Income Tax Issues - Assignment Example

Income Tax Analysis Name Course Name and Code Date Income Tax Analysis Corporations are required to adhere to different regulations and rules. Corporations operate in a controlled business environment because different stakeholders are involved. For example, taxation is important since it supports governmental requirements and expenses. Internal Revenue Service (IRS) is responsible for collecting taxes in America. IRS also provides the guidelines on income tax requirements. Therefore, IRS has to incorporate Income Tax Expense and Taxes that are Payable based on numerous guidelines including GAAP and IRS. The frequently indicated tax on the financial statements is different from what the organizations are expected to pay. An organization has to understand the different fundamentals and approaches in calculating income taxes. Among the numerous fundamentals, the common ones are effective income tax, deferred tax, deferred tax liability, deferred income tax, income tax expense and income tax payable. Income tax payable factors into consideration the current liabilities of a corporation’s balance sheet that includes taxes, which a corporation has to pay the government within a given period of time. However, organizations recognize income tax expenses are indicated in the balance sheets and other documentations that are related to taxable profit. The tax paid should be understood because of temporary difference that exists when it comes to the basis of asset and or liability. Therefore, the financial records indicated in the financial statement may either be deductible or taxable. Deferred tax liability represents the future taxable amounts and it increases the taxes that would be paid in future. Conversely, deferred tax assets represent the refundable tax expected in future because of the deductible temporary difference that is presented in the financial reporting at the end of the current year. In addition, organizations and taxing institutions should understand the significance of deferred income tax. The deferred income tax is a liability because it reflects the already earned income but the tax has not been paid for the earned income within a given taxation period. Therefore, within a given financial period, numerous processes are integrated in ensuring the right taxes are documented for future references. The income tax analysis affects the companies differently based on the nature of business and geographical location of the company. To understand the income tax analysis, Harold Corporation is used as an example in which the discussed taxation methods are applied. The discussion is premised on the amount of taxation paid to the government and the nature of the entire income tax requirements. Scenario of Harold’s Corporation Harold Corporation financial information for 2014 indicated a pretax income of $540,000.The following transactions indicates the reasons contributing to the existence of difference between the taxable income and the pretax financial income: The tax return depreciation is higher compared with the income statement depreciation by $95,000 The amount of income that was collected as rent is higher by $121,000 compared with income indicated in the statements Permanent differences in terms of fines is indicated on the income statement as an expense of $33,000 The estimated tax rate for Harold Corporation is 36% for the previous years and the corporation plans to use the same estimation in future financial calculations. Based on the available information of 2014, deferred taxes are not indicated. The following are some of the calculations to be done based on the provided financial data: a. Calculation of taxable income and income taxes b. Preparation of appropriate documentation to record income payable, deferred income taxes and income tax expense for 2014 c. Starting with “Income before income taxes”, income statement is prepared for the 2014 period through updating the income tax expense section d. Calculating the income tax rate for 2014 Solution Question A: Calculation of Taxable Income (TI) The following are the calculations for the taxable income for the year 2014: Pretax Financial Income for 2014 = $ 540,000 Excess of Depreciation Tax Return = $ (95,000) Unearned Rent collected over the rent that is earned = $ 121,000 Permanent Difference = $ 33,000 Taxable Income = $ 599,000 Calculation of Income Tax Payable (ITP) The following section indicates the calculation of income tax payable for the period 2014: Taxable Income = $ 599,000 Tax Rate = 36% Income Tax Payable = $ 215,640 Based on the indicated calculations, the taxable income is $599,000 while the income tax payable is $215,640. Question B: Recording Income Tax Expense (ITE) The following table presents a summary of income tax expenses of Harold Corporation for 2014: Temporary Difference Future Taxable Deductible Amount Tax Rate Deferred Tax Assets Liabilities Depreciation $ 95,000 36% $ 34,200 Unearned Rent $ (121,000) 36% $ (43,560) Total $ (26,000) $ (43,560) $ 34,200 Calculation of Deferred Income Tax (DIT) The following section provides calculation for deferred tax for assets and liabilities for the periods beginning and ends of 2014: Deferred Tax Liability at the End of Y2014 = $ 34,200 Deferred Tax Liability at the Beginning of Y2014 = $ 0 Deferred Tax Expense for Y2014 = $ 34,200 Deferred Tax Assets at the End of