1. Topic 9: Accounting for Income Taxes
Financial Accounting BFA201
BFA201_13

2. Readings and references
Deegan Chapter 18
AASB 112 Income Taxes
This week’s reading only relates to PP&E.
Looks like a lot of reading…. ALL revision – just scan to make sure you remember it all. Note that Ch 7 was not mentioned in Unit Outline – that relates to inventory, should be revision for you.

3. Independent Study Tasks
Tutorial questions (for workbooks)
Tutorial Question 1 Deegan 7th ed, Ch. 18, Review Question 6 (p. 655)
 Tutorial Question 2 Deegan 7th ed, Ch. 18, Review Question 10 (p. 655)
 Tutorial Question 3: Deegan 7th ed, Ch. 18, Challenging Question 22 (p. 657)
 Tutorial Question 4: Deegan 7th ed, Ch. 18, Challenging Question 23 (p. 658)
Independent study questions
Chapter 18 – Review Question 1
Chapter 18 – Review Question 9
Chapter Review Question 13
Chapter 18 – Review Question 17

4. Learning Objectives BFA201 Financial Accounting - Income Tax
Identify differences between tax and accounting
Understand DTA and DTL
Understand how to account for
changes in tax rates;
tax effect of revaluations;
tax losses
Evaluation of tax effect accounting
Identify the major differences between tax and accounting treatments
Understand how deferred tax assets and deferred tax liabilities arise
Understand how to account for taxation losses
Be able to critically evaluate the balance sheet approach to accounting for taxation
BFA201 Financial Accounting - Income Tax

5. Key Concepts BFA201 Financial Accounting - Income Tax
Temporary differences
Balance sheet approach
Deferred tax assets/liabilities
Carrying amount
Tax base
BFA201 Financial Accounting - Income Tax

6. The Tax Payable Method

7. Tax Payable Method
The method taught in BFA104 (but now we have to learn about tax effect accounting under AASB 112)
This method is based on the view that the amount paid to the ATO is an appropriation of profits by the government.
The income tax expense for the period is the same amount as the income tax payable for the same period.
A balance day adjustment is recorded for income tax based on an estimate of the tax liability at the end of the financial year.
Any over/under provision of tax is accounted for when an assessment is received from the ATO

8. Tax Payable Method
Example: Assume that Freds Ltd has estimated tax payable for the year to be $12,500 as at 30 June 20xx.
Date $
30 June
Income Tax Expense
Income Tax Payable (L)
12 500
An ATO assessment notice assesses the tax to be paid by Fred Ltd at $13,000. This is payable on 10 September:
10 Sept
Income tax Payable (L)
Cash
13 000
Underprovision of IncomeTax Payable (E)
Income tax payable (L)
500

9. Why a Revised Tax Effect Standard?
Development of a conceptual framework in which a balance sheet approach was adopted.
The definition of expense and revenue is dependent on the definition of assets and liabilities.
Equity is a function of the definition of assets and liabilities (ie. a residual)
AASB 112 adopts the balance sheet approach
The approaches adopted de-emphasise the matching process

10. Why is Net Profit according to GAAP different from Taxable Income?

11. Accounting for Income Tax
Accounting Profit (Accounting Standards) = /
Taxable Income (Income Tax Legislation)
Accounting profit is not the same as taxable profit
Tax expense for accounting purposes (income statement) calculated after applying relevant accounting standards
Income tax payable to Tax Office (balance sheet) based on taxable profit derived by the entity applying the rules of taxation law
BFA201 Financial Accounting - Income Tax

12. Accounting Profit and Taxable Income
Income tax payable is based on assessable/taxable income in accord with the Income tax Assessment Act 1997.
Accounting profit is determined in line with various accounting rules (AASB conceptual framework, accounting standards, accepted accounting principles)
Rules are therefore different (eg revenue received in advance)

13. Accounting versus Taxation Income
Income for taxation purposes is known as taxable income
Determined in accordance with Australian income tax legislation, not according to general accounting rules
Differences in accounting and taxation revenue and expenses recognition principles
Governed by AASB 112

