Tuesday, 22 July 2014

Tax Accounting US-RA Comparative Interpretation

Income tax requirements differ considerably from jurisdiction to jurisdiction. The application of the existing requirements to these different circumstances can be difficult, resulting in complex and potentially diverse interpretations. The Accounting Standards of the Republic of Armenia which have been adopted by the Ministry of Finance and Economy and are based on IAS (International Accounting Standards). The common approach for accounting for income tax shared by IAS 12 and SFAS 109 (US GAAP) is the temporary difference approach.  However, the standards provides for exceptions to the temporary difference approach relating to the recognition and measurement of deferred tax assets and liabilities and the allocation of tax. The international accounting standards board constantly working on to remove any exceptions to the temporary differences resulting in simpler requirements based more on principle.


In relation to international standards for presentation financial statements, when determining the object of taxation, accounting of the income and expenses shall be performed on the accrual basis. The taxpayer accounts income and expenses respectively from the moment of the acquisition of the right to receive such income or to recognize the expenses, irrespective of the actual period of deriving such income or making the payments. According to Profit Tax Law of the Republic of Armenia, when accounting income on the accrual basis, the taxpayer shall take into consideration, that the right to receive income is deemed acquired when the corresponding amount is subject to unconditional payment (compensation) to the taxpayer, or when the taxpayer has fulfilled the liabilities of the transaction or the contract, even if the moment of fulfillment of this right is deferred, or the payments are made in parts [1]. From another hand, consistent with international accounting stan-dards revenue from the sale of goods should be recognized when all the following conditions have been satisfied:
(a) the enterprise has transferred to the buyer the significant risks and rewards of ownership of the goods;
(b) the enterprise retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;
(c) the amount of revenue can be measured reliably;
(d) it is probable that the economic benefits associated with the transaction will flow to the enterprise; and
(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably [2].
According to the tax law US companies are required to file tax return and when a company prepares its tax return for a particular year, the revenues and expenses (any gains/losses) included o the return are, by and large, the same as those reported on the company’s income statement for the same year.  However, in some instances tax lows and financial accounting standards differ.  The reason why differ is that the fundamental objectives of financial reporting and those of tax authorities are not the same.  The differences in recognition for financial statements and for tax purposes are reconciled through deferred taxes.
Mentioned disparate revenue recognition approaches in tax and financial accounting fields making timing and temporary differences in tax expenses reporting. The income statement liability method focuses on timing differences, whereas the balance sheet liability method focuses on temporary differences. Timing differences are differences between taxable profit and accounting profit that originate in one period and reverse in one or more subsequent periods. Temporary differences are differences between the tax base of an asset or liability and its carrying amount in the balance sheet. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. 
RESULTS AND ANALYSIS
The objective of accounting for income tax in US companies is to recognize a deferred tax liability or deferred tax asset for the tax consequences of amounts that will become taxable or deductible in future years as a result of transaction or events that already have occurred.    The current US GAAP focuses on the balance sheet and the recognition of liabilities and assets.  Conceptually, though, the balance sheet approach strives to establish deferred tax assets and liabilities that meet the definitions of assets and liabilities provided by the Financial Accounting Standards Board’s conceptual framework. The accounting for income taxes in iGAAP is covered in IAS 12 (“Income Taxes”).  Similar to U.S. GAAP, iGAAP uses the asset and liability approach for recording deferred taxes. The differences between iGAAP and U.S. GAAP involve a few exceptions to the asset-liability approach; some minor differences in the recognition, measurement, and disclosure criteria; and differences in implementation guidance.
Accomplishment of current tax assets and liabilities recognition in Armenian companies bases on following principles. Current tax for current and prior periods should, to the extent unpaid, be recognized as a liability. If the amount already paid in respect of current and prior periods exceeds the amount due for those periods, the excess should be recognized as an asset. When a tax loss is used to recover current tax of a previous period, an enterprise recognizes the benefit as an asset in the period in which the tax loss occurs because it is probable that the benefit will flow to the enterprise and the benefit can be reliably measured. A deferred tax liability is recognizing for all taxable temporary differences. When the carrying amount of the asset exceeds its tax base, the amount of taxable economic benefits will exceed the amount that will be allowed as a deduction for tax purposes. This difference is a taxable temporary difference and the obligation to pay the resulting income taxes in future periods is a deferred tax liability. As the enterprise recovers the carrying amount of the asset, the taxable temporary difference will reverse and the enterprise will have taxable profit. This makes it probable that economic benefits will flow from the enterprise in the form of tax payments. 
    Consequently, current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period. Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences. 
Temporary differences are differences between the carrying amount of an asset or liability in the balance sheet and its tax base. Temporary differences may be either: 
taxable temporary differences, which are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled; or
deductible temporary differences, which are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled.
Tax assets and tax liabilities in Armenian enterprises   presented separately from other assets and liabilities in the balance sheet. Hence,  deferred tax assets and liabilities is distinguished from current tax assets and liabilities. When an enterprise makes a distinction between current and non-current assets and liabilities in its financial statements, it is not classifying deferred tax assets (liabilities) as current assets (liabilities).
Recognizes differed tax liabilities gradually declining in future, in financial statements Armenian enterprises bringing tax expenses,  differed tax actives, is making deductible expenses in future taxation process. When in financing and tax accounting incomes and expenses is been timing congruent, its not making differed tax actives and liabilities’.   
        
