Provision for Income Tax

Companies pay taxes due to their operations. Usually, these taxes fall under the corporation and other taxes. However, income taxes may also apply to individuals and businesses. These entities must calculate the taxes they must pay annually under the tax law. For entities that prepare financial statements, creating a provision for income tax is also mandatory.

What is a Provision for Income Tax?

A provision for income tax refers to an amount recognized in the financial statements estimating future taxes. This amount does not represent the final income tax payable figure. Usually, it may change based on several factors. Nonetheless, entities must create a provision for it based on their calculations. This provision represents the expected amount for income taxes payable in the future.

Therefore, a provision for income tax represents an estimated amount payable in the future. This amount relates to an entity’s current year of operations. Usually, entities can calculate this amount by adjusting their net income to reach taxable income. This process differs based on various factors. However, the tax law for the jurisdiction where an entity operates is the primary influence.

How to calculate the Provision for Income Tax?

Usually, entities calculate the provision for income tax through the income earned before tax. For most of them, this amount comes from the income statement. Once it is available, entities can use the following formula for provision for income tax.

Provision for income tax formula = Net income before taxes x Applicable tax rate

Practically, tax laws require several adjustments to the net income before reaching a taxable amount. These adjustments may allow several expenses while disallowing others. Entities must adjust for these before calculating the amount. Similarly, the applicable tax rates for income tax may differ based on the tax laws.

What are the journal entries for Provision for Income Tax?

The journal entries for provision for income tax are straightforward. The debit side increases the entity’s tax expense in the income statement. Usually, this expense is the final item on that statement. On the other hand, the credit side creates a liability in the balance sheet. Entities can adjust this figure later based on the actual income tax calculations.

Overall, the journal entries to record provision for income tax are as follows.

Dr Income tax expense
Cr Provision for income tax

Example

A business, Green Co., estimates its net income before taxes to be $50,000. The applicable tax rate in the jurisdiction is 20%. Green Co. calculates its provision for income tax as follows.

Provision for income tax = Net income before taxes x Applicable tax rate

Provision for income tax = $50,000 x 20%

Provision for income tax = $10,000

Green Co. records the above provision for income tax using the following journal entries.

Dr Income tax expense $10,000
Cr Provision for income tax $10,000

What is the Over and Under Provision of Income Tax?

As mentioned above, the provision for income tax is an estimate based on the net income before tax. The actual income tax payable may differ based on various factors. Tax laws require businesses to calculate a taxable amount first. Once established, the income tax payable may vary from the amount estimated before.

If the income tax estimation is lower than the actual tax payable, it is called under-provision of income tax. If it is higher, it falls under an over-provision of income tax. None of these is an issue as entities can adjust for these amounts in the upcoming year. The accounting for under- and over-provision of income tax is straightforward.

Conclusion

Entities must estimate and report their income tax before reporting their financial statements. This amount falls under the provision for income tax. For those entities, it creates a liability and increases expenses. Calculating the amount is straightforward based on net income before taxes. However, it may cause an over- or under-provision of income tax.

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