Tax Effect Accounting (IAS 12) Reference: Text , Chapter 11. Week 3: Lecture 2 Topic: Tax Effect Accounting (IAS 12) Reference: Text , Chapter 11. Complied By: Mrs Maheshwari Chand;T2,2013.

What is tax effect accounting How are companies taxed? What amounts are taxed? How do they? Pay tax? Tax legislations ….. FIRCA - Follow the FITA Companies comply with …. Accounting Standards> So need to adjust accounting profit/ loss to Taxable Profit / Losss. Complied By: Mrs Maheshwari Chand;T2,2013.

Accounting profit vs taxable profit Accounting profit does not equal taxable profit Difference caused by different “rules” used for accounting vs tax purposes ACCOUNTING TAX Basis of accounting Equations Principally cash basis Accruals basis Some exceptions to this Taxable income (TI) – tax deductions (TD) = Taxable profit Revenue – Expenses = Accounting profit IAS 12 & AASB112 and the Corporations Act are key sources that determine the appropriate accounting treatment of transactions The Income Tax Assessment Act determines the tax treatment of transactions Text highlighted in red are parts that should be left blank in student version of PPTs – for completion during lectures Complied By: Mrs Maheshwari Chand;T2,2013.

Taxable temporary differences (TTDs) ITEM ACCOUNTING TAX Passive revenue received in arrears Depreciation (accelerated for tax) R&D costs Prepaid expenses Recognised as revenue, with corresponding asset (receivable) when earned Recognised as TI when cash received Rent, interest, royalties etc Recognised as expense based on useful life of asset Recognised as TD based on predetermined rates Common for assets to be depreciated over a shorter life for tax purposes than for accounting purposes Capitalised and amortised Recognised as TD when paid Recorded as an asset and expensed as incurred Recognised as TD when paid Complied By: Mrs Maheshwari Chand;T2,2013.

Deductible temporary differences (DTDs) ITEM ACCOUNTING TAX Passive revenue received in advance Depreciation (accelerated for acctg) Bad/doubtful debts Employee benefits – eg annual leave Recorded as liability . Recognised as revenue when earned. Recognised as TI when cash received Recognised as expense based on useful life of asset Recognised as TD based on predetermined rates Possible for accounting useful life to be shorter than tax useful life Allowance raised and expense recorded when debt considered doubtful Recognised as a TD when debt physically written off Recognised as TD when payment made to staff Liability raised and expense recorded when debt owing to staff Complied By: Mrs Maheshwari Chand;T2,2013. Provisions (eg for warranties) are treated in the same way as employee benefits

Accounting for income taxes The tax consequences of transactions that occur for accounting purposes during a period should be recognised as income or expense during the current period, regardless of when the tax effects will occur This requires identifying the current and future tax consequences of items recognised in the balance sheet Two separate calculations are performed each year: current tax liability movements in deferred tax balances Complied By: Mrs Maheshwari Chand;T2,2013.

Calculation of current tax Accounting profit/(loss) - acctg revenue not assessable for tax + acctg expenses not deductible for tax +/(-) differences between acctg revenue and TI +/(-) differences between acctg expenses and TDs = Taxable profit x tax rate % = Current tax liability (CTL) Complied By: Mrs Maheshwari Chand;T2,2013.

Calculation of current tax - example $60 allowed as a tax deduction for plant. Interest has not yet been received. Bad debts of $20 were written off during the year. Payments of $30 were made to employees in relation to annual leave taken during the year. The tax rate is 30% Required: Calculate the current tax liability of ABC Ltd for 2008 Profit before tax for ABC Ltd for the year to 30 June 2008 is as follows: Sales 1,000 Interest revenue 40 Government grant 80 COGS (450) Depreciation (50) Goodwill impairment (20) Bad debts (30) Annual leave (10) Other expenses (260) PBT 300 Complied By: Mrs Maheshwari Chand;T2,2013.

Calculation of current tax - example 300 Accounting profit before tax Taxable profit Current tax liability (CTL) (30%) Government grant (80) exempt income Goodwill impairment 20 not deductible Interest not yet received (40) Adjustment for plant depreciation (10) Adjustment for bad debt write-offs 10 Adjustment for annual leave paid (20) 180 54 Acctg depn 50 Tax depn (60) Adj req (10) B/debts expense-acctg 30 B/debts w/off- tax (20) Adj req 10 A/L expense- acctg 10 Paid- tax (30) Adj req (20) Complied By: Mrs Maheshwari Chand;T2,2013.

Recording CTL In our previous example the CTL would be recorded as: Dr Income tax expense (current) 54 Cr Current tax liability 54 Complied By: Mrs Maheshwari Chand;T2,2013.

