Balancing change is a specific term that describes a change in a company’s pretax profit. The change is also called a balance or capital allowance, depending on the country or agency covering the company’s tax liability. The purpose is to add or reduce the amount a company must pay in taxes. The difference typically relates to large projects, investments, or depreciation allowances. In most cases, the balancing change reduces profit as it encourages investment from businesses into a country’s economy.
Companies looking to spend copious funds into starting new business divisions or operations typically look for the best state or other locale. Tax breaks and other incentives are a common method that local, state, or federal governments use to achieve investments from these businesses. Companies may need to report these tax incentives as a balancing change in order to properly account for the monetary benefits. The change has a close relation to depreciation as new facilities incur depreciation as part of the natural accounting process. The change itself appears on the company’s income statement after operating profit.
The calculation for a balancing change is not necessarily a standard process. Companies may receive different percentages based on agreements or other obligations between them and government agencies. A common method of calculation, however, is to compute the company’s total taxes payable as if no balancing change exists. For example, a company will multiply its operating profit by the current corporate tax rate. Accountants then multiply the tax discount for the capital investment by the current tax payable, with this percentage being the balancing change.
A journal entry is necessary to input the balancing change onto the income statement. Corporate tax payable is a balance sheet account, meaning the numbers will not appear on the income statement. The journal entry will most likely debit a balancing change account to reduce the company’s currently reported income. The credit will go into a balance sheet account that indicates the change a company takes on its corporate tax payable. The depreciation a company reports may also affect this figure.
A capital allowance is a term closely associated with balancing change. Its use and purpose is quite different, however. A specific percentage may exist between an asset’s cost in the period in which a company purchases it. The capital allowance represents this difference, which is often higher than the asset’s depreciation. Companies must report this difference following standard accounting principles to ensure inclusion on their financial statements.