14. Accounting Tax Revenue Assessable income Less expenses
=Accounting Profit (NPBT)
X tax rate =
INCOME TAX EXPENSE
Assessable income
Less allowable deductions
= Taxable Income
X tax rate (less offsets)
TAX PAYABLE
Accounting profit which is determined by following accounting standards and other accounting rules is different to taxable profit (sometimes called “taxable income”) which is determined by following Australian income tax legislation.
(Note that in the tax legislation “assessable income” less “allowable deductions” equals taxable profit. Companies are taxed at a flat rate on their taxable profit. The rate at present is 30%. Many businesses in Australia pay their tax in quarterly installments.)
Income for taxation purposes is known as taxable income determined in accordance with Australian income tax legislation, not according to general accounting rules. Differences between accounting principles of revenue and expense recognition and taxation principles
Accounting profit is therefore not the same as taxable profit: Tax expense for accounting purposes (income statement) calculated after applying relevant accounting standards. Income tax payable to Tax Office (balance sheet) based on taxable profit derived by the entity applying the rules of taxation law
Income tax payable is amount that must be paid to the government – also know as the CURRENT TAX LIABILITY
Calculated by applying the company income tax rate to taxable income
Income tax expense is amount of income tax shown as an expense on the income statement, not necessarily same as income tax payable
BFA201 Financial Accounting - Income Tax

15. Reconciliation statement
Need to reconcile accounting profit and taxable income
Differences in:
Accounting and assessable income
Depreciation
Non deductible expenditure
Exempt income
Special deductions
As there is a difference between accounting and tax profit, we need to reconcile them.

16. Lecture Example 9-1

17. Accounting profit and taxable income – examples of differences
Transactions
Accounting treatment
Taxation treatment
Rental revenues
Recorded as a liability if received in advance
Assessable when cash is received
Interest revenue
Recorded as revenue as it accrues
Assessable when received
Depreciation of assets
Expense
Deduction allowed, usually at an accelerated rate to accounting, no scrap value included in calculation
Long service leave/sick leave
Recorded as an expense as it accrues overtime
A deduction is allowed when the leave is taken
Entertainment and
Goodwill impairment
Treated as an expense
Not a tax deduction in current or subsequent periods
Fines and penalties
Recorded as an expense when incurred
A deduction is not allowed
The main reason for the difference between accounting rules and tax rules is that accounting rules are based on accrual principles and some of the tax rules are cash based. Example:
revenue that is received in advance is recorded for accounting purposes when earned but is taxed when received
expenses (such as interest) recorded for accounting purposes when accrued are only recognised as a tax deduction when paid
expenses that are prepaid are recorded for accounting purposes when economic benefits are used but can be recorded as a tax deduction when paid
bad debts expense is estimated in the period of sale for accounting purposes but is only recognised as a tax deduction when written off
Provisions for long service leave or sick leave – Dr LSL expense and CR Liability account as that liability accrues overtime – but only allowed as a deduction when the leave is taken and the employee is actually paid.
Depreciation rates are different for accounting and tax – in accounting depreciation is meant to be the allocation of cost over the period you will derive economic benefits. For tax we use the Ruling that states the effective life for each asset, and a formula is legislated – often the resultant rate is greater than used in accounting, with no salvage value used.
development expenditure may be deferred for accounting purposes but can be recognised as a tax deduction when paid
amounts spent on entertainment are expenses for accounting purposes but usually not deductible
BFA201 Financial Accounting - Income Tax

18. Accounting profit and taxable income – cont.
Transactions
Accounting treatment
Taxation treatment
Insurance costs
Recorded as an asset and expensed over time of cover
A deduction is allowed when paid
Product warranties
Recorded as an expense and liability on sale of goods
A deduction is allowed when warranty costs are incurred
Bad and doubtful debts
Recorded as an expense if doubtful
A deduction is allowed when written off
Revaluation of non-current assets
Recorded depreciation as an expense on the revalued carrying amount
A deduction is only allowed on the original cost, not the revalued amount
Tax losses
Not recognised
An offset is allowed against future taxable inccome.

