"Double Dating" transactions?

[David Harrison]

----- Original Message ----- 
From: "Aaron Gaudio" <prothonotar at tarnation.dyndns.org>
To: "David Harrison" <millionaire at shaw.ca>
Cc: <gnucash-user at gnucash.org>
Sent: Thursday, September 02, 2004 11:45 AM
Subject: Re: "Double Dating" transactions?


> On Thu, 2004-09-02 at 09:36 -0700, David Harrison wrote:
>>
>
>> To be honest, I wasn't trying to get into an arguement about this, my 
>> goal was to help. This is a very difficult subject, with many different 
>> possible scenarios. And, sorry in advance for the long post.
>>
>
> No arguments from me, except for a civil exchange of ideas.

Sometimes, it's hard to tell from the written word.  The joys of technology, 
eh?

 BTW, your
> email software does not appear to be wrapping your text.

I'm using outlook express for this message, let me know if works any better. 
I was using a web based email client my ISP provides to answer this morning 
from work.

>
>> Income taxes withheld from a paycheck, or submitted as installments are 
>> not a true expense.  They are a prepaid expense, which is an asset and 
>> should appear on the balance sheet, not the income statement.  The 
>> expense is normally recorded at the end of the year, when the expense is 
>> known (the calculation is made after the year end, but entered dated for 
>> the last day of the year.)
>>
>
> IANAA, but I disagree. I believe (in the US, at least) taxes are owed
> periodically, not at the end of the year. If you are self employed and
> responsible for paying all of your own taxes (that is, no withdrawal
> from your pay check), you *have* to pay quarterly- if you don't a
> penalty is assessed against you. Now, if it turns out you owed more than
> you paid, yes the difference will be due April 15 of the following year
> (unless you file for an extension). But IMO this should be treated the
> same as if you are owed a refund- that is, on an accrual basis.
>
> IMO, taxes would only count as a prepaid expense if you actually pre-
> paid your taxes. For instance, (in the US at least) you can elect to
> have one year's refund held by the IRS to pre-pay the next year's taxes.
> In this case, you could count the un-recovered refund as a pre-paid
> expense, then transfer it into a real expense account once the tax is
> actually due (next quarter, month, etc.).


The same rules apply up here.  If you owe more than a certain amount of 
taxes in a year, the next year you are required to make installments.  If 
you miss the installments, then interest and penalties are appled.  I'll 
comment on the rest below.

>
>
>> I realize that the income tax payable account in a debit balance is 
>> really a receivable, and the name is a misleading - but don't get too 
>> hung up on the name.  Rather than trying to move things back and forth 
>> from payable to receivable, it is normal to post things to a payable 
>> account and have it show a debit balance.  Other accounts that behave the 
>> same way for businesses are (in Canada) GST payable, payroll taxes, 
>> shareholders loan, and others.  Accountants use file prep programs, such 
>> as CaseWare, that recognise when these accounts are in a debit balance, 
>> and reclassify them to current assets  on the financial statements (and 
>> they also rename them to receivable).  But the convention is to post them 
>> to the payable account (I know that there are situations where this isn't 
>> the case, but I am trying to simplify and not deal with the exceptions).
>>
>> If you were following GAAP, the entries that I proposed in my original 
>> posting would be correct. The only time the expense is recorded is at the 
>> end of the year, when you know exact amount of the expense. The montly 
>> payments would be "held" on the balance sheet until then.  If you are not 
>> required to follow GAAP, then you can record it however you want.  The 
>> end goal is to produce a statement that is useful to the user of the 
>> financial statement.
>>
>
> Agreed about the end goal, but I'm not sure about the "only time the
> expense is recorded is at the end of the year". Maybe this is a
> difference between countries. However, to not count tax expenses until
> the end of the year seems like it would skew your financial reports (say
> you produced quarterly statements- your tax payments would show up as
> assets on your balance sheet with no tax liability to counterbalance it-
> making it look like you have a greater book value than you actually
> do).

I agree about the timing issue and the montly statements.

>
>> My comment regarding the cash flow statement was only in regards to my 
>> thinking that maybe he wanted to record the income tax withholdings as an 
>> expense so he could see what his cash outflow was (I hope this sentence 
>> makes sense).  The function of the income statement is not to show cash 
>> flow, it is to match expenses to revenues (matching is one of the 
>> conventions of accounting).  The function of the cash flow statement is 
>> to show the flow of cash in and out of the entity - big difference.
>>
>
> Agreed, but if a tax is an expense when paid, it ought to affect your
> income statement. This is why there is a such thing as "Income before
> Taxes" entry in an income statement, and why tax expense is shown on
> public corporation's income statement after it. See
> http://finance.yahoo.com/q/is?s=MSFT for an example.

The accountants at Microsoft are doing the same thing I'm suggesting.  The 
only difference is that they are doing it on a quarterly basis.  If you were 
to look at the detail of the transactions in the income tax expense account, 
I bet there would be an entry dated for the end of the quarter that records 
the estamated tax expense based on adjusted net income for that quarter.  At 
the end of the year, they would adjust that estimate to record the actual 
tax expense for the year.  I also bet that hidden in the "other liabilities" 
or "other receivables" is an amount of tax estimated to be payable or 
recovered.  The problem with those statements is that there is a) no detail, 
b) no notes to the financial statements, and c) no audit or other report to 
say the basis they are reported on (they are using US GAAP, I assume).

The biggest problem with income taxes is that you never know what your true 
expense is untill well after the year end.  This is because of the huge 
amount of tax planning that can be done.  For example, retirement savings 
for personal taxes, or deferring salaries for corporate taxes.  So any 
amount that you enter on a monthly, quarterly, or other basis is purely an 
estimate.

The other issue is what time frame you are dealing with.  For most of the 
work I do, I am dealing with a full year.  That means that the montly 
breakdown is irrelevant.  For all our clients, they deal with controlling 
the before tax income.  So for them, showing tax expense on a monthly basis 
doesn't help them.  Most banks and other users of the statements look at 
before tax income anyway, so for them recording tax on a montly basis is 
irrelevant to them.

Given all of this, the normal practice is to accumulate the monthly payments 
in the payable account, and record the expense once at the end of the year 
when the tax bill is known.  The difference would then be a recoverable or 
payable, depending on if your monthly payments (whether installments or 
withholdings) are more or less than your taxes due.

You are absolutely right about the monthly statements though not reflecting 
the income tax expense.  You could enter your montly payments as an expense 
if you wanted.  But say at the end of the year you got all the installments 
refunded.  Then all your months would have the expense overstated.   What if 
you owe twice as much.  Than all your months would have the expense 
understated.  I know I'm exagerating, but I hope you see my point.  There is 
no easy answer.

Bill Wisse also sent an email with questions, which I plan to answer next. 
I will put some numerical examples in there that will show a couple of 
different options for him (and anyone else) on how I would record income 
taxes.

David