Changes in the Income Tax Rate

Introduction

Changes in the income tax rate can influence the measurement of income tax expense, and the deferred tax asset and liability carrying amounts in the year of change.

When the income tax rate changes, deferred tax assets and liabilities are adjusted to the new tax rate. An increase in the income tax rate will cause deferred tax assets and liabilities to also increase. Similarly, if the income tax rate decreases, deferred tax assets and liabilities will also decrease. A decrease in deferred tax assets will reduce the extent to which they can offset future tax payments, while a decrease in deferred tax liabilities reduces future tax payments to the tax authorities.

Calculating the effect of income tax rate changes

Consider the following information presented for a company.

Computer equipment value for accounting purposes (carrying amount): 11,000  USD

Computer equipment value for tax purposes (tax base): 9,500 USD

Difference: 1,500 USD

If the income tax rate is 30%, the deferred tax liability in 2016 is calculated as: (11,000 – 9,500) * 30% = $450.

If the tax authorities change the income tax rate to 35%, then the deferred tax liability is: (11,000 – 9,500) * 35% = $525. Despite the similar temporary difference ($1,500), the change in the income tax rate has resulted in a change to the deferred tax liability.

The provision for income tax expense will also be affected by the change in the income tax rate as taxable income for the year will be taxed at a rate of 35%, instead of the previous 30%. The increase in income tax expense which is attributable to the change in tax rate is therefore:

(35% – 30%) * $1,500 = $75.

Example

At the beginning of this year, XYZ Company reported a carrying amount for its machinery of $18,000 and a tax base of $16,000. During the year, the company made a profit and reported payable taxes of $750. At the end of the year, the company reported a carrying value for the same asset of $16,500 and a tax base of $15,000.What should be the company’s tax expense?

First, we calculate the deferred tax liability at the beginning of the year.

DTL = $18,000 – $16,000 = $2,000

Then, at the end of the year the liability became $16,500 – $15,000 = $1,500

To get the income tax expense we aggregate the change in the income tax liability and the taxes payable. A liability decrease would make the tax expense decrease and an increase in taxes payable would increase tax expense.

Thus, income tax expense for the period = $750 – ($2,000 – $1,500) = $250

Question 1

Which of the following statements is most accurate?

A. If the income tax rate decreases, income tax expense will increase

B. If the income tax rate increases, income tax expense and deferred taxes will also increase

C. If the income tax rate decreases, it is uncertain what the impact will be on income tax expense, income tax payable, and deferred taxes (assets and liabilities)

Solution

The correct answer is B.

Choice A is incorrect because when the income tax rate decreases, income tax expense will also decrease. Choice C is incorrect because income tax rate decreases will usually lead to decreases in income tax expense, deferred taxes etc.

Question 2

At the end of the year 2016, Galambo Inc. reported a tax loss of $15,000. If you knew that Galambo had tax assets of $100,000 at the beginning of the year 2017 which went down to only $70,000 at the end of the year 2017, Galambo reported a tax expense for the year 2017 amounting to:

A. $0

B. $15,000

C. $30,000

Solution

The correct answer is B.

Tax expense = Taxes payable (recoverable) + Decrease of tax assets OR – Increase of tax assets = ($15,000) + $30,000 = $15,000

Reading 29 LOS 29d:

calculate income tax expense, income taxes payable, deferred tax assets, and deferred tax liabilities, and calculate and interpret the adjustment to the financial statements related to a change in the income tax rate

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