ACC803 Advanced

Financial Reporting

Week 3: Income Tax Accounting

3.1 Tax effect accounting.

3.2 Deferred Tax Assets (DTA) and Deferred Tax Liabilities (DTL).
 Introduction
Accounting for income taxes -recognizes both the current
tax consequences of transactions and events and the
future tax consequences of the future recovery or
settlement of the carrying amount of an entity's assets and
liabilities.

Current Tax
-Recognize liability for unsettled portion of tax expense.
-Recognize an asset to the extent amounts paid exceed
amounts due.
-Tax loss which can be used against future taxable income
can be recognized as an asset (deferred tax asset).
 The Nature of Income tax
Accounting profit is usually different from taxable profit, Because they are
determined by different principles and rules. the difference arise from a
number of common transactions and may be either permanent or temporary
in nature.

Permanent difference- in accounting and tax profit arise when the treatment
of a transaction by taxation legislation and accounting standard is such that
amount recognized as part of accounting profit are never recognized as part of
taxable profit or vice versa.
- this includes income never subject to taxation and expenditure incurred by
an entity that will never be an allowable deduction. Where such difference
exist, taxable profit will never equal accounting profit.

Temporary difference- in accounting and tax profit arise when the period in
which revenue and expenses are recognized for accounting purposes is
different from the period in which such revenues and expenses are treated as
taxable income and allowable deduction for tax purposes.
 Temporary difference may be either:
a) taxable temporary difference - which are temporary difference that will result in taxable amounts in
determining taxable profit ( tax loss) of future periods when the carrying amount of the asset or liability is
recovered or settled.
- in simple terms, this means that a deferred tax liability will arise when
the carrying value of asset is greater (>) than its tax base or
when the carrying amount of the liability is less (<)than its tax base.

b) deductible temporary difference- which are temporary differences that will result in amounts that are
deductible in determining profit ( tax loss) of future periods when the carrying amount of the asset or liability is
recovered or settled.

a deferred tax asset may arise.

-when the carrying value of the liability is greater (>) than its tax base or
when the carrying value of the asset is less (<) than its tax base,

Asset CA> TB DTL

CA< TB DTA

Liabilities CA<TB DTL

CA> TB DTA
 Some of the difference between accounting rules and tax rules

item Generally accepted accounting rule Tax Rule

Many accurued expenses (for example, long
service leave, warranty costs) An expense when accured Recognised as a tax deduction when paid
Many prepaid expense ( for example, Prepaid Intially as asset -expensed when economic
rent) benefits used Typically a tax deduction when paid
Revenue received in advance (for example, rental Treated as a liability -recognised as revenue when
revenue) earned Typically taxed when received
Not a tax deduction in current or subsequent
Entertainment and goodwill impairment Treated as an expense periods
Treated as a tax deduction when debtor is actually
Doubtful debts Treated as an expense when recognised written off in subsequent period
Development expenditure Often capitalised and subsequently amortised Typically a tax deduction when paid for
 Example
You are provided with the following information of XYZ for the year ended 30th June 2012:
Cash sales $100000
COGS 40000
Amount received in advance for services to be performed in August 2012 5000
Rent expense for year ended 30th June 2012 10000
Rent prepaid for 2 months to 31st August 2012 $1000
Doubtful debts expenses $1000
Amount provided in 2012 for employees long service leave entitlements $3000

Required:
Calculate taxable profit and accounting profit for the year ending 30 June 2012.
 Example
AN entity acquired plant and equipment for $1
million on Jan 1st 20X9.
The assets is depreciated at 25% a year on SLM
and tax legislation permits to depreciate the
assets at 30% a year for tax purpose.
Required:
Calculate any DTL that might arise on the plant
and equipment at 31/12/x9. Its tax rate is 30%.
 Example
Mc Tavish Limited has the following assets in its balance sheet as at 30
June 2011.
Machinery: Acquired at a cost of $400000 on 1st July 2009. It has a useful
life for accounting purposes of 5 years and no expected salvage value. Its
carrying value at 30th June 2011 therefore is $240000. For tax purpose it
can be depreciated at 25% per year.
Interest receivable: Has recorded interest receivable ( interest earned but
not yet received) at $100000. The Tax authority will not tax the interest
until it is received.
Account Receivables: Has made sales on credit terms amounting to
$80000 and at the end of the reporting period the $80000 is still to be
received. The ATO has already included the $80000 in taxable Income.

Required:
Determine the respective tax bases of the above items as at 30 June 2011.
Calculate the DTL or DTA
 Example
Scott Dillon Limited has following liabilities in its statement of financial
position as at 30Th June 2011.
Revenue received in advance: The company has received $100000
for interest revenue received in advance. The tax authority taxes
the revenue when it is received.
Accrued expenses: The company has accrued expenses relating to
unpaid salaries amounting to $50000. The amount of the accrual
will be deductible when actually paid.
Loan Payable: The company has a loan with a carrying value of
$40000. The payment of the loan is not deductible.
Required:
Determine the tax base of Scott Dillon Limited's liabilities.
Calculate the DTL or DTA
 Example
Farrelly Limited's statement of financial position
shows that a provision for warranty expenses
exists with a balance of $10000.
All of the provision was created in the current
financial year and no amount have been paid.
The warranty expense is not deductible until such
time as cost associated with the warranty are
actually paid. The tax rate is 30%.
Required: Determine the balance of the deferred
tax asset and provide the relevant journal entries.
 The following formula is applied to derive the tax base from the carrying amount of the asset:
Carrying amount - Future taxable amounts+ Future deductible amount = Tax base

