Income Taxes Payable vs Income Tax Expense

CFA Level I
#1

I have this formula written down: Income Tax Expense + DTA - DTL = Income Taxes Payable

I saw a question that said this statement is true: Income Tax Expense is based on current period pretax income adjusted for any changes in deferred tax assets and liabilities.

My question is, isn’t that statement true for Income Taxes Payable , since it’s adjusted for DTA & DTL, and Income Tax Expense isn’t adjusted for DTA & DTL?

Also, is Income Taxes Payable on the Tax Return or on the Balance Sheet (Current Liabilities?), or both?

Many thanks.

#2

Income taxes payable appears on the balance sheet; it’s a current liability. The number comes from the tax return.

Whether it’s income taxes payable or income tax expense that’s adjusted for the changes in DTAs and DTLs is a matter of perspective. Suppose that you use accelerated depreciation for tax purposes and straight-line depreciation for financial statements. If you think that what you’re showing on your financial statements is an accurate depiction of your assets, then you can think of any change in your DTL as affecting your taxes payable (reducing them initially, then increasing them later) but not your tax expense. If you think that what you’re showing on your tax return is an accurate depiction of your assets, then you can think of your DTL as affecting your tax expense (increasing it initially, then reducing it later) but not your taxes payable. Neither perspective is intrinsically better than the other.

As for the formula, think of it this way (warning: T-accounts, debits, and credits ahead):

  • When you compute your tax liability on your tax return, you debit Tax Expense (increasing it) and credit Taxes Payable (increasing it).
  • If a DTA increases, you debit the DTA (increasing it) and credit tax expense (decreasing it); if a DTA decreases, you credit the DTA (decreasing it) and debit Tax Expense (increasing it).
  • If a DTL increases, you credit the DTL (increasing it) and debit Tax Expense (increasing it); if a DTL decreases, you debit the DTL (decreasing it) and credit Tax Expense (decreasing it).
  • Thus:

Income Tax Expense = Income Taxes Payable – ΔDTA + ΔDTL

If you solve this for Income Taxes Payable you get a formula that’s close to what you wrote:

Income Tax Expense + ΔDTA – ΔDTL = Income Taxes Payable

Note the essential difference between what I wrote and what you wrote: it’s the change in DTAs and DTLs, not the total DTA and DTL.

#3

Your answers are like keys that unlock some aspect of the CFA that I have trouble opening. Truly appreciate it!!

#4

My pleasure.