Deferred Income Tax in the USA - Research Paper Example

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Deferred Income Tax (In The US)

A majority of the economic actions that take place within the organization are affected by taxes. For the purpose of obtaining an equal and just evaluation of the investments within the organization, it is important that the firm considers and evaluates the affect that taxes has on their organization. A number of researchers and practitioners that are involved in the field of finance and accounting deal with taxes and the various types of tax pay rates on a day to day basis. This is the reason that one may find a lot of literature that deals with all types of taxes and the calculation of these taxes.

A deferred income tax is referred to as a legal responsibility that is noted down on a balance sheet that is a resultant of the income that has already been earned and has been identified for the purpose of accounting and not for the purpose of tax. A temporary difference that results due to the difference between the tax laws and the methods of accounting in the payable amount of income tax of the company, the difference that is recorded is called the deferred income tax (Weil, Schipper, & Francis, 2014).

If we take of this in other words, it can be said that the income has been identified by the organization, and yet the tax that is related to that income has not been identified. For example, if we assume that the total amount of tax that an organization has to pay is $50,000, but because of the laws of the taxes the amount that has to actually be payed for that year is $100,000. This additional amount of $50,000 is called as the deferred income tax liability that the organization will have to pay in the days to come.

Deferred income tax liability and tax payable are two concepts in financial accounting both of which appear as liabilities on the balance sheet of any organization and both are a portrayal of the taxes that has to be paid by the organization in the upcoming future. However, the difference between them is that they occur in different manner. Tax payable points towards the taxes that the company is liable to pay but hasn’t payed yet because of the fact that the time to pay the tax has arrived yet. On the contrary, the deferred income tax liability is the amount of tax that the organization is liable to pay and should have payed by then but hasn’t payed because of the difference that exists between the rules of accounting and the laws of tax (Whittington & Delaney, 2013).

The tax payable is the representation of all types of taxes that have been implemented on the organization and is applicable since the last time the organization payed its taxes. The total amount of tax that has to be payed by the organization can include all types of taxes such as income tax, sales tax, property tax, payroll tax that has to be paid. Assume that the amount of ensued tax of the organization is $1,000, this means that the tax payable liability is $1,000. When the date of paying the taxes arrives then the cash balance is reduced to $1,000. Now talking about the deferred income tax liability; we assume that based on the financial standards, the firm has to pay a tax of $13,000 for that particular year. However, because of the depreciation of the tax returns, the tax bill of the business came out to be $12,500 and this is the amount that is payable to the government. This is the amount that is recorded in the financial accounting book of the organization and the difference of $500 is what is termed as the deferred income tax liability. The deferred income tax liability is what helps the organization maintain a balance in the balance sheet. Once side of the balance sheet shows the decline of the asset by $12,500 and on the contrary the liabilities show an increment of $500 and a decrement of the equity by $13,000. Hence the total net decrement was of $12,500 (Merritt, n.d.).

The process of deferred income tax consists of four steps. The first step of the entire process consists of accounting basis and tax basis, second step is called deferred income taxes proof, then the application of the appropriate tax rate and lastly, valuation allowance. In the first step of the process of deferred income tax we see that it talks about two things i.e., accounting and tax. Based on this we say that the accounting values comprise of the financial statements and the trial balance whereas on the other hand, the tax values comprise of the tax returns and other financial calculations of an organization.

The next step in the process is the deferred income taxes proof according to which the organization has to reconcile any sort of amendments that may exist from the difference of the previous year to the temporary difference in the form of a schedule in 3 columns. An example of the columns approach is as follows

The third step which is known as the application of the appropriate tax rates consists of application of those rates that are assumed to be applicable in the case when the reverse of difference takes place. For this purpose consider the following circumstances such as change in the tax rates, definitely enacted vs. the enacted and that this is subjected to the tax in a number of provinces. The last and final step of this process is the valuation allowance. For this purpose the organization must take regard of whether the assets of the deferred taxes can be actualized, and also that the amount should be considered for the purpose of accounting. For this step some of the factors that should be taken into consideration includes the proof of the potential realization, the planning strategies of taxes and situations wherein the organization’ head have to think that whether the situation is probable or more likely not (Speake & Basso, 2011).

