Accounting for Income Tax Chapter 6 Accounting for Income Tax

Overview Accounting for Companies is regulated by Australian Accounting Standards Board (AASBs) and Income tax legislation for preparation of specific income tax reports.

Overview Continued Income tax legislation and AASB's may treat items differently Some of these differences will be permanent, such as fines. Other temporary timing differences result from a simple difference on a yearly basis, with the overall treatment being the same (over a period of years).

Overview Continued If the tax and accounting treatment differ in any year due to temporary differences, the result is that in the future more or less tax will be payable. This is the deferred tax asset or liability.

Accounting Profit and Taxable Income 6.1 Accounting Profit and Taxable Income

Permanent Differences Arise when income/expense items are recognised for accounting but never for tax purposes or vice-versa.

Examples Item Accounting Treatment Tax Treatment Receipt of exempt income Recognised as income Not assessable as income Entertainment expenses Recognised as an expense Not allowable deduction unless subject to Fringe Benefits Tax Penalties and fines Recognised as an expense when incurred Not an allowable deduction Impairment of goodwill Recognised as an expense in accordance with AASB 136

Temporary Differences Arise when income/expense items are recognised for accounting but are not assessable/deductible for tax until a future time. The opposite can also apply – income/expense is assessable but not for accounting until a future period.

Example Item Accounting Treatment Tax Treatment Doubtful debts Expense recognised by recording an allowance when a debt is considered doubtful Not an allowable deduction until the debt is deemed bad and physically written off Provision for annual leave / Long service leave Expense is recognised as the employee’s entitlement accrues in accordance with AASB 119 the entitlement is paid to the employee

Reconciliation of Accounting Profit to Taxable Income

6.2 Tax Payable Method

Tax Payable Method The tax payable method may be likened to a cash basis of accounting.

Steps in Tax Payable Method 1. Calculate taxable income 2. Calculate tax payable (Taxable Income * Tax%) 3. Recognise the amount payable: Debit Income Tax Expense (Expense) Credit Current Tax Payable (Liability)

6.3 Tax Effect Method

Tax Effect Method Under tax effect accounting the following is recognised in the Statement of Financial Position: Current Tax Payable Deferred Tax Assets Deferred Tax Liabilities

Tax Effect Accounting Accounting under the two methods differs due to differences between accounting profit and taxable income for a period. A difference results due to how accounting treats a particular item and its corresponding treatment for tax.

Temporary Differences Temporary differences are differences between the carrying amount and tax base of an asset or liability. Temporary difference = Carrying Amount – Tax Base

Temporary Difference Carrying amount is the amount of an asset or liability as recorded in the Statement of Financial Position less depreciation. Tax base is the amount attributable to an asset or liability under the income tax legislation.

Temporary Differences There are two types of temporary differences: Taxable temporary differences and deductible temporary differences

Taxable Temporary Differences (TTDs) Temporary differences that will result in an increase to taxable income in future periods when the carrying amount of the asset or liability is recovered or settled. This means:

Deferred Tax Liability (DTL) The Deferred Tax Liability is calculated as:

Deductable Temporary Differences (DTDs) Temporary differences that will result in a decrease to taxable income in future periods when the asset/liability is settled. The effect of a DTD will be:

Steps in Tax Effect Accounting 1. Calculate taxable income. Accounting profit is adjusted for permanent and temporary differences. 2. Calculate current tax payable (Taxable Income * Tax %) 3. Recognise the expense and the liability for the current tax payable

Steps in Tax Effect Accounting 4. Record tax expense relating to DTD’s: 5. Record tax expense relating to assessable temporary differences:

Steps in Tax Effect Accounting 6. Reserve the effect of timing difference in steps 4 and 5 in future periods when the asset or liability is recovered or settled.

Recognising Deferred Tax Assets and Liabilities 6.4 Recognising Deferred Tax Assets and Liabilities

Account for Deferred Tax Balances Under AASB 112 the following steps are necessary to account for deferred tax balances: Determine the tax base. Categorise the differences into assessable or deductible temporary. Calculate deferred tax assets/liabilities arising from temporary differences.

Step 1: Calculate the tax base. The tax base is the amount attributable to each asset or liability for tax purposes. Calculated by adjusting the accounting carrying amount of the asset or liability for deductions claimable/amounts assessable in the future in respect of that asset or liability.

Step 1: Calculate the Tax Base

Step 1: Calculate the Tax Base A difference between carrying amount and tax base indicates that recovery or settlement of the asset or liability will make future tax payments larger or smaller.

Step 1: Calculate the Tax Base The future deductible amounts are the remaining amounts that will be deductible in future years. The future assessable amounts are the future income streams expected to be derived from use of the asset but not exceeding the accounting carrying amount.

Step 2: Determine Taxable or Deductible Temporary (Timing) Differences Under AASB 112, temporary differences are equal to the difference between the carrying amount of an asset or liability and its tax base.

Step 2 Determine Taxable or Deductible Temporary (Timing) Differences

Step 3: Calculate and Recognise Temporary Differences The TTD will result in payment of more tax in the future.

Step 3: Calculate and Recognise Temporary Differences The temporary difference will result in payment of less tax in the future, and represents an asset that will be realised in the future.

Step 3: Offsetting Deferred Tax Under AASB 112, companies can offset deferred tax asset and deferred tax liability balances if there is no legal impediment.

Temporary Differences from Tax Losses 6.5 Temporary Differences from Tax Losses

Temporary Differences from Tax Losses When allowable deductions exceed assessable income, a tax loss results. This tax loss can be carried forward to future income tax years to reduce taxable income in those years.

Temporary Differences from Tax Losses Under AASB 112, a deferred tax asset must be recognised for the carry forward of unused tax losses when it is probable that the company will earn future income to utilise those tax losses.

Reversal of Temporary Differences 6.6 Reversal of Temporary Differences

Temporary Differences Reversal Temporary differences result from differences between taxable income and accounting profit. By definition all temporary differences will reverse.