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Chapter 18

AFM391 Chapter Notes - Chapter 18: Accrual, Basis Of Accounting, Balance Sheet


Department
Accounting & Financial Management
Course Code
AFM391
Professor
Duane Kennedy
Chapter
18

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Methods of Accounting for Income Taxes
Taxes payable method: records an amount for income tax expense equal to the tax payments for
the current period
o Record income statement expense for income taxes and the corresponding liability
according to the amount payable to the tax authorities
Both federal and provincial levels
o There is a mismatch of income and income tax expense
o Difference in timing between
Accrual accounting income recognized for financial reporting
Income recognized for tax purposes
Income statement approach (deferral method)
o Focuses on obtaining the income statement value for income tax expense that best matches
the amount of income recognized for the year
Regardless of when cash flows occur
o Produces an effective tax rate that is consistent throughout the years
Rate expected based on the assumed statutory tax rate
Better matches the income tax expense to the amount of income recorded
o Accounting income: amount of income (before subtracting income tax) recognized for
financial reporting purposes
o Taxable income: amount of income recognized for tax purposes used to compute taxes
payable
Balance sheet method (accrual method)
o Focuses on obtaining the balance sheet value for the income tax liability (asset) that best
reflects the assets and liabilities recognized on the balance sheet
o Produces fluctuating tax rates even though the statutory rate remains constant
No change if tax rates remain the same
o Accepted approach in both IFRS and ASPE
Permanent differences: arises from a transaction or event that affects accounting income but never
taxable income, or vice versa
Dividends received by corporations
o Included in income, not taxable
Initiation fees for membership in clubs and association
o Accounting expense, not tax deductible
Life insurance premium for employees
o Accounting expense, not tax deductible
Capital gains
o Full gain included in income, only half of the capital gain is included in taxable income
Meal and entertainment costs
o Accounting expense, only half is tax deductible
Amount of accounting income and taxable income will never reconcile
o Follow tax treatment to compute the tax expense for financial reporting purposes
Income tax expense is the same as tax payable
Temporary difference: arises from a transaction or event that affects both accounting income and
taxable income, but in different reporting periods
Examples
o Construction in process
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Reflected in balance sheet, not taxable
o Taxable income on construction in process
o Will eventually reverse at a later time
Deferred tax liability: amount of income tax payable in future periods as a result of taxable
temporary differences
Taxable temporary difference: temporary difference that results in future taxable income being
higher than accounting income
Deductible temporary different: temporary difference that results in future taxable income being
less than accounting income
o Record an asset for the reduction in taxes payable in the future
o Deferred tax asset: amount of income tax recoverable in future periods as a result of
deductible temporary differences, losses or tax credits carried forward
Aka future income tax asset in ASPE
Common temporary differences
o Revenue on construction contracts
Accounting recognizes using percentage of completion
Taxes can use completed contract method
o Fair value increase on biological assets
Accounting recognizes fair value gains through income
Taxes recognize income upon disposal of or production from biological assets
o Warranty costs
Accounting accrues expenses to match revenue recognition
Taxes deduct when actual costs are incurred
o Finance leases
Accounting records interest and depreciation expense
Tax treatment deducts only lease payment
o Depreciation, depletion, amortization
Accounting records expenses using methods and rates according to company's
accounting policy
Tax treatment deducts capital cost allowance using rates and methods specified in tax
rules
Temporary differences due to depreciation
o Capital cost allowance (CCA): depreciation for tax purposes
Usually exceeds depreciation for tax purposes
Governments' desire to encourage investment in capital assets
High CCA deductions decrease the present value of taxes because less taxes are due in
the early periods of the assets' lives
Taxable income tends to be less than accounting income
Originating difference: a temporary difference that widens the gap between accounting and tax
values of an asset or liability
Reversing difference: a temporary difference that narrows the gap between accounting and tax
values of an asset or liability
We can distinguish income tax expense into a current component and a deferred component
o Current component
Taxes payable for the year
o Deferred portion
Taxes in future years
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