Chapter 21 Corporate Earnings and Capital Transactions Flashcards
Corporate Income Tax
One of the disadvantages of the corporate form of business is that corporations must pay income taxes on their profits. Taxable income can be calculated differently for federal, state, and local purposes; however, the procedures to record these taxes are identical. For the sake of simplicity, we will cover federal taxes only and assume that taxable income and financial reporting income are identical. In reality, the two are often different because of special tax provisions.
Corporate Income Tax
One of the disadvantages of the corporate form of business is that corporations must pay income taxes on their profits. Taxable income can be calculated differently for federal, state, and local purposes; however, the procedures to record these taxes are identical. For the sake of simplicity, we will cover federal taxes only and assume that taxable income and financial reporting income are identical. In reality, the two are often different because of special tax provisions.
QUARTERLY TAX ESTIMATES:
Corporations estimate their income taxes for the year and make estimated tax payments four times during the year. To avoid a penalty, the tax deposits at the end of the year must be equal to or higher than the tax liability for the year. For calendar year corporations, the estimated tax payments are due on April 15, June 15, September 15, and December 15. To record an estimated tax payment, debit Income Tax Expense and credit Cash.
Mountain Supplies, Inc., estimated its tax liability for 2013 to be $20,000. During the year, it made four tax deposits of $5,000 ($20,000 ÷ 4). The journal entry to record the first deposit (April 15) is as follows;
Mountain Supplies, Inc., estimated its tax liability for 2013 to be $20,000. During the year, it made four tax deposits of $5,000 ($20,000 ÷ 4). The journal entry to record the first deposit (April 15) is as follows:
At the end of the year, the Income Tax Expense account has a balance of $20,000.
At the end of the year, the Income Tax Expense account has a balance of $20,000.
The amount owed is recorded in the Income Tax Payable account, a liability.
The amount owed is recorded in the Income Tax Payable account, a liability.
Because the tax return is complex and differences exist between taxable income and financial income, this computation can also be described as an estimate. The tentative tax expense computed at the end of the year usually differs from the actual tax expense shown on the tax return. The difference is recorded in the Income Tax Expense account.
Because the tax return is complex and differences exist between taxable income and financial income, this computation can also be described as an estimate. The tentative tax expense computed at the end of the year usually differs from the actual tax expense shown on the tax return. The difference is recorded in the Income Tax Expense account.
DEFERRED INCOME TAXES:
Usually net income reported on the financial statements does not match taxable income reported on the tax return because tax laws do not always follow generally accepted accounting principles.
Income can be included in taxable income this year and appear on the financial statements in later years, or vice versa.
Income can be included on the financial statements but never appear in taxable income.
Expenses can be included in taxable income this year and appear on the financial statements in later years, or vice versa.
Expenses can be included on the financial statements and never be deducted from taxable income.
Accountants use the concept of deferred income taxes to match income tax on the financial statements to the related net income.
DEFERRED INCOME TAXES:
Usually net income reported on the financial statements does not match taxable income reported on the tax return because tax laws do not always follow generally accepted accounting principles.
Income can be included in taxable income this year and appear on the financial statements in later years, or vice versa.
Income can be included on the financial statements but never appear in taxable income.
Expenses can be included in taxable income this year and appear on the financial statements in later years, or vice versa.
Expenses can be included on the financial statements and never be deducted from taxable income.
Accountants use the concept of deferred income taxes to match income tax on the financial statements to the related net income.
Each year, the accountant estimates the amount of future taxes that will be paid as a result of the MACRS depreciation taken in this and prior years. An adjustment for the future taxes is made to Tax Expense and to the liability account, Deferred Income Tax Liability.
Each year, the accountant estimates the amount of future taxes that will be paid as a result of the MACRS depreciation taken in this and prior years. An adjustment for the future taxes is made to Tax Expense and to the liability account, Deferred Income Tax Liability.
Mountain Supplies, Inc., made tax deposits of $20,000. The difference between the tax deposits and the total tax is $6,150 ($26,150 − $20,000). An adjustment is made to debit Income Tax Expense for $6,150 and to credit Income Tax Payable for $6,150.
Mountain Supplies, Inc., made tax deposits of $20,000. The difference between the tax deposits and the total tax is $6,150 ($26,150 − $20,000). An adjustment is made to debit Income Tax Expense for $6,150 and to credit Income Tax Payable for $6,150.
Worksheet
Asset, liability, and equity accounts are extended to the Balance Sheet columns. Revenue and expense accounts are extended to the Income Statement columns.
Worksheet
Asset, liability, and equity accounts are extended to the Balance Sheet columns. Revenue and expense accounts are extended to the Income Statement columns.
The fundamental accounting equation for corporations can be restated as Assets = Liabilities + (Paid-in Capital + Retained Earnings).
The fundamental accounting equation for corporations can be restated as Assets = Liabilities + (Paid-in Capital + Retained Earnings).
Paid-in Capital: (or contributed capital) represents the amount of capital acquired from capital stock transactions.
Paid-in Capital: (or contributed capital) represents the amount of capital acquired from capital stock transactions.
Retained Earnings: represents the cumulative profits and losses of the corporation not distributed as dividends. Dividends reduce retained earnings.
Retained Earnings: represents the cumulative profits and losses of the corporation not distributed as dividends. Dividends reduce retained earnings.
Retained Earnings:
There are legal and financial distinctions between paid-in capital and retained earnings. This is why profits and losses are accumulated in retained earnings, separate from the capital paid in by the stockholders.
It is important to remember that retained earnings does not represent a cash fund. Retained earnings are reinvested in inventory, plant and equipment, and various other types of assets. A corporation can have a large cash balance but no retained earnings. Conversely, it can have a large balance in the Retained Earnings account but no cash.
Dividend Policy: Before declaring a dividend, the board of directors considers two issues: legality and financial feasibility.
Dividend Policy: Before declaring a dividend, the board of directors considers two issues: legality and financial feasibility.
