The amount of income taxes that is due to the government for a period of time is rarely the same as the amount of income tax expense

The amount of income taxes that is due to the government for a period of time is rarely the same as the amount of income tax expense that is reported on the income statement for that same period under IFRS and one of the alternatives under PE GAAP.

Instructions

(a) Explain the objectives of accounting for income taxes in general purpose financial statements.

(b) Explain the basic principles that are applied in accounting for income taxes at the date of the financial statements to meet the objectives discussed in (a).

(c) Explain how the recognition of future tax accounts on the balance sheet is consistent with the conceptual framework, noting the differences between IFRS and PE GAAP.

(d) Using the definition of an asset and a liability (from Chapter 2), discuss why future income tax assets and future tax liabilities as currently measured and reported might not meet this definition.  

(a) The following are objectives in accounting for income taxes:

    1.  To recognize the amount of taxes payable or refundable for the current year.

    2.  To recognize future income tax liabilities and assets for the future tax consequences of events that have been recognized in the financial statements or tax returns.

(b) The following basic principles are applied in accounting for income taxes at the date of the financial statements:

    1.  A current income tax liability or asset is recognized for the estimated taxes payable or refundable on the tax return for the current year.

    2.  A future income tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and carry-forwards using the enacted (or substantially enacted) marginal tax rates.

    3.  The measurement of current and future tax liabilities and assets is based on provisions of the enacted tax law; the effects of future changes in tax laws or rates are not anticipated.

    4.  The measurement of future income tax assets is adjusted, if necessary, to not recognize tax benefits that, based on available evidence, are not expected to be realized.

(c) Under the asset and liability method (balance sheet liability method) of accounting for income taxes, the future income tax outflows and inflows related to the realization of assets and the settlement of liabilities for their carrying amounts are recognized as future income tax liabilities and future income tax assets.

These future income tax liabilities and future income tax assets meet the conceptual definitions of liabilities and assets. In other words, temporary differences between an asset or liability's carrying amount and its tax basis, unused tax losses, and income tax reductions may generate future benefits in the form of reduced tax payments in later periods. Such items would be recognized as future income tax assets when the appropriate criteria are met, since they satisfy the conceptual definition of assets.

This method is considered to be more effective in achieving the objective of financial reporting— communicating information that is useful to users—as the method provides users with information about a company’s economic resources and obligations regarding income tax consequences of all transactions and events.

In reporting future tax assets and liabilities, there is one difference between PE GAAP and IFRS.  PE GAAP (under this alternative) will report future income tax assets or future income tax liabilities as either current or non-current.  This classification will depend on when the future income tax amount is expected to reverse.   Under current IFRS, all future tax assets and liabilities are classified as non-current.

(d) An assetis “a present economic resource that the entity has an enforceable right to access”.  Currently, there are two issues with respect to future income tax assets, as discussed below:

·          The value of this asset will be received sometime in the future.  As such, it should be discounted to approximate the current value of the benefit to be received.  Ideally, some measurement using probabilities of likely outcomes would be used to determine the best estimate of the economic resource.

·         Does this represent an enforceable right to access?  In the case of loss carry forward benefits, the company has not yet made a profit, the government does not yet owe the company this amount, and the realization of this asset is very dependent on a future event that may or may not happen.  Consequently, the right is not enforceable.  This asset represents a “conditional right to receive the benefits”.  Given this strict definition, perhaps the future tax asset arising from the use of loss carry forwards should not be recorded.

A liability is “an economic burden which is a present obligation that is enforceable.”  Similar issues arise in looking at this definition as follows:

·         The value of this liability will be paid sometime in the future.  As such, it should be discounted to approximate the current value of the benefit to be received.  In addition, there are a variety of different outcomes.  As a result, the entity should estimate the amount and timing of the obligation under each of these different outcomes, determine the present values of each of these outcomes, and then estimate the probability of each outcome. 

    Does this represent a represent enforceable obligation?  The company does not yet owe these taxes. The amount of the future liability will depend on future taxable profits, and when these temporary differences will reverse.  For example, if a company continues to invest in property, plant and equipment and the capital cost allowance claim is always greater than the depreciation for tax purposes, then it may be along timer ( if ever) that this liability will arise  Consequently, the obligation is not presently enforceable.  This liability represents a “conditional obligation to pay”, given certain future events occur.  As described above in the first point, using a measurement that considers the probability of different outcomes would likely better reflect the amount of the future obligation.