Y2014 = $ (43,560) Deferred Tax Assets at the Beginning of Y2014 = $ 0 Deferred Tax Benefit for Y2014 = $ (43,560) Deferred Tax Benefit for Y2014 = $ (43,560) Deferred Tax Expense for Y2014 = $ 34,200 Net Deferred Tax Benefit for Y2014 = $ (9,360) Calculation of Income Tax Payable (ITP) The following section presents the calculation of income tax payable Net Deferred Tax Benefit for Y2014 = $ (9,360) Current Tax Expense for 2014 = $215,640 Income Tax Expense for Y2014 = $ 206,280 The following section indicates the Journal Entry and the requirement in which the credit section should balance with the debit section: Income Tax Expense = $ 206,280 Deferred Tax Assets = $ 43,560 Deferred Tax Liabilities = $ 34,200 Income Tax Payables = $ 215,640 Based on the Journal Entry calculations, the balancing amounts for Harold Corporation is $249,840. Question C: Prepare Income Tax Expense (ITP) The section presents the calculation of income tax expenses during both periods and circumstances associated with the transactions: Income before Income Taxes = $ 540,000 Income Tax Expense: Current = $ 215,640 Deferred = $ (9,360) $ (206,280) Net Income = $ 333,720 Question D: Calculation of Effective Tax Rate (ETR) The following section calculates the effective tax rate. The effective tax rate is obtained through dividing the total income tax expense against the pretax financial income. The formula is Total income tax expense/Pretax financial income: ($333,720 / $540,000)*100 = 61.8%. From the calculations, it is evident that Harold Corporation is paying more. For example, the government expectation is 36% but Harold Corporation is paying 61.8%. IFRS vs. US GAAP The world accounting and financial requirements are changing because of the dynamics associated with the corporations and the requirements of different stakeholders. The commonly used method is the International Financial Reporting Standards (IFRS) in providing information relating to public corporations. The IFRS has a high impact on the financial world and influences the US corporations on the manner of completion of financial requirements and expectations. The IFRS incorporates variables such as acquisition, merger, cross border transactions and even the requirements of US Generally Accepted Accounting Principles (GAAP). For an international investor or individual aiming to do business internationally in nature, it is imperative for the investor to understand the contents and requirements of IFRS. Nevertheless, the investor and other stakeholders should understand there is a difference between the IFRS and the GAAP. The notable difference is the application of GAAP to US corporations while IFRS is embraced by numerous countries across the world. In addition, another unique difference is that IFRS is a “Principles Based” while the GAAP is a “Rules Based.” The following table elaborates on the differences between the two accounting and financial standards: GAAP vs. IFRS Terms GAAP IFRS Elements of performance Incorporates numerous accounting components such as losses, gains, liabilities, assets, expenses and revenue (Barth et al., 2012) Considers either expenses or revenue and liabilities or assets. Therefore, the accounting system is direct Financial statements documentation requirements Numerous documentations are required, which include footnotes, cash flow statement, statement of comprehensive income, changes in equity, balance sheet and income statement Require minimal documentation and the required documents are changes in equity, balance sheet and income statement Reversal of inventory GAAP prohibits such transactions (Hail, Leuz & Wysocki, 2010) Qualifications exist to determine reversal Asset’s Definition Definition of assets It defines an asset as an future economic benefit It identifies asset as a future viable economic benefit Assets are resources that a corporation will employ in bringing future economic benefit to the corporation Tax basis identification The tax amount required is specific and indisputable (Henry, Lin & Yang, 2009) Numerous financial requirements are required before determining the amount to be taxed and the amount of tax Recognition of deferred tax assets The amount is recognized in full and then reduced based on valuation requirements and other variables associated with deferred tax asset. Therefore, a portion of the amount may not be realized The deferred tax asset is accounted for up to the amount, which is provable to be realized (Lin, Riccardi & Wang, 2012) Deferred tax classification It depends on the liabilities and assets classification in which the transactions are related with It is non current Reference Barth, M. E., Landsman, W. R., Lang, M., & Williams, C. (2012). Are IFRS-based and US GAAP-based accounting amounts comparable? Journal of Accounting and Economics, 54(1), 68-93. Hail, L., Leuz, C., & Wysocki, P. (2010). Global accounting convergence and the potential adoption of IFRS by the US (Part I): Conceptual underpinnings and economic analysis. Accounting Horizons, 24(3), 355-394. Henry, E., Lin, S., & Yang, Y. W. (2009). The European-US “GAAP Gap”: IFRS to US GAAP Form 20-F Reconciliations. Accounting Horizons, 23(2), 121-150. Lin, S., Riccardi, W., & Wang, C. (2012). Does accounting quality change following a switch from US GAAP to IFRS? Evidence from Germany. Journal of Accounting and Public Policy, 31(6), 641-657. INCOME TAX ANALYSIS 9 Read More