Catherine Duffy: Okay, welcome back, so here are we to get started with step one of the
calculation for the current income tax expense. When we're doing tax accounting, we're essentially
looking for two different numbers. We're looking for the current tax expense for the year and
we're looking for the deferred tax expense for the year and both of those could be a
benefit, so if it ends up being a debit, it's going to be expense. If it's a credit, it's
a benefit through the income statement, so we're going to start with the first calculation,
being the calculation of the current tax. You could do the deferred tax first, but I'm
going to do the current tax expense calculation first.
I like to call this one usually step one. Okay, so step one is calculation of current
income tax expense. To calculate the current expense, so this is the tax that you actually
have to pay this year. We always start with our accounting income and adjust it, just
like we would on a tax return. Adjust it to the taxable income figure, which is the figure
that you're taxed, that you have to pay is based on. We'll start with that accounting
income for 2016 and that was 80,000, so that's our starting point. Then we're going to adjust
this just like you would on a tax return, you're going to adjust this for things that
are different between the accounting income and what the taxes are based on. There are
lots of things that are different in the tax act between accounting and tax and given the
facts that I gave you originally related to this situation, we've got a few different
things and we usually classify those in this rough calculation here, splitting it between
the permanent and the differences that are not permanent, or time indifferences.
Let's start with the permanent differences. In the facts that I gave you, there were three
things that happen to be permanent differences, they will never be taxed the same way they
are recorded for accounting. One of them is the dividend income, so we have dividend income
that we received from Canadian corporations of 8,000 dollars, so that's included in that
accounting income figure. We don't have to pay tax on that. The tax laws say we don't
have to pay tax on that. I could get into a long explanation of why we don't have to,
but just the fact is the tax law says we don't have to pay tax on that 8,000 dollars because
it's already been taxed in the corporation that paid the dividend.
We subtract that from the accounting income to lower how much we're going to have to pay
tax for this year because we don't have to pay tax on the 8,000 anymore. Another item
that is considered a permanent difference is fines that we expensed, so we paid some
pines and we expensed them in this 80,000 dollars this year, they were for 3,000 dollars
and the tax law says that you are not allowed to expense for taxes anyways. You can't deduct
those 3,000 dollars worth of fines. You're allowed to as legitimate business expense
because you did pay it, you're allowed to expense it for business, so it's okay that's
it's subtracted in the accounting income, but it's not okay for calculating your taxes
owning, so you add it back.
The other one in the example that I gave you was meals and entertainment expense, so M
and E for short. The tax law currently says that 50% of your meals and entertainment expense
are not allowed to be deducted for tax purposes. We had meals and entertainment expense of
7,000 dollars I believe, so 3,500 dollars is not allowed to be expensed for tax, so
we'll add that back into that accounting income. Those are our three permanent differences.
Now there are other differences though that are different between accounting and tax,
but only in this particular year, so it's saying that it's something that's in this
accounting income or not in this accounting income, but should be in the taxes figure
for calculating the taxes that are owing, so a couple of examples of those and we'll
call those timing differences or temporary differences.
One of those is related to depreciation. There is depreciation that has been expensed of
80,000 dollars in there. That is not a legitimate expense for tax purposes, however, for tax
purposes you're allowed to take capital cost allowance, or CCA. The CCA for this year for
2016 works out to 3,000 dollars and that can be subtracted for tax purposes, so let's just
take a look at these numbers here, so this particular one was from the accounting net
book value where we depreciated 2,000 dollars per year. Whereas this was related to the
undepreciated capital cost allowance that ended the year last year, 2,500 dollars and
I think it had a tax class rate of 12%, so 2,500 dollars times 12% that was the amount
that was allowed deducted for tax purposes. Those two things will not be the same this
year, but eventually that whole asset that was purchased, the whole property, plant,
and equipment asset, eventually for accounting it will all have been expensed down to a net
book value of zero and eventually for tax, in theory anyways. It will eventually all
get deducted as CCA over many years to the point where it gets down to a class value
of zero.