Temporary differences Arise when the period in which revenue and expenses are recognised for accounting is different from the period in which items are recognised for tax Arise principally due to the accruals vs cash basis of recognising transactions. Differences either result in: The company paying more tax in the future Taxable temporary differences (TTDs) Result in deferred tax liabilities (DTLs) The company paying less tax in the future Deductible temporary differences (DTDs) Result in deferred tax assets (DTAs) Complied By: Mrs Maheshwari Chand;T2,2013.

Temporary differences Certain temporary difference are excluded from being recognised. IAS 12/AASB 112 prohibits temporary differences from being recognised in relation to: Goodwill The initial recognition of assets and liabilities that do not arise from a business combination. Providing certain recognition criteria are met, deductible temporary differences arising from tax losses can lead to the recognition of DTAs. Complied By: Mrs Maheshwari Chand;T2,2013.

Recognition of DTLs and DTAs Deferred tax liabilities Deferred tax liabilities must be recognised in full Deferred tax assets Deferred tax assets relating to temporary differences and tax losses are recognised only if: there are sufficient taxable temporary differences for the entity to use against the deductible temporary differences; OR if it is probable that the entity will have sufficient future taxable profit (against which the tax benefit can be offset) Complied By: Mrs Maheshwari Chand;T2,2013.

Calculation of deferred tax The existence of temporary differences results in the carrying amounts of an entity’s assets and liabilities being different from the amounts that would arise if a balance sheet was prepared for tax authorities Carrying amount (CA)- Tax base (TB)- asset and liability balances that would appear in a “tax balance sheet”. Temporary differences are calculated as follows: asset and liability balances (net of accumulated depreciation, allowances etc) based on accounting balance sheet. CA – TB = TTD/(DTD) Complied By: Mrs Maheshwari Chand;T2,2013.

Recap: Tax Base – ‘is the amt attributed to an asset or liability for tax purpose’. Temporary Difference- ‘is the diff bet the CA of an asset or Liability in the statement of financial position and its tax base’. TTD- ‘Temporary difference that “will result in taxable amounts in determining taxable profit (tax loss) of future periods when carrying amount of an asset or liability if recovered or settled’. DTD- ‘Temporary differences that ‘will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the CA of an asset or liability is recovered or settled’. Complied By: Mrs Maheshwari Chand;T2,2013.

Recap cont’ Thus Temporary differences are calculated as: Deferred tax assets- ‘amounts of income taxes recoverable in future periods and arise from deductible temporary differences’. DTL- ‘are amounts of income taxes payable in the future and arise from taxable temporary differences’. Thus Temporary differences are calculated as: TTD/DTD = CA (A/L) – TB (A/L) DTA/ DTL = DTD/TTD X Tax rate Complied By: Mrs Maheshwari Chand;T2,2013.

Calculating the tax base Calculating the tax base for an asset CA – future taxable amounts + future deductible amounts = TB Calculating the tax base for a liability + future taxable amounts - future deductible amounts Complied By: Mrs Maheshwari Chand;T2,2013.

Calculate TB for an asset/ liability 1. A machine cost $100. for acc and tax purpose , depreciation is of $30, has already been deducted. Calculate the Tax base of Machine (A)??? Current liability includes accrued expenses with a carrying amount of $100. The related expense will be deducted for tax purposes on a cash basis. Calculate the tax base of the accrued exp(L)??? Complied By: Mrs Maheshwari Chand;T2,2013.

Calculating the tax base - examples FTA FDA TB Prepayment: $3,000 Interest receivable:$1,000 Plant: cost $10,000, acctg a/depn $4,600, tax a/depn $6,500 Trade receivables: $52,000 Allowance for b/debts: $2,000 Trade payables: $30,000 Annual leave liability: $3,900 3,000 - 3,000 + - = - 1,000 - 1,000 + - = - 5,400 - 5,400 + 3,500 = 3,500 50,000 - - + 2,000 = 52,000 30,000 + - - - = 30,000 3,900 + - - 3,900 = - Complied By: Mrs Maheshwari Chand;T2,2013.

Calculating the tax base – examples Notes to worksheet: Prepayments- deductible when paid for tax purposes- therefore no balance would appear as an asset in the “tax” balance sheet. Interest receivable- assessable when received- therefore no balance would appear as a receivable asset in the “tax” balance sheet. Plant- WDV for tax purposes = $10,000 - $6,500 = $3,500. Trade receivables- bad debts not deductible for tax until physically written off- therefore the gross trade receivables amount would appear in the “tax” balance sheet. Trade payables- no differences in the treatment of trade payables for tax and accounting purposes- therefore CA = TB. Annual leave liability - deductible when paid for tax purposes- therefore no balance would appear as a liability in the “tax” balance sheet. Complied By: Mrs Maheshwari Chand;T2,2013.

