Under
the asset-liability method, the tax rates used for future income tax
calculations are those enacted at the balance sheet date, based on how the
reversal will be treated for tax purposes.
Instructions
For
each of the following situations, discuss the impact on future income tax
balances.
(a)
At December 31, 2010, Golden Corporation has one temporary difference that will
reverse and cause taxable amounts in 2011. In 2010, new tax legislation sets
tax rates equal to 45% for 2010, 40% for 2011, and 34% for 2012 and the years
thereafter.
Explain
what circumstances would require Golden to calculate its future tax liability
at the end of 2010 by multiplying the temporary difference by:
1.
……………. 45%.
2.
……………. 40%.
3.
……………. 34%.
(b)
Record Inc. uses the fair value method for reporting its investment properties.
The company has an investment property with an original cost of $5 million and
a tax carrying amount of $3.5 million due to cumulative capital cost allowance
claimed to date of $1.5 million. This asset is increased to its fair value of
$8 million for accounting purposes. No equivalent adjustment is made for tax
purposes. The tax rate is 30% for normal business purposes. If the asset is
sold for more than cost, the cumulative capital cost allowance of $1.5 million
will be included in taxable income as recaptured depreciation, but sale
proceeds in excess of cost will be taxable at 15%. Calculate the related future
income balance assuming:
1.
the value of the asset will be recovered through its use
2.
the value of the asset will be recovered by selling the asset (c) Assume the same above for (a) and (b),
but the company is now revaluing a tract of land and a building that are
included in property, plant, and equipment. The change in revaluation has been
reported in other comprehensive income. All numbers remain the same as
discussed in (a) and (b) above. What differences in the tax impact, if any,
would be required?
(a)
(1) The 45% tax rate would be used in calculating the future income tax
liability at December 31, 2010, if a net operating loss expected in 2011 is to
be carried back to 2010 (the enacted tax rate is 45% in 2010). (See discussion
below.)
(2) The
40% tax rate would be used in calculating the future income tax liability at
December 31, 2010, if taxable income is expected in 2011 (the tax rate enacted
for 2011 is 40% and 2011 is the year in which the future taxable amount is
expected to occur). (See discussion below.)
(3) The
34% tax rate would be used in calculating the future income tax liability at
December 31, 2010, if a net operating loss expected in 2011 is to be carried
forward to 2012 (the tax rate enacted for 2012 is 34%). (See discussion below.)
Discussion:
In determining the
future tax consequences of temporary differences, it is helpful to prepare a
schedule that shows in which future years existing temporary differences will
result in taxable or deductible amounts. The appropriate enacted tax rate is
applied to these future taxable and deductible amounts. In determining the
appropriate tax rate, you must make assumptions about whether the entity will
report taxable income or losses in the various future years expected to be
affected by the reversal of existing temporary differences. Thus, you calculate
the taxes payable or refundable in the future due to existing temporary
differences. In making these calculations, you apply the provisions of the tax
laws and enacted tax rates for the relevant periods.
For future taxable
amounts:
1. If
taxable income is expected in the year that a future taxable amount is
scheduled, use the enacted rate for that future year to calculate the related
future income tax liability.
2. If
an operating loss is expected in the year that a future taxable amount is
scheduled, use the enacted rate of what would be the prior year that the
operating loss would be carried back to (or the enacted rate of the future year
to which the carry forward would apply, whichever is appropriate), to calculate
the related future income tax liability.
For future deductible amounts:
1. If
taxable income is expected in the year that a future deductible amount is
scheduled, use the enacted rate for that future year to calculate the related
future income tax asset.
2. If
an operating loss is expected in the year that a future deductible amount is
scheduled, use the enacted rate of what would be the prior year that the
operating loss would be carried back to (or the enacted rate of the future year
to which the carry forward would apply, whichever is appropriate), to calculate
the related future income tax asset.
(b)
(1) Assuming that
the company will recover the asset value through use, the company will generate
taxable income of $ 8 million, but only be able to deduct CCA of
$3,500,000. Consequently, a temporary
taxable difference between the current carrying value and the tax value is
$8,000,000 minus $3,500,000 which is $4,500,000. At a tax rate of 30%, a future income tax
liability of $1,350,000 will be reported.
As the gain on this fair value adjustment is reported in net income, any
change in the future income tax liability account required to report a total
amount of $1,350,000 would also be reported in net income.
(2) If the company
expects to recover the value of the asset through a sale in the next year, the
proceeds on this sale will attract different income tax rates. The future income tax liability should be
calculated based on the applicable tax rates to be paid. Given the above information, the future
income tax liability is calculated as follows:
$1,500,000 will be
recaptured and taxed at 30% = $450,000
$3,000,000 will be
taxed as capital gains and attract a tax rate of 15% (as given in the question)
= $450,000
Total future tax
liability will be $900,000 (= $450,000 + $450,000).
Any change
required to adjust the future tax liability will be reported in net income, as
the fair value adjustment was reported in net income.
(c) If this
property was measured using the revaluation method, the same numbers would
apply as calculated above. However,
changes required to adjust the future tax liability account will be reflected
in other comprehensive income, since the revaluation adjustment was reported to
the other comprehensive income account.
