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 asset
is “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.