Eventually they both do get fully expensed, both for accounting and for tax, but in any
given year, there can be differences. In this year, you can see that there is a difference
of a 1,000 dollars, where you can have more deduction for tax than you can for accounting
of an additional 1,000 dollars. Another timing difference was the warranty. This year we
actually spent 8,500 dollars repairing some products that we had sold in prior years and
we had accrued as a warranty liability. The entry when we did this, when we paid for these
repairs to these products would have been a debit to the warranty liability and a credit
to cash or accounts payable or whatever inventory that we had, so 8,500 dollars. You can see
neither, this entry didn't do anything to our income statement, so it had no effect
on our accounting net income. The entire warranty had been expensed in the prior years, but
this year when we actually spent some money, we just drew down the liability.
Well for tax purposes, you're only allowed to deduct this when you actually pay the warranty
and I almost had a little mistake here, can't forget the brackets. You are allowed to subtract
this or deduct the warranty when you actually pay it, so this is the actual amount spent,
so this can be deducted for tax purposes this year. Okay, so that's warranty.
Another item we had was our restructuring liability. This accrual that we made of 10,000
dollars, so that restructuring liability, why are we adding it back? We're adding it
back because when we recorded this liability, we would have expensed it, so debit the expense,
credit the liability. That expense is therefore in that net income calculation, but the tax
laws say that you can't expense for tax purposes a liability that's just an accrual and hasn't
actually been incurred. We're going to add it back this year and then in the future years,
next year or whenever we do get around to restructuring the plant, then we'll deduct
what we actually spent, so it's very similar to this warranty situation, so we'll add back
this expense. We've expensed for accounting for now, but in future years we're going to
deduct it.
Then the last one that we had that was a timing difference was related to the rental income
that we had accrued, so we had accrued 6,000 dollars worth of rental income. The journal
entry when we accrued the rental income was a debit to some type of receivable, so it
could be rent receivable or something, I'll just say accounts receivable, for simplicity.
The entry we recorded in 2016 was a debit to the accounts receivable and a credit to
rental income, 6,000 dollars, so this rental income value is included in this net income
of 80,000 dollars, but we haven't yet received the money for it. The tax laws says that we
don't have to pay tax on this 6,000 dollars until we actually get the money from our customer,
even though for accounting we needed to accrue it, we don't have to pay the tax on it.
We're going to subtract it this year and then next year when we do collect this accounts
receivable, then we're going to have to add it back to include it in our income for tax
purposes. These are all the total permanent and timing differences, when you do this calculation,
technically you don't need to split it up between the permanent and the timing differences.
The two categories there, this is just rough work. The reason it's a good idea to split
things between permanent and timing differences because we're going to use these timing differences,
these are going to help give us a clue when we get onto the next stage, step two where
we do the deferred tax accounting calculation, these are going to give us a clue of the kinds
of things that we've got floating around that will affect our deferred taxes, so after you've
identified all of your permanent differences and timing differences, anything that is different
between accounting income and taxable income for this year, you're going to add them all
up. You get your taxable income for this fiscal year, and that taxable income will likely
be, and hopefully will be the same taxable income you get when you do get around to doing
your tax return.
Usually you're doing the accounting for taxes well before you get around to actually doing
the formal tax return, but our expectations are that this is what going to be what your
taxes payable for this year is based on, going to be based on this taxable income figure
of 73,000 dollars and you multiply that by the current year's tax rate, so whatever the
legislation says you have to pay tax on this year and we'll just make an assumption of
a simple 20% rate times a 73,000 dollars taxable income, this is your current tax expense.
It's not the whole tax expense for accounting purposes, it's just the current portion, so
you'll debit that tax expense of 14,600 and you'll credit a current income tax payable
liability that you have to pay to the government.
Okay, so that was the competition of the current tax calculation for 2016, we'll have another
video a little bit later that will summarize all of the journal entries for tax accounting,
but for now we're finished this calculation and whenever you're ready you can move on
to the step two calculations of deferred taxes.