                t0                                                                                                                     t1
                                                           REPORTING PERIOD                                                                                                                                                                                                                                                                          


                               Income (IF) and expenses (EF) of                                                       
                                      Financial Accounting                  
                   
                                                                                    .     
                                    Income (IT) and expenses (ET) of
                                      Tax Accounting                                                                         


Figure 1  Timing harmonious incomes and expenses  in Financial and Tax Accounting    
                framework 
   

In Armenian enterprises accounting practice the differed tax liabilities taking place in cases, when:
- recognized income in financial accounting > recognized income in tax 
      accounting 
                                       IF >IT                  (figure 2)
- recognized expenses in financial accounting < recognized expenses in tax    
      accounting 
                                      EF < ET            (figure 3)


In practice activity Armenian enterprises differed tax assets generally is occurred in two cases, when: 
- recognized income in financial accounting > recognized income in tax 
      accounting 
                                       IF < IT                  (figure 4)
- recognized expenses in financial accounting > recognized expenses in tax    
      accounting 
                                      EF > ET            (figure 5)








                                               
                t0                                                                                                         t1
                                          REPORTING PERIOD  (IF >IT)                                                                                                                                                                                                                                                                                            

                     Incomes recognized by 
                     Financial Accounting                  
                                                                                     POST REPORTING PERIOD
                                                                                    .     
                            Differed Tax                                      Incomes recognized by 
                                   Liabilities                                    Tax Accounting                  
                                    


Figure 2 The timing process of presentation Differed Tax Liabilities in Financial 
               Statement (when IF >IT)


      t0                                                                                                         t1
                          REPORTING PERIOD  (EF < ET)                                                                                                                                                                                                                                                                                            
                                                                                     Expenses recognized by
                 Differed Tax                                                Financial Accounting
                 Liabilities                                                                                                           
                                                                                     POST REPORTING PERIOD
                                                                                    .     
                Expenses recognized by 
                  Tax Accounting                  
                                    


Figure 3 The timing process of presentation Differed Tax Liabilities in Financial 
               Statement  (when EF < ET)



                          REPORTING PERIOD  (IF < IT)                                                                                                                                                                                                                                                                                            
                                                                                     Incomes recognized by
                 Differed Tax                                                Financial Accounting
                 Assets                                                                                                           
                                                                                     POST REPORTING PERIOD
                                                                                    .     
                Incomes recognized by 
                  Tax Accounting                  
                                    


