Accounting For Income Taxes & Accounting For Share-based Payments, Lecture notes of Corporate Finance

Download Accounting For Income Taxes & Accounting For Share-based Payments and more Lecture notes Corporate Finance in PDF only on Docsity!

Accounting For Income Taxes

Understand the difference between accounting and taxable income and perform a reconciliation between the two Understand the difference between carrying value and tax base of assets and liabilities and quantify each Identify the circumstances in which taxable or deductible temporary differences arise

Session Objectives

Calculate temporary differences and related deferred tax amounts on the balance sheet

Accounting Income Versus Taxable Income

A key element in determining income tax expense is understanding the difference between accounting

income and taxable income.

• The profit or loss for a period before deducting tax expense
• Income before tax on the income statement for the period

Accounting Income

• The profit or loss for a period determined in accordance with rules established by taxation authorities
• Taxable Income on tax returns

Taxable Income

VS.

Reconciling Accounting Income and Taxable Income

Income taxes are based on taxable income and not accounting income. Under IFRS, disclosure of a

reconciliation between tax expense and accounting income is required.

Expenses not deductible under tax laws but recognized for accounting purposes Income included under tax laws but not recognized for accounting purposes Expenses deductible under tax laws but not recognized for accounting purposes Income not included under tax laws but recognized for accounting purposes

Accounting Income

= Taxable Income

Carrying Amount Versus Tax Base

Example:

An asset has an original cost of $1,000.

• Accumulated depreciation for accounting purposes: $
• Tax depreciation to-date: $ Carrying Amount: Cost $1, Accumulated Depreciation Net Book Value $

Tax Base: Cost $1, Tax Depreciation To-Date Tax Base $ The amount attributed to an asset or liability for tax purposes

Tax Base

The net book value of an asset or liability recorded on a company’s balance sheet for accounting purposes

Carrying Amount

Temporary Differences

Temporary differences are the differences between the carrying amount of assets and liabilities for

accounting purposes and their respective tax bases.

They can also be thought of the differences between accounting income and taxable income that

eventually reverse (are eliminated).

Temporary

Difference

Carrying

Amount

Tax

Base

Permanent differences are differences between the tax and

financial reporting of revenue or expense items which will not be

reversed in the future.

Taxable Temporary Differences Tax Depreciation > Accounting Depreciation Installment Sales Capitalized Development Costs Amortized Over Time

Common Examples of Temporary Differences

Deductible Temporary Differences Tax Depreciation < Accounting Depreciation Accrued Expenses Unearned Revenue Tax Losses

Deferred Tax Assets and Liabilities

Deferred tax assets are the amounts of income tax recoverable in future periods.

Deferred tax liabilities are the amounts of income tax payable in future periods.

Deferred Tax Asset Deferred Tax Asset Deductible Temporary Difference Unused Tax Loss or Credit Tax Rate Tax Rate Deferred Tax Liability Taxable Temporary Difference Tax^ Rate

Accounting For Share-based Payments

Gain an understanding of the key elements of share-based payments Calculate share-based payment expenses under scenarios with service conditions only Calculate share-based payment expenses under scenarios with both service and performance conditions

Session Objectives

Share-based Payment Classification

The accounting treatment for share-based payment transactions differs depending on the classification.

Equity-settled Payments

• Occur when transactions are settled using an entity’s own equity instruments
• Typical example: stock options

Cash-settled Payments

• Occur when transactions are settled in cash, the amount of which is based on the value of equity instruments
• Typical example: share appreciation rights

Determination of Grant Date

Grant date is the date an entity grants the right to receive equity instruments to its employee.

The grant date occurs when all of the following have occurred:

When the terms and conditions are agreed upon and understood by both the entity and its employee.

Agreement

The right to cash or equity instruments of the entity has been conferred on the employee.

Rights Conferred

The share-based payment agreement has received the necessary and appropriate approvals.

Approval

Determining Fair Value

The fair value of equity instruments granted to employees in share-based payment transactions is

measured at the grant date (or measurement date).

The fair value of equity instruments is not adjusted subsequent to the grant date in respect of changes

in market conditions.

2. Valuation Techniques If market prices are not available, then fair value is estimated using a valuation technique (e.g. Black- Scholes, binomial pricing models). 1. Market Prices If market prices are available for the actual equity instruments granted, then the estimate of fair value is based on these market prices.

Accounting For Share-based Payments

Example #1 (service condition only) :

Company XYZ grants 100 share options to each of its 500 employees, which can be exercised at anytime over 3 years subject to a 2-year service condition.

• The fair value of each option is determined to be $20 at the grant date.
• An estimated 75% of the 500 employees will complete the service condition required for receiving the options. Employee benefit expense recognition: Grant Date Year 1 Year 2 Year 3 Year 4 Year 5 $0 (^) + $375, = 100 options x 500 employees x 75% x $20 x 1 / 2 years

= 100 x 500 x 75% x $20 x 2 / 2 years – $375,000 recognized in Year 1 Total employee benefit expense: = $750,