19. The Balance Sheet Approach under AASB 112: Tax Effect Accounting

20. The Balance Sheet Approach Under AASB 112
Focuses on comparing the carrying value of an entity’s assets and liabilities (determined by accounting rules) with the tax base for those assets and liabilities (determined by taxation rules)
comparing balance sheet derived using accounting rules with balance sheet derived from taxation rules
Recognises Deferred Tax Assets and Deferred Tax Liabilities –
i.e. benefits we will get from having paid more tax now – have an asset to use against any expense we might have in later years – DTA;
on the other hand we might have an obligation to pay more tax in the future – that obligation is a liability so we are deferring that liability until later- DTL

21. AASB112 prescribes accounting treatment for income taxes
In Balance Sheet:
CURRENT income tax (Tax Legislation)
FUTURE tax consequences**
“Tax Effect Accounting”…. because accounting and tax rules differ
In Income Statement:
Income tax expense (based on acc profit)
In Other Comprehensive Income Statement:
Tax related to OCI
AASB112 prescribes accounting treatment for Current Tax Consequences – based on assessment of tax income or tax loss as per Aust. Income tax legislation
FUTURE tax consequences is the main focus of AASB112 – it recognises Deferred Tax Assets and Deferred Tax Liabilities –
i.e. benefits we will get from having paid more tax now – have an asset to use against any expense we might have in later years – DTA; on the other hand we might have an obligation to pay more tax in the future – that obligation is a liability so we are deferring that liability until later.
The focus on future tax consequences is commonly referred to as TAX EFFECT ACCOUNTING. Must recognise CURRENT & FUTURE tax consequences. Income tax expense = Current tax liability (benefit) + ↑↓future tax consequences
Income tax expense i.e. Current tax + ↑↓future (deferred) tax
If a transaction is recognised in P&L for the period, the related tax expense or benefit must be recognised at the same time.
In the same way amount in OCI or equity also must have the related tax effect recognised
BFA201 Financial Accounting - Income Tax

22. AASB112 BFA201 Financial Accounting - Income Tax
Accounting for the differences between accounting and tax rules:
Two separate calculations are performed each year:
Current tax liability (tax payable)
Movements in deferred tax balances
BFA201 Financial Accounting - Income Tax

23. Calculation of current tax
Accounting profit/loss
- accounting revenue not assessable for tax
+ accounting expenses not deductible for tax
+/(-) differences between accounting revenue and tax income
+/(-) differences between accounting expenses and tax deductions
= Taxable profit (Taxable Income)
x tax rate %
= Current tax liability (Tax Payable)
This is the same as our earlier reconciliation statement, the only difference is that we are multiplying it by the tax rate to get the current tax liability.
Para 5 definition: Current tax = amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period.
BFA201 Financial Accounting - Income Tax

24. Lecture Example 9-2

25. Calculation of current tax - example
Depreciation allowed for tax $60.
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.
Govt grant exempt for tax.
The tax rate is 30%
Required:
Calculate the current tax liability of PQR Ltd for 2010
Profit before tax for PQR Ltd for the year to 30 June 2010 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)
NPBT
300
There are a few things here that you may not know. We have discussed depreciation and interest.
Goodwill impairment – AASB 112 para 21 prohibits goodwill impairment from being recognised from initial recognition (also ATO does not permit it).
Bad debts and annual leave expenses (or long service leave, or personal leave) often come about because we raise a provision – tax only allows these when they have been incurred (paid).
See if you can calculate the current tax.

