In accounting, the taxes you're going to pay down the road are as important as the ones you're currently writing a check for. Owing a big load of income tax bill affects your firm's financial future, so you need to capture it in your financial statements. Income tax payable goes on the balance sheet while you find "tax paid" in the cash flow statement.
Tip
You report income tax payable on your current profits as a liability on the balance sheet. The tax incurred in the current accounting period goes down on your income statement as an expense. The cash-flow statement reports the actual taxes paid in the quarter, month or year.
Income Tax Payable
Income tax payable is exactly what it sounds like, Accounting Tools says, an accounting entry for the amount of state, federal, foreign and local income tax you currently owe. The amount is based on your profits adjusted for any deductions and accounting methods that reduce the tax bill. Depreciating your assets, for example, reduces your taxable income even though you don't spend any cash on it.
Paying what you owe clears out the income tax payable account. For example, if you owe the federal government $1,500 on this quarter's profits you record that as income tax payable. When you cut the IRS a check, you report $1,500 in income tax expense and reduce income tax payable by the same amount.
In practice, the amount of income tax you pay may not equal what's in the account. Tax accounting allows you to depreciate assets faster than you can in regular accounting; your ledgers may show a $300 depreciation expense for this quarter, for instance, while your tax accounting makes it $400. That difference means that while your income tax payable is $1,500 your expense is only $1,400. Over time, the two systems eventually balance out and you can turn all the payable tax into tax expense.
Accounting Tools says timing matters in other ways. If you haven't recorded a transaction in your accounts, you can't count it as taxable income or as a tax deduction. Say you have $700 in Accounts Receivable that you suspect will never be paid. Unpaid bills are a tax write off but not until you enter the $700 in your journals as a bad debt expense.
Income Tax Payable: The Balance Sheet
The three big financial statements are the balance sheet, the income statement and the cash-flow statement. Your taxes affect all three of them, but in different ways. You don't find income tax payable in the cash flow statement, for instance, but in the balance sheet.
Like other unpaid debts, accounting treats income tax payable as a liability. The balance sheet records liabilities and subtracts them from your assets; what's left is the owners' equity. If your company has, say, $2.3 million in assets and $1.5 million in liabilities, equity is $800,000. That's what the owners would divide up if the company paid all its debts, then closed its doors.
Suppose you're making out the balance sheet for the current quarter. Your income tax payable account at the start of the quarter reported $32,000, of which you paid $30,000. You had a good three months and the income tax payable on your quarterly income was another $40,000. The Corporate Finance Institute says you'd record $42,000 in income tax payable as a liability on the balance sheet at quarter's end.
You include income tax payable on the same section of the balance sheet as all your tax liabilities. With entries such as Medicare and Social Security, it's important to track not only the amounts you take out of your employees' paychecks but your contribution as their employer. If you have taxes due more than a year from the date of the statement, you count them as long-term liability. Otherwise they're current liabilities.
Tax Paid in Cash Flow Statement
Your income statement records your expenses and income for a given period. The cash flow statement records how much money actually changed hands while the income statement reports money earned or owed. They treat your tax bills differently.
The income statement records your income tax expense, Accounting Tools says, the tax bill you incurred for the period covered by the statement. Figuring out your expense is the kind of arcane number-crunching many companies outsource to a tax accountant. In that case, you can base your income statement's expense entry on your historical percentage. That should do until your tax person can adjust it.
The amount of taxes your company paid for the accounting period goes on the cash flow statement. If you paid $30,000 during the last quarter and accrued a total $42,000 tax liability, you'd report the $30,000 as an expenditure on your cash flow statement. The amount you haven't paid doesn't affect your cash flow. That's why you don't see income tax expense or income tax payable in the cash flow statement.
The cash flow and income statements are both important to understanding your financial situation. The income statement shows how profitable you are. For example, the statement may show you've generated a lot of sales revenue this quarter even if the customers haven't paid yet. The cash flow statement shows how much money you have on hand, which tells you whether you have enough to pay your utilities, tax bills and employees.
Cash Flow Statement Format
The cash flow statement format, the Corporate Finance Institute says, breaks down into three sections for operating, investment and financing activities. Operating activities covers the revenue and expenses related to your core business. If your company invests money, the cash you earn or lose from that goes in the second section. The financing section deals with items such as dividend payments.
There are two ways to collect the information you need. With a direct-method cash flow statement you go to your accounts and calculate the amount you paid to the tax man, the money you received from customers, the money you spent on long-term assets and so on. This seems simple, but Accounting Tools says most bookkeeping systems don't segregate out cash-transaction information. Gathering the data makes for a lot of extra work.
The indirect method sounds more complicated, but it usually works out simpler. You start with the income statement, then delete the items that don't involve cash flow. For example, depreciation expense doesn't involve spending cash, so while you report it on the income statement, you deduct it back out when you figure your cash flow.
Whichever way you derive the figures, you record tax paid in the cash flow statement as part of operating activities. Alternatively, Accounting Coach says, you can report them at the bottom of the cash-flow statement or in the footnotes to your financial statements. U.S. accounting standards require you report your tax bill but not that you include it in the body of your cash-flow statement.
