As far as I know, tax base is the net amount of asset/liability used for tax reporting purposes. In the case of an asset, carrying amount is the net book value in financial statements while tax base is the ‘tax book value’ that is used to calculate tax in tax returns, and this makes sense to me.
However, I do not really understand the concept of tax base of a liability. What exactly is tax base of a liability? The amount that is used to calculate tax for the current year? For example, if we have warranty expense of 5k and it is not deductible until next year in the tax return. So the carrying amount of the liability is 5k (ok I get this) and the tax base is 0 because 5k is only deductible in the future so this year the amount used to calculate tax is 0?
If that logic is correct, how does that apply to the case of unearned revenue? Suppose we have unearned revenue of 10k so the carrying amount of the liability is 10k. To calculate tax base, we need to subtract the amount not taxable in the future from the carrying amount, according to the formula, so tax base is also 0 in this case. What does this mean? Following the logic of the previous example, tax base should be the amount that is taxable this year and it should be 10k instead?
Please explain to me what is wrong with the way I understand the two examples, and show me the correct way to understand them. I spent hours and hours searching on the internet and watching tutorial videos on youtube. I also read similar threads in the forum but to no avail. They say the formulas to calculate tax base of a liability and tax base of unearned revenue, and I remember them now, but I cannot figure out the connection between them.
The tax base of an asset is the amount that can contribute to your _ future _ tax deductions (as through depreciation). It’s the total original amount available less the amount you’ve already used.
Analogously, the tax base of a liability is the amount that can contribute to your _ future _ taxable income (as through revenue recognition). It’s the total amount originally available less the amount you’ve already used.
The primary difference is that for assets the tax base frequently declines slowly over time (as with depreciation), whereas for liabilities it’s usually all or nothing. For example, on a deposit from a customer (a liability), you’re usually taxed when the cash is received, so the _ future _ contribution to taxable income (and, therefore, the _ tax base _) will be zero.
Thanks S2000magician. You are always here when people are in need.
So as you said, the tax base liability is the amount that can contribute to the future taxable income. How does that apply in the case of warranty expense as I mentioned? The total amount originally available is 5k ,and why is 5k the amount already used ? I thought nothing has been used, and 5k will be used in the future.
The key to understanding the warranty liability is to note that when we create a warranty liability on the balance sheet, we also create a warranty expense on the income statement, whereas when we create an unearned revenue liability on the balance sheet, we don’t create an expense on the income statement.
“Why does that matter?” I hear you ask.
Because the expense we show on our income statement doesn’t appear on our income tax return, so when we perform the warranty work in the future, we’ll be offsetting that (on our tax return) with a warranty expense (that we couldn’t deduct today); thus, the net contribution to our _ future _ taxable income is zero.
So because we already expense what should be expensed in the future, in the end we basically contribute nothing. We take the net amount (in this case it is 0) and it will be the contribution to our future taxable income, which is the definition of a tax base.
Thank you again for helping me. This has been bugging me for a few days.
For Asset it’s assumed that when an asset is recognised, it is expected that its carrying amount will be recovered in the form of economic benefits that flow to the entity in future periods. If the carrying amount of the asset is greater than its tax base, then taxable economic benefits will also be greater than the amount that will be allowed as a deduction for tax purposes. The difference is therefore a taxable temporary difference and the obligation to pay the resulting income taxes in future periods is a deferred tax liability. And visa versa when carrying amount is less than tax base.
But, as I wrote above, with liabilities it’s usually all-or-nothing; they don’t generally contribute to revenues slowly over time (whereas assets can contribute to expenses slowly over time).
for liability carring amount is expected economic resources outflow, tax base is portion of this outflow which can’t be deducted for tax purposes that’s why it creates taxable income if tax base is more than carrying amount ? Is this interpretation correct?
And I do not understand how tax base can be more than carrying amount for liability. As tax base = carrying amount - amount deductible in future. from this equation tax base can be more than carrying amount if deductable amount for future is negative. It does not make sense for me.
No: the tax base of a liability is the portion that will contribute to future taxable income, not the portion that can’t be deducted*. As I wrote above, it’s the original amount less the amount you’ve already recognized for tax purposes.
Most tax systems are cash-based (not accrual-based). Suppose that you receive a deposit from a customer. For financial reporting, you list it as a liability until you deliver the goods/services, so the carrying amount is the full value of the deposit. But the tax authorities tax you on the deposit as if you’d earned it (cash-basis), so its tax basis is zero: no contribution to future taxable income.
Imagine that a tax authority would tax you on only 60% of deposits (and tax you on the remaining 40% when you deliver the goods/services: when you _ earn _ the money). In that case, the tax basis would be the value of the deposit less the amount taxed (60% of the deposit): 40% of the deposit.
Again, it’s not the carrying amount less the amount deductible in the future; it’s the original amount less the amount already recognized for tax purposes. Depending on how you recognize the amount for financial purposes and how tax authorities recognize it for tax purposes, the tax basis could be less than, equal to, or greater than the carrying amount. (Note that the most likely case in the real world is that the tax basis will be less than the carrying amount; on the Level I CFA exam, it could be any of the three, however.)
I also agree with above mentioned compliment that you are always here to help us whenever we stuck.
I read complete thread and found things little bit complicated to understand.
I learnt the concept of taxable base on the basis of difference in the fact that finacial reporting is based on cash as well accrual basis but on other hand finacial reporting for tax purpose is based on only cash basis.
So all those taxable net income which we have considered based on accrual basis will create this temporary difference of DTA or DTA as per the case of taxable income greater than pretax income or viceversa respectively.
Please correct me in case i am wrong and complete me in case I am lacking behind.
According to the definition: The tax base of a liability is the amount that is taxable in the future for tax purpose or in other words, the amount that can contribute to the future taxable income. So we have a liability: a loan of $100, this amount can not contribute to future taxable income and is not taxable in the future when it is repaid. So why its tax base of liability equals to its carrying value of 100, not 0?
Your definition for tax base is much more simple and logical for me than one from CFAI curriculum.