26. Calculation of current tax - example
Accounting Profit
300
Add (back)
Goodwill impairment (not deductible ) 20
Depreciation of plant (Acc NOT Tax) 50
Bad debts expense 30
Annual leave expense 10
110
Deduct
Government grant (tax exempt)
(80)
Interest (not yet received)
(40)
Depreciation of plant (for tax purposes)
(60)
Write off bad debts
(20)
Annual leave PAID
(30)
(230)
Taxable income
180
Current tax liability at 30% 54
Acctg depn 50
Tax depn (60)
Adj req (10)
not deductible
B/debts expense-acctg 30
B/debts w/off- tax (20)
Adj req
exempt income
A/L expense- acctg 10
Paid- tax (30)
Adj req (20)
BFA201 Financial Accounting - Income Tax

27. Recording Current Tax Liability
Journal entry:
Dr Current income tax expense 54
Cr Current tax liability (or tax payable) 54
Recognising the current tax liability, based on the current tax income for the year
Note: Income Tax Expense (accounting)
= Current + deferred tax expense
From the previous slide we end up with a current tax liability (what we need to pay the ATO) of $54:
Dr Current tax expense
Cr Current tax liability
DIFFERENT to income tax expense from accounting
Accounting profit 300 – 80(exempt – permanent difference) = 220 x 30% = 90 (Income tax expense) = Current + deferred tax expense
BFA201 Financial Accounting - Income Tax

28. Carrying Amount Vs Tax Base of Asset or Liability
Carrying amount is the amount the asset or liability is recorded at in the accounting records
Tax base is defined as the amount that is attributed to an asset or liability for tax purposes
Where the tax base is different from the carrying amount a ‘temporary difference’ can arise

29. Temporary Differences
An assessable temporary difference:
will result in an increase (decrease) in income tax payable (recoverable) in future periods when the carrying amount of the asset or liability is recovered or settled
creates a liability - deferred tax liability
A deductible temporary difference:
will result in a decrease (increase) in income tax payable (recoverable) in future periods when the carrying amount of the asset or liability is recovered or settled
creates an asset - deferred tax asset

30. Deferred Tax Liability Vs Deferred Tax Asset
the carrying amount of the asset exceeds the tax base
taxation payments have effectively been deferred to future periods
tax is reduced or ‘saved’ in early years, but additional tax will need to be paid later
Deferred tax asset:
the carrying amount of an asset is less than the tax base
Income tax expense has been higher in the early periods
In a future period, there will be a tax benefit because the carrying amount will be zero, but there will still be a tax deduction.

31. Example of Deferred Tax Liability
Carrying amount of a non-current depreciable asset exceeds the tax base in early years, as depreciation allowable as a deduction for tax purposes is greater than depreciation for accounting purposes
This will be reversed in later years when no depreciation is allowable for tax purposes

32. Example of Deferred Tax Asset
Tax base of a depreciable asset exceeds the carrying amount in early years, as depreciation allowable as a deduction for tax purposes is less than depreciation for accounting purposes
This will be reversed in later years when the asset is fully depreciated for accounting purposes, but depreciation is still allowable as a deduction for tax purposes

33. Income Tax Expense
Represents the sum of the tax attributable to the taxable income, plus or minus any adjustments relating to temporary differences
Defined in AASB 112 as:
the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax

34. Income Tax Payable
The amount of tax generally expected to be paid, as a result of the year’s operations, within the next financial period
Under balance sheet method income tax payable does not necessarily equate to tax expense
tax expense is affected by temporary differences

35. Calculation of Income Tax Payable
Income tax payable is based on taxable income
Calculation of income tax payable:
tax rate multiplied by taxable income

36. Journal Entry to Record Income Tax Expense
If deferred tax asset:
to recognise tax expense that relates to the temporary difference:
Dr Deferred tax asset (temp. difference x tax rate)
Cr Income tax expense
to recognise tax expense that relates to the entity’s taxable income:
Dr Income tax expense
Cr Income tax payable

37. Journal Entry to Record Income Tax Expense
If deferred tax liability:
to recognise tax expense that relates to the temporary difference:
Dr Income tax expense
Cr Deferred tax liability (temp. difference x tax rate)
to recognise tax expense that relates to the entity’s taxable income:
Cr Income tax payable

38. Reversal in Future Periods
In future periods, timing differences will reverse
deferred tax asset will be credited
deferred tax liability will be debited

