Tax expense

At its simplest, a company's tax expense, or tax charge, as it sometimes called, is computed in by multiplying the income before tax number, as reported to shareholders, by the appropriate tax rate. In reality, the computation is typically considerably more complex due to things such as expenses considered not deductible by taxing authorities ("add backs"), the range of tax rates applicable to various levels of income, different tax rates in different jurisdictions, multiple layers of tax on income, and other issues. [cite web
url=http://papers.ssrn.com/sol3/papers.cfm?abstract_id=314563
title=SSRN-Last Chance Earnings Management: Using the Tax Expense to Achieve Earnings Targets by Dan S. Dhaliwal, Cristi Gleason, Lillian Mills
publisher=papers.ssrn.com
accessdate=2008-05-08
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Historically, in many places, a "revenue-expense" method was used, in which the income statement was seen as primary, and the balance sheet as secondary. Under International Financial Reporting Standards, as well as many other accounting principles, tax expense is the result of computing current and deferred tax payable using the "asset-liability" method in which the balance sheet is seen as primary and the income statement as secondary. The new approach in the United States was codified in "SFAS 96" published in December 1987, and updated in February 1992 with "SFAS 109", accounting for income taxes from a balance-sheet approach. See List of FASB Pronouncements.

"Current tax payable" is computed by multiplying the taxable income number, as reported to the tax authorities, by the appropriate tax rate. As with tax expense, the computation is made more complex by the range of tax rates that are applicable to various levels of income and the various deductions and adjustments that the tax authorities allow.

In the United States, the U.K. and elsewhere, companies are permitted to report one pre-tax income number called income before tax to shareholders, and another, called taxable income, to the tax authorities. The result is a gap between tax expense computed using income before tax and current tax payable computed using taxable income. This gap is known as "deferred tax". If the tax expense exceeds the current tax payable then there is a deferred tax payable; if the current tax payable exceeds the tax expense then there is a deferred tax receivable.

In the long run, income before tax and taxable income will likely be equal. If the one is less in earlier years, then it will be greater in later years. Deferred taxes will reverse themselves in the long run and in total will zero out, unless there is something like a change in tax rates in the intervening period. A deferred tax payable results from a tax break in the early years and will reverse itself in later years; a deferred tax receivable results from more taxes being paid in early years than the tax expense reported to shareholders and will again reverse itself in later years. The deferred tax amount is computed by estimating the amount and the timing of the reversal and multiplying that by the appropriate tax rates.

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