Contains some examples of the calculation of tax bases for assets

Future Future
taxable deductible
CA amounts amounts Tax Base
Prepayments $3000 : fully deductible for tax
whe paid 3000 -3000 0 0

Trade receivables $50000 less $2000

allowance for doubtful debts: sales revenue
is already included in taxable profit 50000 0 2000 52000
Plant and equipment costing $10000 has a
carrying value of $5400: accumulated
depreciation at tax rates is $6500 5400 -5400 3500 3500
Loan receivable $25000: Loan repayment wll
have not tax consequences 25000 0 0 25000
Interest receivable $1000: recoginsedas
revenue but not taxable until received 1000 -1000 0 0
 The following formula can be applied to derive the tax base from the carrying amount of the
liability
Carrying amount + Future taxable amounts- Future deductible amount = Tax base

Future Future
taxable deductible
CA amounts amounts Tax Base
Provision for annual leave $3900: not
deductible for tax until paid 3900 0 -3900 0
Trade payables $34000: Expense already
deducted from taxable income 34000 0 0 34000
Subscription revenue received in advance
$500: Taxed when received. 500 -500 0 0
Loan Payable $20000 : Loan repayment will
have no tax consequences 20000 0 0 20000
Accured expense $6700: deductible when
paid in cash 6700 0 -6700 0
Accured penalties $700: Not tax deductible 700 0 0 700
Calculation of DTA or DTL

CA of assets or Liabilities - TB of assets or liabilities

= Taxable or Deductible temporary difference
* Tax Rate = DTA or DTL

Deferred tax liabilities

Recognise liabilities for all taxable temporary differences

Deferred tax assets

Recognise for deductible temporary differences, unused tax losses, unused tax
credits to the extent that taxable profit will be available against which the asset can
be used.
 Example of Worksheet
Extract from
Accounting
Balance Sheet Deductible Taxable Reval. Surplus Income tax
temporary temporary Tax expense payable
Tax bases differences differences
$ $ $ $ $ $ $
Assets
Cash 60 000 60 000
Accts re net 50 000 60 000 10 000 (10 000)
Prepaid Ins. 20 000 20 000 20 000
Inventory 80 000 80 000
Plantnet 450 000 400 000 50 000 50 000
Land 600 000 400 000 200 000 (200 000)

1 260 000 1 000 000

Liabilities
Accts pay. 60 000 60 000
Prov LSL 30 000 30 000 (30 000)
Prov warty 40 000 40 000 (40 000)
Loan pay. 400 000 400 000
530 000 460 000
Net assets 730 000 540 000

Temporary differences at period end 80 000 270 000 (10 000) (200 000)

Less: Prior period amounts

Movement for the period 80 000 270 000 (10 000) (200 000)

Tax effected at 30% 24 000 81 000 (3 000) (60 000)

Tax on taxable income, 30% x $700 000 210 000 210 000
Income tax adjustments 24 000 81 000 207 000 (60 000) 210 000
 Practice Question
ABC Limited commerce's operations on 1st July 2011 and presents its first statement
of comprehensive Income and statement of financial position of 30th June 2012.
The statements are prepared before considering taxation. The following information is
available:
Statement of comprehensive Income for the year ended 30th June 2012.

Gross Profit 730000

Expense
Administration expenses 80000
Salaries 200000
Long service leave 20000
Warranty expense 30000
Depreciation expense- Plant 80000
Insurance 20000
430000
Accounting profit before tax 300000
Continued.
Assets and Liabilities as disclosed in the statement of financial position as at 30th June 2012
Assets
Cash 20000
Inventory 100000
Accounts receivales 100000
Prepaid Insurance 10000
Plant- Cost 400000
Less Accumulated depreciation 80000
320000
Total assets 550000
Liabilities
Accounts payable 80000
Provision for warranty expenses 20000
Loan payable 200000
Provision for long servce leave expense 20000
Total Liabilities 320000
Net Assets 230000
 Other Information
All administration and salaries expense incurred have been paid. It is not deductible
until it is actually paid.
None of the long service expense has actually been paid. It is not deductible until it is
actually paid.
Warranty expense were accrued and, at the end, actual payments of $10000 had been
made ( leaving an accrued balance of $20000). Deductions are available only when the
amounts are paid and not as they are accrued.
Insurance was initially prepaid to the amount of $30000. At year end, the unused
component of the prepaid insurance amounted to $10000. Actual amounts paid are
allowed as a tax deduction.
Amounts received from sales, including those on credit terms, are taxed at the time
the sale is made.
The plant is depreciated over 5 years for accounting purpose but over 4 years for
taxation purposes.
The tax rate is 30%.

Required:
Prepare a worksheet to calculate the end of reporting period adjustment to DTA or DTL
account as ta 30th June 2012 and show the necessary journal entries.
 Readings
Week 3 Reading 2 The Reputational Costs of
Tax Avoidance
Week 3 Reading 3 Determinants of the
Accounting Change for Income Tax