39. Deferred Tax: Differences
Permanent or temporary
Permanent differences = transactions are NEVER recognised as part of taxable profit (or vice versa)
No accounting required for permanent differences other than disclosure in the notes
Differences can be permanent or temporary. Permanent differences arise where the treatment of transactions are NEVER recognised as part of taxable profit (or vice versa) eg. entertainment costs; fines or penalties; government grant from our last example
No accounting required for permanent differences other than disclosure in the notes
Examples of permanent differences are:
Where income is recognised for accounting purposes that is tax exempt.
Where expenses are recognised for accounting purposes that are not allowable deductions.
Where expenses are allowed for tax purposes that are not recognised for accounting purposes.
Where assessable income is not recognised for accounting purposes.

40. Deferred Tax: Temporary differences
Deferred tax liabilities (DTLs) and deferred tax assets (DTAs):
Arise because of temporary differences between the carrying amount and tax base of an asset
They are removed from the accounts on reversal of the 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 (timing difference)

41. Temporary Differences
These differences are either:
Taxable or deductible
1. The company paying more tax in the future
Taxable temporary differences (TTDs)
Result in deferred tax liabilities (DTLs)
2. The company paying less tax in the future
Deductible temporary differences (DTDs)
Result in deferred tax assets (DTAs)
Certain temporary difference are excluded from being recognised.
AASB 112 prohibits temporary differences from being recognised in relation to initial recognition of goodwill.
Providing certain recognition criteria are met, deductible temporary differences arising from tax losses can lead to the recognition of DTAs.
Company paying more tax in the future (less now) means it increases a liability in the future.
Company pays less tax in the future (more now) means there will be a benefit in the future.
BFA201 Financial Accounting - Income Tax

42. Depreciation example
Captain Ltd had a depreciable asset costing $100,000 and a zero residual value:
For accounting purposes:
The asset was depreciated over 4 years on a straight-line basis
For taxation purposes:
The asset had an effective life of 4 years and was depreciated on a diminishing value basis.

43. Temporary differences
Depreciation expenses for accounting and tax purposes:
Taxation: Yr 1 100,000 x 200%/4 = 50,000
Yr 2 50,000 x 200%/4 = 25,000
Yr 3 25,000 x 200%/4 = 12,500
Yr 4 12,500 x 200%/4 = 6,250

44. AASB 112: Balance Sheet approach
COMPARES:
carrying amounts for assets and liabilities (determined by accounting rules) WITH
the value that those assets and liabilities would have if a balance sheet was prepared following income tax rules (their tax base).
To account for this difference, AASB 112 “Income taxes” takes a “balance sheet” approach: derived using accounting rules with a balance sheet derived from taxation rules
Carrying amount is the amount the asset or liability is recorded at in the accounting records
Tax base is the amount the asset or liability would be recorded at if the balance sheet were prepared applying taxation rules

45. Balance sheet approach: depreciation
Yr 1 end:
Accounting records:
Cost $100,000
Accum dep (25,000)
Carrying amt $75,000
Yr 1 end:
TAX records:
Cost $100,000
Accum dep (50,000)
TAX BASE = $50,000
Difference = $ 25,000
Temporary difference
The carrying amount of the asset in the accounting records at the end of the first year would be:
$100,000 (Cost) Less $25,000 (Accumulated depreciation) = $75,000
The tax base of an asset or liability is: The amount at which the asset (or liability) would be shown in a balance sheet derived from accounts prepared for tax purposes.
In this example, the asset’s tax base at the end of the first year would be:
$100,000 (Cost) Less $50,000 (Accumulated depreciation) = $50,000
Different depreciation charges result in temporary differences between the carrying amount and tax base of the asset
The use of diminishing value depreciation for tax purposes has deferred the payment of some tax until later periods
Temporary differences will reverse in future periods (years 3 and 4), i.e. depreciation expense for accounting purposes will become greater than depreciation claimed for tax purposes
The amount of the deferral is: The excess of the carrying amount over the tax base of the asset multiplied by the tax rate i.e. $25,000 X 0.30 = $7,500 Using diminishing value instead of straight-line depreciation for tax purposes has ‘saved’ $7,500 tax in the first year that will have to be paid in the future.
These differences between the accounting and tax treatments for a depreciable asset give rise to FUTURE TAX CONSEQUENCES
BFA201 Financial Accounting - Income Tax

