Ignoring rates of taxation, assume that the bank estimates that its taxes will be $2,400 for the ensuing year. At that rate it is advisable to set up each month a charge of $200 making for the year an accumulation of $2,400, which is the amount estimated to cover the taxes. The most satisfactory method of monthly entry to cover this allotment process is as follows:

Debit: Expense (22) ...................

(Taxes on the auxiliary Expense Book)

$200

Credit: Reserve for Taxes (34)........

$200

Of course, at the end of the year when, for purposes of illustration, the taxes are to be paid, the reserve account would amount to $2,400. If that is the exact amount of the tax to be paid, the entry covering the payment for the taxes is as follows:

Debit: Reserve for Taxes (34) .......

$2,400

Credit: Cash (11).................

$2,400

An excess or deficiency in the reserve account would be taken care of by a credit or debit to undivided profits.

Income Taxation

Corporate income and auxiliary taxes have made the determination of taxable income of banks, as well as other corporations, a considerable problem. The frequent changes in law-makes the problem complicated, so that it is advisable for a bank to keep auxiliary tax records of all of its income in order that when the time for a declaration of income for taxation purposes approaches, the problem of analysis is made simpler. Such auxiliary records should show the source and character of each item of income. Also, any income which is reapplied in reduction of an asset but on which tax has nevertheless been paid, should be distinctly marked or classified on the auxiliary record so that when the asset on which profits have been applied, such as a security, is itself sold, the bank may not be obliged to pay a tax on income twice. To illustrate: If $1,000 par of bonds purchased at 90, or at a cost of $900 drops in market value to $800 and the bank applies $150 profit from the sale of another investment, that would of course reduce the depreciated item from a book value of $900 to $750. That is below the new market. If the bond on which this $150 profit has been applied is later sold at $850 it might seem on the face that a $100 profit has been made, but in fact there has been a loss of $50. All such items should be shown on auxiliary records pro'perly classified so that credit may be correctly taken on the income tax return.