Question

In its first year of operations, your company's income tax expense was $40,000, and your year-end income taxes payable came to $40,000. Explain what happened here.

Answer 1

• Issue mentioned:

Income Tax expense = $ 40,000

Income Tax Payable at the end of year = $ 40,000

• At the end of year, the companies calculate their Net Income (before Income taxes) when they prepare Income Statement. Now, income tax expense is to be calculated at the prevailing income tax rate. On the basis of that tax rate, income tax expense is calculated and shown in Income Statement. A partial Income Statement as an example is provided for understanding:

Net Income before Income Tax expense	$                      100,000.00
Income Tax Expense (say 40%)	$                         40,000.00
Net Income	$                         60,000.00

• Now the entry to record such Income tax expense will be:

A debit to Income Tax expense, and
a credit to Income tax Payable OR a credit to Cash (if taxes paid in cash, which is highly unlikely as income taxes are paid next year once they are determined).

• Hence, in the given question, what really happed is that:

>The company has to record expense to the period it belongs whether the cash has been paid or not (following the accrual concept). Income tax expense is ‘an expense’ related to the period in which such ‘income’ is earned.

>The company calculated its Income Tax expense on its Net Income before income taxes, which came to be $ 40,000

>Company didn’t pay that tax in cash that time and recorded the amount as ‘due’ Income Tax Payable, which will be paid in later coming period.

This is why the company’s income tax expense is $ 40,000, and Income Tax payable is also $ 40,000.

• Income Tax expense is an ‘expense’ and is taken to Income Statement, while Income Tax Payable is a ‘current liability’ to be reported under ‘Liabilities’ section of Balance Sheet. When the income taxes are paid, the liability gets decreased.