Deferred tax assets and liabilities Calculating a deferred tax asset (DTA) DTD x tax rate % = DTA Calculating a deferred tax liability (DTL) TTD x tax rate % = DTL Recording a DTA/DTL Dr Deferred tax asset Dr/Cr Income tax expense Cr Deferred tax liability The tax rate % is that which is expected to apply when the asset will be realised or the liability settled BALANCING ITEM Complied By: Mrs Maheshwari Chand;T2,2013.

Calculation of deferred tax example The balance sheet of ABC Ltd at 30 June 2008 is as follows: Assets Liabilities Cash 260 Trade payables 296 Trade receivables 300 Loan 485 Allowance for b/debts (30) 270 A/L liability 15 Interest receivable 40 Deferred tax liability 9 Inventory 100 805 Plant 500 Equity Accum dep’n (300) 200 Share capital 700 Goodwill 800 R/earnings 175 Deferred tax asset 10 875 1,680 Complied By: Mrs Maheshwari Chand;T2,2013.

Calculation of deferred tax example The balances in the deferred tax asset and liability accounts are the carried forward closing balances from the prior year Accumulated depreciation of plant for tax purposes is $360 Required: Complete the deferred tax worksheet on the following page and prepare the journal to record deferred tax movements for the 30 June 2008 year. Complied By: Mrs Maheshwari Chand;T2,2013.

Calculation of deferred tax example Relevant assets & liabilities CA FTA FDA TB TTD DTD Trade receivables Interest receivable Plant Goodwill A/L liability Total temporary differences Less: excluded differences Temporary differences DTL/DTA (@ 30%) Less: opening balances Adjustment 270 - 30 300 30 40 40 - - 40 200 200 140 140 60 800 800 - - 800 15 - 15 - 15 900 45 (800) - 100 45 30 13 9 10 21 3 Complied By: Mrs Maheshwari Chand;T2,2013.

Calculation of deferred tax example Notes to worksheet: Items where the CA = TB have been omitted from worksheet (eg cash, payables, loan) 2. IAS 12/AASB 112 does not permit the recognition of a DTL relating to goodwill. The TTD arising is referred to as an “excluded” temporary difference 3. Negative figures in the adjustment section would denote decreases in the DTA/DTL balances during the year Complied By: Mrs Maheshwari Chand;T2,2013.

Calculation of deferred tax example Entry to record deferred tax movement: Dr Deferred tax asset 3 Dr Income tax expense 18 Cr Deferred tax liability 21 Summary: Current tax liability (slide 10) Deferred tax movement(DTL &DTA) Total income tax expense BALANCE 54 18 72 Complied By: Mrs Maheshwari Chand;T2,2013.

Offsetting tax assets and liabilities Both current and deferred tax assets and liabilities are to be offset against each other and a net figure shown in the balance sheet position for: Current tax Deferred tax Complied By: Mrs Maheshwari Chand;T2,2013.

Change in tax rates When a new tax rate is enacted, that new rate should be applied: when calculating current tax liability when calculating adjustments to deferred tax accounts to carried forward deferred tax balances from previous years Complied By: Mrs Maheshwari Chand;T2,2013.

Tax Losses Tax losses are created when allowable deductions exceed assessable income The tax act allows losses to be carried forward and used as a deduction against future taxable income Tax losses provide future deductions and (subject to recognition criteria) create deferred tax assets Exempt income cannot contribute to carry forward losses If prima facie tax loss is $(10 000) but there is exempt income of $2 000 the allowable carry forward loss would be $(8 000) Complied By: Mrs Maheshwari Chand;T2,2013.

Tax Losses Recoupment occurs as soon as the company earns a taxable income Tax loss recouped is recorded in the determination of taxable income and a journal entry raised to reverse the DTA If a prior year’s loss carried forward is being recouped and there is exempt income in the year of recoupment, the exempt income must first be offset against the loss Complied By: Mrs Maheshwari Chand;T2,2013.

Disclosures Tax assets & liabilities must be classified as current or non-current on the face of the statement of financial position Current and deferred tax assets and liabilities can be offset in most cases Tax expense on the statement of comprehensive income .. Refer… IAS 1 Disclosures Complied By: Mrs Maheshwari Chand;T2,2013.

Further Disclosure Standards IAS 1 Presentation of Financial Statements IAS 16 Property Plant and Equipment IAS 12 Income Taxes Complied By: Mrs Maheshwari Chand;T2,2013.

Summary Important concepts: Temporary Differences Tax bases of assets and Liabilities Deferred tax assets, Deferred tax liabilities and current tax Current tax and deferred tax expense (income) Complied By: Mrs Maheshwari Chand;T2,2013.

End of Lecture Refer to illustrative examples for more information End of Lecture Refer to illustrative examples for more information. Thank You. Complied By: Mrs Maheshwari Chand;T2,2013.