Financial statements of any organization are the representation of the all the financial activities that are carried out within the business, it might also outline the finance of an individual. These are also a representation of the entire information of finance regarding the person or business in consideration in a clear and concise manner so that it may be easy for that business, individual and the reader to understand and comprehend. The financial statements usually includes any one or all of the following such as the statements of income, balance sheets, cash flows and the statements concerning the earnings that are retained and many other possible statements. The financial statements also help in quantifying the strength, liquidity and performance of the organization with regards to the finance of the organization (Fridson & Alvarez, 2002).

The next term at hand is known as the effective tax rate is the average rate at which an organization or even an individual is charged with taxes. In the case of an individual the effective tax rate is the average rate with which the amount that they earn is charged with taxes. On the other hand, the effective tax rate for an organization is the average rate with which the pretax profits of an organization are charged with taxes. The calculation for both of these cases are different as well. In the case of an individual, the effective tax rate can be calculated by dividing the total tax expense with the taxable income. Whereas, in the case of an organization the effective tax rate can be calculated by dividing the total tax expense with the earning of an organization before the taxes are charged. The effective tax rate is the rate that any tax payer would have to pay when all the types of taxes are involved and then are divisible by the income that is taxable. There have been many issues and debates over the calculation of the average effective tax rate which reflects the lack of theoretical foundation regarding the matter (Cordes, Ebel, & Gravelle, 2005).

Those organizations and individuals that utilize the financial statements are in a continuous process of highlighting the importance of the disclosures that are informative and help in making important decisions. There are a number of disclosures of income taxes that are relevant to the financial statements such as the constituent of the income before the taxes are applied on it, this type of disclosure represents the quantity of book taxes before the income taxes. The next constituent is of income tax expense; this points towards the total amount of income tax that is payable at that current moment and the amount that has been deferred due to the differences that have taken place because of the local and international operations. Last is known as the reconciliation from the statutory to effective tax rate; this type of effective tax rate evens out the income tax expense that is divisible by the book income prior to the income taxes (Stickney & Stickney, 2010).

These income tax disclosures are an important tool for dealing with the stake holders and the shareholders of an organization. Disclosures are not only there to report the financial matters of an organization or an individual, rather these are one of the ways by which an organization can explain their stories to others. The requirement for disclosures varies depending upon the type of entity but each of these disclosures is of equal importance (Wiseman, 2013).

The importance of an organization effective tax rate can be explained by taking an example of an organization whose effective tax rate has departed to a great extent from 35% to 40% range. In this case, special attention should be given so that it could be made that these rates are reverted back to the original percentage in the upcoming future, hence possessing a great impact on the earning of the organization. It is therefore important to monitor the effective tax rate of any organization because this effective tax rate is a true image of any organization’s tax liability as compared to the marginal tax rate (Mulford & Comiskey, 2002).

In conclusion, it could be said that the finance and accounting of any organization is incomplete without the analysis of its taxes and other relevant aspects. The deferred income taxes is a term that is about the taxes that an organization has to pay but is not yet due for payment. The other two concepts that are involved in the financial matters of the organization are known as tax payable and deferred income tax liability, both of which are almost the same with minor differences. Tax payable is the amount of that the company has to pay according to the legislation and is implemented since the last time the organization paid its taxes whereas on the other hand, the deferred tax liability is the difference that exists between the reduction in cash and the actual amount of tax that an organization has to pay. This deferred income tax liability allows the firm to maintain a balance on its financial sheets. The process of the deferred income consists of four steps; these steps start with the accounting basis and the tax basis, next comes the evidence of the deferred income tax, third is the application of a tax rate that is appropriate and lastly, the allowance of valuation. Financial statement is a representation of the financial matters relevant to an organization or individual. The effective tax rate is defined as the average rate with which an organization or individual is taxed; the effective tax rate is dependent upon the income that an individual earns or on the profits of an organization. The calculation of the effective tax rate varies depending upon whether the tax is being payed by an individual or organization. The effective tax rate of an organization is an important aspect since they are a true reflection of the earnings of an organization. The financial disclosures are relevant to the financial statements of an organization and play an equally important role.