46. Another Small Example of Tax Effect Accounting

47. Example: Deferred Tax Liability
Machine cost $200,000 in 2000
Depreciation for accounting purposes: 5 years, no residual, straight line basis
Tax rate 30%
Depreciation for tax purposes: 4 years, no residual, straight line basis
After One Year
Carrying Amount
Tax Base
Cost
200,000
Less Acc. Depn
40,000
50,000
160,000
150,000

48. Second year After Two Years Carrying Amount Tax Base Cost 200,000
Less Acc. Depn
80,000
100,000
120,000

49. Third year After Three Years Carrying Amount Tax Base Cost 200,000
Less Acc. Depn
120,000
150,000
80,000
50,000

50. Fourth Year After Four Years Carrying Amount Tax Base Cost 200,000
Less Acc. Depn
160,000
40,000

51. Fifth Year After Five Years Carrying Amount Tax Base Cost 200,000
Less Acc. Depn

52. In the last year, there will be no deduction for tax purposes,
In this situation the tax office has granted a greater deduction relative to the consumption of the economic benefit
BUT the tax deduction is over 4 years – in the 5th there is NO deduction.
In the last year, there will be no deduction for tax purposes,
2001
2002
2003
2004
2005
Accounting Profit
500,000
600,000
650,000
700,000
800,000
Add Accounting Depreciation
40,000
Less Tax Depreciation
(50,000)
Taxable Income
490,000
590,000
640,000
690,000
840,000
Tax Payable
147,000
177,000
192,000
207,000
252,000

53. What you gain in the first 4 years you lose in the 5th
Reduced tax years 1 to % = $3,000 per year
In the fifth year you have run out of tax deductions for depreciation.
So therefore the tax liability is deferred not eliminated.

54. First Year Income tax expense 3,000 Deferred tax liability 147,000
Income tax payable

55. Second Year Income tax expense 3,000 Deferred tax liability 177,000
Income tax payable

56. Third Year Income tax expense 3,000 Deferred tax liability 192,000
Income tax payable

57. Fourth Year Income tax expense 3,000 Deferred tax liability 207,000
Income tax payable

58. Fifth Year Deferred tax liability 12,000 Income tax expense 252,000
Income tax payable

59. Calculation of deferred tax
CA – TB = TTD / (DTD)
Carrying amount (CA) = asset and liability balances (net of accumulated depreciation, allowances etc) based on ACCOUNTING balance sheet
Tax Base (TB) – asset and liability balances that would appear in a “TAX” balance sheet

60. Calculating the tax base
For an asset: CA
– future taxable amounts
+ future deductible amounts
= TB
For a liability:
+ future taxable amounts
- future deductible amounts

61. Calculating the tax bases of assets and working out the temporary differences

62. Example – tax base for assets
A depreciable asset, not revalued, intended for use in the business.
Hairy Co purchased an asset on 1 July 2011 for $100,000. For accounting purposes depreciation is charged at 10% pa straight line and the rate for tax purposes is 25% straight line. Residual value is zero.
One year later, at 30 June 2012, depreciation is as follows:
Accounting
Tax
Cost
100,000
Less Depreciation
10,000
25,000
Carrying Amount
90,000
Tax Base
75,000 OR
Tax Base = carrying amount – future taxable amount + future deductible amount
= 90,000 – 90, ,000
= 75,000
There are two tax effects involved:
Deductible amount: the amount that can be deducted from assessable income in arriving at taxable income in the future (as we have been able to deduct a higher amount of depreciation – 25,000 compared to 10,000, we have less to deduct in the future).
Taxable (assessable) amount: the income expected to be generated by using the asset.
This is very similar to how we reconciled accounting to tax profit at the very beginning.
BFA201 Financial Accounting - Income Tax

