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Chapter 18

AFM391 Chapter Notes - Chapter 18: Income Tax, Tahsis, Deferred Tax


Department
Accounting & Financial Management
Course Code
AFM391
Professor
Christine Wiedman
Chapter
18

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Chapter 18: Income Taxes
1
Accounting Income vs. Taxable Income & Accounting Methods for Income Taxes
Accounting for income taxes is complex as it involves the interaction between accounting
income and taxable income.
Accounting income (also known as “income before taxes”) is determined according to financial
reporting rules (accrual basis) such as IFRS and ASPE.
Objective is to provide useful information to financial statements users.
Taxable income is determined according to Income Tax Act and Regulation (close to cash basis)
Objective is to raise money to support government operations
Accounting methods for Income Taxes
There are three accounting methods for income taxes:
1. Taxes Payable Method
a. Allowed only under ASPE
2. Deferral Method (Income statement approach)
a. No longer used and we won’t cover it
3. Accrual Method (Balance sheet approach, or temporary difference approach)
Required under IFRS
ASPE gives the option to use this method
The focus of this chapter.
Methods 2 and 3 are called “tax allocation” methods.
IFRS requires method 3.
ASPE allows either method 1 or method 3.
Our focus is on the Accrual method in this chapter, but let’s briefly explain the Taxes Payable
method
Taxes Payable Method: focuses on current income tax
Income tax expense = Current income tax expense = Taxable income x Tax rate
Income tax expense reported on the I/S only has one component
Current income tax expense.
Accrual method: focuses on both current income tax and deferred (future) income tax
Income tax expense = Current income tax expense + Deferred income tax expense
Income tax expense reported on the I/S has two components:
Current income expense, and
Deferred (future) income tax expense.
We will use the following example to illustrate the difference between the taxes payable and
accrual methods.
Tahsis Company reports:
$100K of accounting income in 2019 and 2020 using the %-of-completion method, but

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2
$80K of taxable income in 2019 & $120K in 2020 using the completed contract method.
Taxes Payable Method
Taxes payable method calculates income tax expense based on taxable income for the period
This method ignores the difference between the accounting income and taxable income (see
previous slide).
As a result, income tax expense for the period does not match the revenue for the
period (i.e., does NOT satisfy the matching principle).
1. To record income tax payable
Dr. Income Tax Expense:
Cr. Income tax payable
2. To record payment of income tax payable:
Dr. Income tax payable
Cr. Cash
Taxes Payable Method Example

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Mismatch: 2019 accounting income is $100K, but income tax expense is based on 2019 taxable
income of $80K Income tax expense = $80K x 40% = $32K
What happens to $20K, which is the difference between accounting income and taxable income
in 2019?
This $20K will be included in 2020 taxable income (i.e., it’ll reverse in 2020, thus
increasing 2020 tax payable by $8K.)
This future tax payment of $8K is a liability at the end of 2019.
Taxes payable method ignores the $8K, while
Accrual Method recognizes this $8K as Deferred Tax Liability at the end of 2019 as the second
component of income tax expense:
Accrual Method
Taxes payable method does NOT account for temporary differences, thus:
it does not satisfy the matching principle, and
it potentially omits significant assets and liabilities for future taxes.
The first component is current tax expense (same as the Taxes Payable Method).
The second component is future tax consequences of the temporary differences. In the
previous example:
The $20K is the temporary difference between the accounting and taxable income
originated in 2019.
$8K ($20K x 40%) is future tax consequence of this temporary difference.
Both components reported on the income statement in 2019
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