Figure 4 The timing process of presentation Differed Tax Assets in Financial 
               Statement  (when IF < IT)

                t0                                                                                                         t1
                                          REPORTING PERIOD  (EF >ET)                                                                                                                                                                                                                                                                                            

                     Incomes recognized by 
                     Financial Accounting                  
                                                                                     POST REPORTING PERIOD
                                                                                    .     
                            Differed Tax                                       Expenses recognized by 
                                Assets                                               Tax Accounting                  
                                    


Figure 5  The timing process of presentation Differed Tax Assets in Financial 
               Statement (when EF >ET)


The more situations for differed tax assets formation in practice is related to depreciation accounting process, when Armenian Law of Profit Tax suggested only straight-line method, but simultaneously  IAS 16 “Property, Plant and Equipment” offers variety of depreciation methods an asset on a systematic basis over its useful life. These methods besides of  straight-line method include also diminishing balance method and the units of production method. Straight-line depreciation results in a constant charge over the useful life if the asset's residual value does not change. The diminishing balance method results in a decreasing charge over the useful life [3]. Consequently, using accelerating depreciating method is bringing temporary differences in tax expenses recognition and as a result  in balance shit is  presented as a differed tax assets.   
For example, is purchased fixed assets by $ 3000, with 5 year useful life exploitation and $1000 per year returns. The profit tax percentage for all period of fixed asset operation is 20%. Consequently, by the and of assets exploitation period (5-th year) the enterprise will be have revenue $5000, proceeds profit $2000 and accordingly   will get hold of tax obligation $400.  
By the requirements of Armenian Profit Tax Law, based on  Straight – Line method value of depreciation for all years of assets exploitation will be:
                      $3000 : 5 years = $600 
    According to enterprise accounting policy, accelerating approach of amortization will present depreciation value  by each years of assets exploitation period such us:          
                                     1 + 2 + 3 + 4 + 5 = 15

I year                  5/15 x 3000 = 1000
II year                 4/15 x 3000 = 800
III year                3/15 x 3000 = 600
IV year               2/15 x 3000 = 400
V year                1/15 x 3000 = 200
In this case Tax Accounting will be recognize profit tax expenses as $80 constant value for all period asset operation (see table 1), but from another hand, in financial accounting tax expenses will be present by differed time attitude (see table 2), in consequence making differed tax assets.  
Table 1 
Profit Tax Formation in case of using Straight Line Depreciation method  [4]
                 
       Items                         Years
   1          2           3             4              5 Total
Revenue 1 000 1 000 1 000 1 000 1 000 5 000
Expenses 600 600 600 600 600 3 000
Profit before tax 400 400 400 400 400 2 000
Profit Tax 80 80 80 80 80 400
Net Profit 320 320 320 320 320 1 600

Table 2
Profit Tax Formation in case of using Accelerating  Depreciation 

       Items                            Years
   1          2             3            4              5        Total

Revenue 1 000 1 000 1 000 1 000 1 000 5 000
Expenses 1 000 800 600 400 200 3 000
Profit before tax 0 200 400 600 800 2 000
Profit Tax 0 40 80 120 160 400
Net Profit 0 160 320 480 640 1 600
     
In Armenian companies arrangement of  differed tax assets is presented by financial accounting according following transactions:   
First year
Recognition of tax paying responsibility
Dt Current tax Expanses………..80
   Kt Profit  Tax Liabilities……………………80
Recognition of differed tax assets
Dt Differed Tax Assets………………..80
   Kt Differed Tax Expenses…………………80 

Profit Tax Expense presentation in  Financial Statement = 
 Current tax Expanses + Differed Tax Expenses = 80 - 80 = 0
                                                 Second year 
Recognition of tax paying responsibility
Dt Current tax Expanses………..80
   Kt Profit  Tax Liabilities……………………80
Recognition of differed tax assets
Dt Differed Tax Assets………………..40
   Kt Differed Tax Expenses…………………40 

