Income taxes

Income taxesAccounting income+/- permanent differences: revenues and expenses reported for accounting purposes but not for taxable income+/- timing differences: elements of accounting income that do factor into taxable income, but do so in a period different than when recognized for financial reporting= taxable incomePermanent differences- exampleEquity incomeDividends received from taxable canadian corporationsNon deductible fines, taxes. PenaltiesClub membership feesEntertainment expenses (50% allowable)Advertising expenses in US magazinesTiming, temporary differencesTiming differenceTemporary differenceDepreciation, cca, gains and losses on depreciable assetsNBV/UCC differenceWarranty expense and warranty costsWarranty liability Pension expenses, contributions to plansPension accountBond discount/premium amortizationsAccumulated amortized bond discount/premiumDeferred development costsUnamortized deferred development costsFive year example Suppose we build a plant costing $1 million and we get a special 50% CCA rate. The tax rate itself is 40%, and we know we will earn $150 000 each year for 10 years.We might expect this income statementNet Income before taxes (NIBT) 150 000Income Tax (40%)(60 000) Net Income90 000But in fact because of timing differencesSince we use depreciation for accounting purposes and cca for income tax purposes, we actually see something different this creates what we call a timing difference.NOTE: this illustration is a timing difference we will see a permanent difference laterLets look at the mathCost is 1 million CCA= 50% tax rate = 40%Year 1- 10, we will earn 150 000 in NIBTStraight line depreciationYear 1We will write this statement/ tableNIBT 150 000Add: Depreciation100 000Less CCA(250 000)(1 000 000 x 50% x )taxable income0Remember thoughWe expect a tax expense of $60 000 and net income after tax of $90 000What we do is create a deferred tax account- the value of a future tax asset or liability with an ASSET being a DEBIT and a LIABILITY a CREDIT balance in the accountThe tax asset causes future taxable income to go down, and a tax liability causes future taxable income to go upWe can measure this DIT (Deferred income tax) account

How do we measure it?Right now, we measure it as the timing difference between two numbersNBV of plant: 1m asset 100 000 depre=900000UCC of plant: 1m asset- 250 000 cca=750 000

DIFFERENCE = 150 000 this is the temporary difference it is cca we cannot take in future years even though we take depreciationThis is our journal entryWe take that difference of 150 000We multiply it by the tax rate of 40%= 60000

Income tax expense (deferred)60 000DIT account60 000Try to use this so you can move the DIT account from asset to liability when neededIncome statement looks like thisNIBT150 000Income tax expenseCurrent portion0Deferred portion60000(60 000)Net income90 000In year 2 NIBT150 000Add depreciation100 000Less cca (750 000 x 50%)(375 000)Net loss(125 000)

Now we have a loss carry forward so this makes a second timing differenceLets calculate the DIT accountNBV= 900 000 100 000= 800 000 UCC= 750 000 375 000= 375 000 425 000 x 40% tax= 170 000Asset or liability?2) Loss carry forward125 000 x 40% = 50 000 Asset or liability? Dit accountUse a t- accountOur total balance should be $120 000 ($170 k - $50 k) and we have a balance of $60 k now Journal entryIncome tax expense (deferred)60 kDIT60kSame income statement appearanceYear 3NIBT150 000Add depreciation100 000Less CCA (375 000 x 50%)(187 500)Taxable income $62 500Less Loss carry forward (62 500) Net Income0Now the DIT calculationNBV= 800 000 100 000 = 700 000UCC= 375 000 187 500 = 187 500512 500x 40% = 205 000And the Loss carryforward:125 000 62 500 = 62 500 x 40%= (25 000) 180 000Tax liability, right why?So we need to make these entriesThe current DIT account balance is 120 000 and it should be $180 000, so

Income tax expense (deferred)60 000DIT account60 000

The income statement still looks the same

Year 4NIBT150 000Add depreciation100 000Less CCA (187 500 x 50%)(93 750)Taxable income before loss c/fwd156 250Loss c/forward(62 500)Taxable income 93 750Income tax (40%)- current portion (37 500)Net income 56 250Lets calculate the DIT accountNBV: 700 000 100 000 = 600 000UCC: 187 500 93 750 = 93 750 506 250 x 40%=202 500

The loss carry forward is used up so this is the ending DIT account balance (up from 180 000)So the journal entries areREMEMBER, we finally had a current tax expenseIncome tax expense- current37 500income tax payable37 500

Income tax expense deferred42 500DIT account42 500Now the income statement changes a littleNIBT150 000Income tax expense- current 37 500- deferred22 500(60 000)Net income90 000Year 5NIBT150 000Add depreciation100 000Less CCA (93 750 x 50%)(46 875)Taxable income 203 125Income tax (40%)-current portion (81 250)Net income121 875

Lets calculate the DIT account balanceNBV= 600 000 100 000 = 500 000UCC= 93750 46 875 = 46 875453 125 x 40%= 181 250

Remember our balance is 202 500 so we need to lower that by 21 250So now the journal entries areIncome tax expense- current81 250income tax payable81 250

AndDIT account21 250income tax expense- deferred21 250The income statement will look like thisNIBT150 000Less income tax - current81 250- deferred(21 250)(60 000)Net income90 000The concept isHow permanent and temporary differences affect taxable income and accounting income differently.