Income Tax Expense, provision and payable previous, liability, following, provision, understand

Bad5shah

Guys,

Can you help me understand the following (and also make sure my understanding of this is correct)

Income tax expense - Goes on income statement and need not be an expense from the current period. It can have adjustments for previous DTL and DTA. Therefore,

Income Tax expense = Taxes Payable + delta in DTL - delta in DTA.

Taxes payable - Balance sheet liability that has been accrued to date. Not necessarily taxes owed due to current tax period.

1) What is Income tax provision?

2) To calculate the effective tax rate from income statement why do we do Income Tax expense/EBIT.

I am confused because income tax expense includes accrued taxes payable. So doesn't calculating effective tax rate this way distort the rate by including effects of accrued taxes. (e.g. If I earn 100 and pay 34 as taxes this year my tax rate is 34%, however, let's say if I had 34 tax payable from prior years and earned 100 this year and paid 64, using the equation above my IT expense is 68 and my tax rate is 68%. Should it still be 34%, because the other 34 is tax payable from previous year...lost in the world of income taxes.)

3) Also, how would you explain a layman the difference between effective tax rate and statutory tax rate? (Please not the book definition of statutory rate: rate charged by local government of domicile)

Thanks!

btcapital

I suck at accounting but since no one else replied I can try to help you out.

1. When a company prepares the balance sheet, in most cases the income tax expense is not paid out. So the company makes a provision for this. That is income tax provision. In simple terms

Income tax expense=Income tax provision

2. By accrued income taxes payable it is referring to the Income Taxes accrued during the current year. Not last years tax.

3. Statutory rate is the tax rate the government would normally want to impose on a company. Let me make an example.

EBIT=$100 (includes profit of $40 from a particular product X)
Statutory Tax=50%

Now the government decides to exempt all profits from product X from taxes. So you would pay only ($100-$40)=$60*0.5=$30 in taxes. This exemption is permanent and you would never have to pay it back. So, not DTA/DTL is created.

Effective Tax=Tax Expense/EBT=$30/$100=%30

A permanent difference is causing a difference in the statutory tax rate and the effective tax rate. Note that, if this was not a permanent difference then a DTL would have been created and the Effective Tax Rate would have equalled the statutory tax rate.

koba

Thanks Khasif. This helps!

suyash1989

you are welcome