Chapter 5.2® - Income Tax Provision or Expense? Differences between Taxable & Accounting Income (Permanent & Temporary Differences)

• 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

Provision or Expense?

It has been noted in common that companies show the income tax expense in the income statement as “provision for income taxes”.

The reason that companies use provision for the income tax expense is that when the company has loss for tax purposes, the income statement entry for income taxes may be a credit rather than debit.

Interperiod tax allocation:

This deals with allocating tax expense to an appropriate year, irrespective of when it is actually paid. A company might adopt those accounting policies that management perceives will best satisfy the objectives of the financial statement users and preparers. The only objective is to measure income.

Difference between Taxable and Accounting Income:

The both accounting net income and taxable income are the net result of matching the revenues and expenses of a period. Most items of revenue and expense are recognized in the same period for both accounting and tax purposes. But there are some differences and those are as follows:

• Permanent Differences
• Temporary Differences

Permanent Differences:

This kind of difference arises when an income statement element – a revenue, gain, expense, or loss – enters the computation of either taxable income or pre-tax accounting income but never enters into the computation of the other.

Example:

Dividend income received from another tax paying Canadian corporation is included in pre-tax accounting income but is not subject to tax.

When dividends are reported as income for accounting purposes, they are permanent difference because they are not subject to taxation.

Temporary Differences:

The temporary differences arise when the tax basis of an asset or liability differs from its accounting carrying value. Temporary differences lead to timing differences, wherein an item of revenue or expense (or gain or loss) will be recognized both in the income statement and on the tax return, but in different periods. The timing difference originates in the period in which it first enters the computation of either taxable income or accounting income, and reverses in the subsequent period when that item enters into the computation of the other measure. An item can either:

• be included in accounting income first, and then included in taxable income in a subsequent period, or
• enter into the calculation of taxable income first, and then be included in accounting income in a later period.

Let's consider an example. Revenue on a long-term contract may be recognized on a percentage-of-completion basis for accounting purposes. For the income tax purposes, the recognition of revenue can be delayed until the contract is completed, provided that the contract lasts no more than two years. The revenue recognized in the first year will enter into the determination of net income, thereby giving rise to an originating temporary difference. In the following year, after the contract has been completed, the revenue and related expenses will be included in taxable income