Chapter 18 - Income Taxes Flashcards
What are the three reasons accounting and taxable income differs?
- Temporary differences
- Permanent differences
- Loss Carry Forwards
What is a temporary difference/ timing difference
An asset or liability has a different value for tax purposes than it does for accounting purposes.
What causes temporary differences?
Company has included an expense or revenue in both accounting and taxable income but not for the same period.
What items do timing differences develop on?
Pension expenses
Warranties
Amortization.
What is a permanent difference?
An item that the company has deducted from or included in the determination of accounting income or taxable income and not the other (and never will be)
What are examples of permanent differences?
- 50% of entertainment costs
- Non deductible club expenses
- Non taxable portion of capital gains
- Dividend revenue from corporations.
How long can corporations carry non capital tax?
- Back three years
- Forward 20 years
How long can corporations carry net capital losses? What is the result of claiming these on the tax return?
- Back three years
- Forward indefinitely.
- Taxable income to differ from income before taxes on the statement of income.
Is a company permitted to deduct depreciation on an income tax return?
No, because the CRA feels like it is amount that is too prone to estimations.
What is the rule regarding income taxes, AKA when do we recognize it?
Income taxes should be recorded in the time in which they relate regardless of the cash movement pertaining to the item.
What is the substitute for the depreciation on the income tax return? Is this optional?
Deduct the capital cost allowance which is a tax form of depreciation based upon prescribed rates in the income tax act of $30,000. It is optional
T or F: It is very common for the table income before taxes will be lower than the accounting income before taxes? What stage is this true in?
True
This is true in the early stages of the life of an asset as the CCA rates are higher than the depreciation rates used for accounting purposes.
What is the difference between the taxable income from the tax return and the income before taxes accounting. What do we do with the expense?
It is a deferred incomes taxes that represents an amount that will have to be paid in the future. We split the expense into its current portion and the long term portion.
What happens during the loss years?
In the lost years we will have a negative expense therefore we will recognize it instead as a income tax benefit not an expense.
When do firms pay off the deferred income tax liability? When does this cause?
Years when the CCA claimed is less than the depreciation recorded in the accounts, causing the accounting income before income taxes to be lower than the taxable income on the tax return, making the company create a debit against the deferred income taxes account, resulting in reversing the temporary difference.
Is the deferred income tax liability a legally enforceable claim? Is it still considered a liability, if so why?
No it is not. It is still a liability because:
1. It is a present obligation because taxable income in future periods will be higher.
2. It arises from past transactions or events
3. It will require the use of assets or giving up economic benefits in the future.
What is the formula for a temporary difference?
The carrying amount of the asset - Tax Value of the Asset
What are the two types of temporary differences?
Taxable temporary difference
Deductible temporary difference
What is a taxable temporary difference?
Tax Cost of Asset < Carrying amount of Asset, deferred income tax liability arises. Results in the recording of a liability for deferred income taxes.
or
Tax Cost of Liability > Carrying Amount of Liability
What is a deductible temporary difference?
Tax Cost of Asset > Carrying Amount of Asset, deferred income tax asset. Will use this excess tax cost in the future to reduce taxable income.
or
Tax Cost of Liability < Carrying Amount of Liability
What is the formula for the deferred income tax expense/benefit?
Change in deferred income tax account on the statement of financial position.
What are the three reasons that we can record a deferred income tax asset as an asset?
- The asset will contribute to future cash flows because when the company realizes, its income tax lowers
- The entity controls the access to the benefits provided.
- It results from a past transaction or event.
Describe the temporary differences impact on total income tax expense
The temporary difference does not cause a change in the total income tax expense, it merely changes the value of deferred income tax portion, changing the current income tax portion.
What is the reversals of temporary differences explain?
If in the first year the company had a taxable temporary difference, this causes an increase in the DIT expense but lowers the CIT Expense. When it reverses DIT expense gots down and CIT goes up, balancing it. The reversal affects the cash and interacts with the CIT., does not touch DIT.
What is the tax cost/ tax basis of an asset / liability ?
The tax basis of an asset is the amount, determined with reference to the rules established by the taxation authorities that could be deducted in the determination of taxable income if the asset were recovered for its carrying amount.
What are the three tax basis of an asset according to the CPA Handbook?
- If amounts related to an asset are deductible for more than one year, the tax basis is the original tax basis less amounts that an entity has deducted in the past.
- If the entity can only deduct the cost of an asset when it withdraws it from use, the deductible amount at that time is equal to the tax basis now
- If the carrying amount of the asset was not tax deductible and any income arising from the its settlement was not taxable, than its tax basis would be equal to the carrying amount.
What is a tax basis off a liability?
Carrying Amount - Any amount that will be deductible for income tax purposes in respect of that liability in future periods.
What are considerations for taxing deferred revenues?
