Question

There are six steps in calculating the current and deferred income tax expense or benefit components of a company’s income tax provision. Identify one of the six steps and describe the step in detail, explaining the issues that should be considered in that step and how it is computed.

Answer 1

Solution :

The following are six steps in calculating the current and deferred income tax expense or benefit components of a company’s income tax provision.

1. Adjust Pre tax net income for all permanent differences
2. Identify all temporary differences and tax carryforward amounts
3. Calculate current income tax expense/benefit
4. Determine balances in DTA/DTL accounts
5. Evaluate need for valuation allowance for gross DTA
6. Calculate deferred income tax/benefit

*Deferred income tax/Benefit:

A deferred income tax is a liability recorded on a Balance sheets resulting from a difference in income recognition between tax laws and the company's accounting methods. For this reason, the company's payable income tax may not equate to the total tax expense reported

The income tax expense or benefit includes not only current income taxes, but also a deferred income tax component. This deferred portion is calculated by analyzing the change in the company's total net deferred income tax asset or liability from the beginning to the end of the reporting period. Similar to the calculation of current income tax, the calculation of deferred taxes should be done on a tax jurisdiction-by-tax jurisdiction basis.

Certain accounting practices and tax laws often result in a portion of a company’s income being realized and accounted for in one accounting period, but not taxable until another. For this reason, the income tax burden associated with this not-yet-taxed sum is reported as a tax liability until paid in the following accounting period.

Example:

Suppose company ABC earns $1 million in a given quarter, $850,000 of which is taxable in the current quarter. Due to the manner by which ABC accounts for income against tax codes, it is not required to pay tax on the remaining $150,000 until the following quarter. As a result, the $150,000 is still reflected on the income statement as part of the $1 million in realized income for the current quarter and the amount of tax on the $150,000 is reflected as a liability on the balance sheet.