63. Example – tax base for assets
Carrying amount – tax base
90,000 – 75,000 = temporary difference $15,000
DTL $4,500 ($15,000 x 30% tax rate)
Deferred tax liability = taxable temporary difference x tax rate
The future taxable amount is greater than the future deductible amount therefore more tax is payable in the future.
Payment of tax is reduced or ‘saved’ in early years, but additional tax will need to be paid later
Taxation payments have effectively been deferred to future periods. This is because taxable allowable deductions for depreciation are higher, so taxable income is lower, so less tax is paid. However this is a timing difference, so this will be reversed later.
BFA201 Financial Accounting - Income Tax

64. Calculating the tax bases of liabilities and working out the temporary differences

65. Example – tax base for liabilities
Provisions for employee benefits such as long service leave
Hairy Co has a balance in the provision for long service leave of $40,000 at 30 June This amount is fully deductible when paid.
Accounting
Tax
Carrying Amount
40,000
Tax Base
------ OR
Tax Base = carrying amount – future deductible amount + future taxable amount
= 40,000 – 40,
= 0
Calculation of tax base for liabilities can also be determined by formula:
Carrying amount – future deductible amount + future taxable amount (for liabilities future taxable amount = 0)
Exception to the rule
tax base of a liability that is in the nature of ‘revenue received in advance’ must be calculated as the liability’s carrying amount less any amount of the revenue received in advance that has been included in assessable amounts in the current or a previous reporting period. This will result in a deferred tax asset.
BFA201 Financial Accounting - Income Tax

66. Example – tax base for liabilities
Carrying amount – tax base
40,000 – 0 = temporary difference $40,000
DTA $12,000 ($40,000 x 30% tax rate)
The future taxable amount is less than the future deductible amount so less tax will be paid in the future
BFA201 Financial Accounting - Income Tax

67. Calculating the tax base - examples
Hairy Co CA
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, , =
1, , =
5, , ,500 = 3,500
50, , = 52,000
30, = 30,000
3, , = -
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.
BFA201 Financial Accounting - Income Tax

68. Important rules

69. Deferred tax liability Deferred tax asset Assets
Tax base of an asset = Carrying amount + Future deductible amount – Future assessable amount
Tax base of a liability = Carrying amount – Future deductible amount + Future assessable amount
Deferred tax liability
Deferred tax asset
Assets
Carrying amount > Tax base
Carrying amount < Tax base
Liabilities

70. Deferred Tax Assets and Deferred Tax Liabilities
deferred tax liability arises when:
carrying amount > tax base
deferred tax asset arises when:
carrying amount < tax base
Liabilities:

71. Classification of temporary differences and measurement of deferred tax balances.
Carrying Amount of asset
>
Tax base of asset
<
Carrying Amount of liability
Tax base of liability
Difference =
Assessable temporary difference times the tax rate
= Deferred tax liability
= Deferred tax asset
Examples: depreciation, rent/interest receivable, prepaid rent/insurance, assets revalued upwards from original cost.
Examples: accounts receivable with a provision for doubtful debts
Examples: provision for long service leave, annual leave, warranties, rent paid in arrears, rent received in advance
Examples: hybrid securities such as convertible notes that are apportioned between debt and equity components for accounting purposes but treated as wholly debt for tax purposes.

72. Summary Assets: Liabilities: DTL = Carrying amount > Tax base
DTA = Tax base > Carrying amount
Liabilities:
DTA = Carrying amount > Tax base
DTL = Tax base > Carrying amount
Assets:
deferred tax liability arises when: carrying amount > tax base
deferred tax asset arises when carrying amount < tax base
Liabilities:
deferred tax liability arises when: carrying amount < tax base
deferred tax asset arises when: carrying amount > tax base

73. 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 (deferred)
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

74. Worksheet Methodology

75. Lecture Example 9-3

76. Calculation of deferred tax example
The balance sheet of PQR Ltd at 30 June 2010 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
Accumulated depreciation of plant for tax purposes is $360
Calculate DTA & DTL for 2010 and prepare the journal entries to record deferred tax movements for the 30 June 2010 year.

