Chapter 5.1® - Accounting for Corporate Income Taxes & Intra-period Tax Allocations

• Part 5.1 - Accounting for Corporate Income Taxes & Intra-period Tax Allocations
• Part 5.2 - Income Tax Provision or Expense? Differences between Taxable & Accounting Income (Permanent & Temporary Differences)
• Part 5.3 - Conceptual Issues in Interperiod Tax Allocation - Comprehensive & Partial Tax Allocation Methods (theory only)
• Part 5.4 - Future Tax Calculations using the Deferral or Liability (Accrual) Methods, Basic Illustration of Interperiod tax Allocation
• Part 5.5 - Changes in Income Tax Rate, Recording Future Tax Liability
• Part 5.6 - Difference between Carrying Value and Tax Basis
• Part 5.7 - Reconciliation of Effective Tax Rates & Differential Reporting & Accounting Treatment of the Investment Tax Credit

Now, we will see as how to measure income tax expense as the total amount of income tax that is assessed for the reporting year. But we might have three complications. One complication might arise from the fact that the income tax payable by a corporation is determined as a single amount, but the revenues, expenses, gains and losses that give rise to taxable income are reported in different sections of the income statement. Therefore, one task of financial reporting for income taxes is to disaggregate the single income tax amount and report it in the appropriate sections of the financial statements. This disaggregation is called intraperiod income tax allocation.

The second complication arises when in a result of an accounting practice known as interperiod income tax allocation. In this allocation, the income tax expense recognized for accounting purposes in that same period, regardless of what year these items are included in tax calculations. By doing this, a company’s income tax expense usually differs from the amount of taxes actually payable to the government. The difference between income tax expense and income tax payable results ina widely misunderstood account known as future income tax liability.

The third complication arises when a corporation has an operating loss for tax purposes. A tax loss entitles the corporation to reduce its tax obligation for past and future years.

Now, we will discuss in little depth as how those three complications affect on the financial statements.

Intraperiod Tax Allocation:

At the time when a corporation determines its total tax bill for the year, the total income tax expense must be reported in the financial statements in accordance with the nature of the income, gains and losses. This is called ‘intraperiod tax allocation’. The total income tax expense must be allocated to the following:

Income statement

• Continuing operation
• Discontinues operation
• Extraordinary gains and losses

Statement of changes in retained earnings

• Capital transactions
• Restatements of prior periods

Illustration Example

Assume the following:

The tax expense will be $320,000, determined as follows:

Here is the journal entry to record this tax expense:

While preparing the income statement, the $320,000 income tax expense is allocated to operating income and extraordinary loss. The loss reduced the taxes payable by $200,000 X 40% = $80,000. Therefore, this amount is deducted from the extraordinary item. The income tax expense is shown as the amount that is payable on the operating income: $1,000,000 X 40% = $400,000. The lower portion of the income statement would appear as follows: