Final answer:
When a company must pay more tax than reported on the Income Statement, it results in a deferred tax liability. Companies pay corporate taxes based on net profits, and the effective tax rate represents the average corporate tax on the company's income, adjusted for tax benefits available in the tax year.
Step-by-step explanation:
If tax laws require a company to pay more tax than is indicated by activities reported on the Income Statement (IS), the company reports a deferred tax liability. This situation arises because the income reported on financial statements (used for investors and creditors) may differ from taxable income due to timing or recognition differences in revenue or expenses. The corporate income tax that companies are subject to is based on net profits, but complex tax code provisions can make the exact tax amount difficult to determine.
Corporate taxes are levied on the profits earned by a company, and as a company’s income increases, both the absolute tax owed and the effective tax rate tend to increase. The effective tax rate is the average rate at which a company is taxed on its earned income and incorporates various tax benefits that may be applied within the fiscal year.
Understanding these concepts is essential in the business field, particularly for those interested in accounting and finance, as they deal with fiscal policy and the calculation of taxes owed by corporate entities.