Tax basis of the Liability = Carrying amount - Amounts that are not taxable in the future.
What are considerations for taxing liabilities whose settlement has no tax consequences?
Tax Basis = Carrying Amount
What are other examples of temporary differences?
- The CRA requires companies to use the cash basis of accounting for certain accounts like warranty expense, pension expense because they are prone to management estimations.
- The CRA in certain situations will allow a company to recognize its revenue on the cash basis of accounting rather than the accrual basis.
What typically happens when CRA requests cash basis of accounting rather than accruals?
Taxable income is lower as there is a delay in recognizing the revenue, thus the AR on the statement of financial position may be greater than AR for tax purposes.
What is the deferred income tax asset account formula when there is an absence of a loss carry forward?
Cumulative temporary difference * Future income Tax Rate
What is the concern regarding the tax allocation approach of the CCA? Under which conditions is this likely to occur?
While it adheres to the matching principle, some accountants believe the recording of the DIT liability will result in the company never having to pay it. This is because many businesses grow over time and due to this, the CCA claimed on the tax returns will exceed the depreciation recorded on the accounts. During inflationary periods.
What do supports of this perspective state?
They state that the taxable income not accounting income attracts income tax, thus there is no relationship between accounting income and Income that expense that we need to account for. In addition, because they are not legally enforceable claims we should not record them.
What is the taxes payable approach? When can we use this?
The income tax owing on the tax return is the only amount record. Only ASPE permits this.
What method does temporary difference in tax apply too? Why is this the only acceptable way under IFRS?
It is a tax allocation method and it is only for IFRS.
This method is used as it :
1. Properly recognizes existence of deferred income tax assets and liabilities that users of the financial statement should consider when evaluating a company.
2. Allows users to understand the effective income tax rate
3. Avoids the fluctuations that may arise from using the taxes payable basis.
What is the impact of permanent differences?
We do not recognize the effects of a permanent difference for tax purposes, we record no income tax expense or benefit on permanent differences on either the tax allocation or the taxes payable approach.
What is the formula for income tax expense using the allocation approach?
- In simple situations where no loss carry forward exists, the tax allocation approach has the following formula:
(Taxable income * current rate) + (Temporary difference arising this period*Future tax rate) + (Change in future tax rate * Opening cummulative temporary difference)
Term 1 - Current Income Tax Expense
Term 2 and 3 - Deferred Income Tax Expense
What is the DIT Expense / Benefit equivalent too?
It is the change in the DIT on the statement of financial position.
What is the true rate that the DIT Asset / Liability should be recognized at? Why do we use the current rate?
It should be recognized at the income tax rate on the date that the benefit is recognized or the expense is paid. Typically we do not know what the rate will be later on in the future,
What situation would the income tax rate change?
This would occur when the government has enacted or substantially enacted a rate change.
What is a difficult situation we may face regarding income tax rates? How do we account for this?
If it is to be realized over several years and the income tax rate varies over those years. We will make an estimate of that day that it will be settled or realized for the temporary difference and apply the future income tax rate applicable to the temporary difference to value the resulting future income tax asset or liability.
What happens if the DIT asset or liability suddenly has a rate change?
It will be revalued using the new future income tax rate. This is a change in estimate, thus account for it on a prospective basis, thus
it will be changed in the current years income tax expenses
No adjustment to opening RE
Why do some accountants believe this is inappropriate?
The income tax rate changes or lowers net income and government policy shouldn’t be used to affect the way we measure the performance of a business.
Under both IFRs and ASPE, how do we keep track of multiple temporary differences?
- A DIT Asset should be set up to account for the tax effect of deductible temporary differences
- A separate DIT Liability account should be set up for taxable temporary differences.
- DIT Assets and Liabilities as Non current items.
- Companies report only one Net DIT Asset or Liability as a non current item.
What situation would arise where a DIT Asset / Liability does not relate to an amount on the statement of FP?
- Record an expenditure as an expense for accounting purposes but capitalize the item for tax purposes.
- Records a DIT asset to recognize the benefit of a loss carry forward
Why do we see both a DIT asset an a DIT liability for public company’s?
Companies cannot net these accounts together if they relate to different legal entities included in consolidated statements.
How do we reassess the DIT Asset Account?
- The reversal cannot occur until the company can earn enough taxable income in the future to absorb taxable temporary differences that reverse and realize the benefits of DIT assets.
When do we assess the collectibility benefit of the DIT? What is the underlying assumption?
We will assess its collectibility at the end of the period. The assumption is that the it will be collectible
What happens if the DIT asset is not more likely than not to be able to absorb the taxable deductible amount?
We will write down the DIT Asset.
What approach is used under IFRS and ASPE to perform the write down?
Under ASPE we use the allowance method and IFRS we will write it down to the asset, but since the laws for IFRS are always changing we will use the allowance method.