Profit Tax Expense presentation in  Financial Statement = 
 Current tax Expenses + Differed Tax Expenses = 80 - 40 = 40
                                    Third  year 
Recognition of tax paying responsibility
Dt Current tax Expanses………..80
   Kt Profit  Tax Liabilities……………………80
Recognition of differed tax assets
Dt Differed Tax Assets………………..0
   Kt Differed Tax Expenses…………………0 

Profit Tax Expense presentation in  Financial Statement = 
 Current tax Expenses + Differed Tax Expenses = 80 - 0 = 80
                                            Fourth year
Recognition of tax paying responsibility
Dt Current tax Expanses………..80
   Kt Profit  Tax Liabilities……………………80
Declining of differed tax assets 
Dt Differed Tax Expenses…………………40
    Kt Differed Tax Assets………………..40
   
Profit Tax Expense presentation in  Financial Statement = 
Current tax Expenses + Differed Tax Expenses = 80 + 40 = 120

Fifth  year
Recognition of tax paying responsibility
Dt Current tax Expanses………..80
   Kt Profit  Tax Liabilities……………………80
Declining of differed tax assets 
Dt Differed Tax Expenses…………………80
    Kt Differed Tax Assets………………..80
   
Profit Tax Expense presentation in  Financial Statement = 
 Current tax Expanses + Differed Tax Expenses = 80 + 80 = 160



Expenses recognized                        Revenues recognized          
by Financial Accounting                  by Financial Accounting                                                                                    

                                                   
                                   Profit presentation
                                In Financial Statements’
                                                      






                                               Differed Tax 
                                            Adjustments


                                                
                                                  

                                                   + , -
                                     Profit Recognition
                                   through Tax Accounting


Figure 6 The  mechanism of profit configuration   

    Accordingly, in Armenian companies in order for transforming from financial accounting into tax accounting profit in use adjustments processing, related to recognition and downgrading differed tax assets and liabilities (see figure 6).  



CONCLUSION

Incidentally, IAS 12 describes recognition and measurement of deferred taxes using a temporary difference approach, similar to the method of FAS 109, Accounting for Income Taxes. Although there are significant differences in the treatment of tax basis, uncertain tax positions and recognition of deferred tax assets and liabilities, FASB and IASB working on the issue of differences. The IASB (International Accounting Standards Board) issued an Exposure Draft of an IFRS to replace IAS 12 Income Taxes with the intention of eliminating many of the differences between the IFRS and FASB standards.  
 Tax Accounting US-RA Comparative Interpretation making conclusion, that there are several differences between IFRS and GAAP relating to accounting for and reporting of income taxes: 
Firstly, the tax rate used for measuring deferred taxes under GAAP is the enacted tax rate in place when the timing difference is expected to reverse, whereas under IFRS, the substantially enacted tax rate is used. 
Secondly, under GAAP, the classification of the deferred tax asset or liability is either short-term or long-term depending on the underlying relationship of the timing difference.  Under IFRS, deferred tax assets and liabilities are always recorded as long-term.
Thirdly,  under GAAP (for non-public companies), a reconciliation of the expected tax expense to actual is not required in detail and only a disclosure of the nature of the reconciling items is required.  IFRS requires the complete reconciliation, including the nature and amounts.



         Literature:

1. The Law of Republic of Armenia on Profit Tax, 1997, item 43
2. International Accounting Standard 18 “Revenue”, item18, (revised  2003)
3. International Accounting Standard 16 “Property, Plant and Equipment”, item 62 (revised  2005)
4. S.Eloyan, Estimation of Tax Assets in Tobacco Production, Bulletin of State    
    Agrarian University of Armenia, #2, 2009, pages 110-111 
5.  “Income Taxes”, International Accounting Standard No. 12 (IASCF), as mended 
     effective January 1, 2009. item 11
6. FASB ASC 740-10-35: Income Taxes-Overall-Subsequent Measurement “Accounting for Income Taxes, Statement of Financial Accounting standards No. 109.    
2005, item 3

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