Study Guide: CFA Level 1

Liabilities - Income Tax Terminology

Taxable vs. Financial Income
Taxable Income versus Financial Income:
  1. Taxable income is calculated in accordance with prescribed tax regulations and rules.
  2. Financial income is measured and reported in accordance with generally accepted accounting principles.
Differences between taxable income and financial income occur because tax regulations and GAAP are frequently different. This will create a temporary difference between the tax basis of an asset or liability and its reported amount in the financial statements. This difference will result in taxable amounts or deductible amounts in future years when the asset is recovered or the liability is settled. This is known as "deferred income taxes".

Tax Terminology Basics
  • Taxable income is the amount of income subject to income taxes over the company's reporting period.
  • Tax payable refers to the tax liability recorded on the balance sheet as a result of taxable income. Tax payable is the amount of taxes that has not been paid but will be in the near term.
  • Income tax paid is the actual taxes paid out of cash. This includes what was paid for this period and other periods during this accounting period.
  • Tax-loss carry-forward occurs when a company has created a net loss within an accounting period that it cannot use to lower previous income taxes paid but can be used in the future to offset future taxable income.
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Terminology Found on the Income Statement
  • Tax payable includes total taxes to be paid within the accounting period. Said differently, it is equal to the amount of income taxes paid or payable for the period.
  • Deferred tax expenses represent the increase in the deferred tax-liability balance from the beginning to the end of the accounting period (noncash expense).
  • Income tax expense includes tax payable and deferred income tax expenses. It is composed of cash and noncash items. Thus it is not the actual tax paid to the government within the accounting period.
Terminology Found on the Balance Sheet
  • Deferred tax asset represents the increase in taxes refundable (saved) in future years as a result of deductible temporary differences at the end of the current year.
  • Deferred tax liability represents the increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year.
Other terminology:
  • Valuation allowance represents that portion of the deferred tax asset that is more likely not to be realized.
Types of Differences
  • Temporary difference is the difference between the book basis and tax basis of an asset or liability that is expected to reverse over time.
  • Permanent difference is the difference between the book basis and tax basis of an asset or liability that is not expected to reverse over time.
Look Out!

Note: Temporary differences create deferred taxes, while permanent differences cause a firm's effective income tax rate (book income tax expense / pre-tax book income) to differ from the statutory tax rate.
Next: Tax Deferred Liabilities »
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