts to less than 50%, the LCF
has to be written off.
What is disclosed in the financial statements for
income tax?


Companies must disclose income tax expense
(current and future) and the effect of LCF
recognition.
Unrecognized LCFs are disclosed in the notes.
continued...
What is disclosed in the financial statements for
income tax? (continued)

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Public companies must explain in a note the
difference between the effective tax rate reported
in the financial statements and the statutory rate.
The effective tax rate is the income tax expense
(including future income taxes) divided by the
pretax net income.
continued...
What is disclosed in the financial statements for
income tax? (continued)


The cash flow statement will include only the
amounts of taxes actually payable or receivable
for the year.
All allocations, whether for temporary differences
or for tax loss carryforwards, must be adjusted
out.