77. Calculation of deferred tax example
Relevant assets & liabilities CA
FTA
FDA TB
DTD
TTD
Trade receivables
270 - 30
300
Interest receivable 40
Plant
200
140 60
Goodwill
800
Annual Leave liability 15
Total temporary differences 45
900
Less: excluded differences
(800)
Temporary differences
100
DTA; DTL 30%) 13
Less: opening balances 10 9
Adjustment 3 21
Notes to worksheet:
Items where the CA = TB have been omitted from worksheet (eg cash, payables, loan)
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
Can skip FTA and FDA columns if can calculate tax base. Deegan doesn’t use the extra columns.
DTD x tax rate = DTA
TTD x tax rate = DTL
BFA201 Financial Accounting - Income Tax

78. Calculation of deferred tax example
Entry to record deferred tax movement:
Dr Deferred tax asset 3
Dr Income tax expense (deferred)
Cr Deferred tax liability
Summary:
Current tax liability (slide 35) 54
Deferred tax movement 18
Total income tax expense 72
BALANCE
NOTE (from slide 34) : Accounting Profit (Permanent differences 80 +(20)) = 240 x 30% = 72 (Income tax expense)
Accounting Profit (20)= x 30% = 72 (Income tax expense)
80 = Gov grant – exempt
(20) = goodwill impairment – not deductible
BFA201 Financial Accounting - Income Tax

79. Changes in tax rates

80. Tax Rate Changes Existing DTL Existing DTA Expense Tax rate Tax rate
Income
Tax rate
Income
Expense
BFA201_13
Tax rates will change across time and will have implications for value to be attributed to pre-existing deferred tax assets and deferred tax liabilities
An increase in tax rates will create an expense (which will be of the nature of income tax expense) when an entity has deferred tax liabilities, and will create income in the presence of deferred tax assets
Conversely, a decrease in tax rates will create income when an entity has deferred tax liabilities, whereas a decrease will create an expense in the presence of deferred tax assets
BFA201 Financial Accounting - Income Tax

81. Tax rate changes example
For tax purposes AGRO Co has the following deferred tax balances as at 1 July 2015:
Deferred tax asset $
Deferred tax liability $
The above balances were calculated when the tax rate was 30%. On 1 August 2015 the government reduced the corporate tax rate to 28%.
Provide the journal entries to adjust the carry-forward balances of the deferred tax asset and deferred tax liability.
BFA201_13
BFA201 Financial Accounting - Income Tax

82. Tax rate changes example
Balance at Balance at Change
1 July August 2015
DTA $ $
x 28/30 = $ ($33,333)
DTL $ $
× 28/30 = $ ($20 000)
OR x (30-28)/30 = 33,333
x (30-28)/30 = 20,000
The accounting entry at 1 August 2015 would be:
Dr Deferred tax liability
Dr Income tax exp. (deferred)
Cr Deferred tax asset
BFA201 Financial Accounting - Income Tax

83. Lecture Example 9-4

84. BFA201 Financial Accounting - Income Tax
Lecture Case Study
BFA201 Financial Accounting - Income Tax

85. Solution to Case Study BFA201 Financial Accounting - Income Tax
Step 1 – Calculate taxable profit
BFA201_13
If given tax profit NOT accounting profit – need to do the opposite.
BFA201 Financial Accounting - Income Tax

86. Solution to Case Study cont.
Step 2 – Calculate temporary differences
BFA201_13
If given tax profit NOT accounting profit – need to do the opposite.
DTD x tax rate = DTA
TTD x tax rate = DTL
This table is the shorter version – misses out calculating the extra 2 columns which is fine as long as you can calculate the tax base.
BFA201 Financial Accounting - Income Tax

87. Lecture Case Study BFA201 Financial Accounting - Income Tax
Offsetting deferred tax liabilities and deferred tax assets
Offsetting Rule (para 71)
Deferred tax liability 2,520
Deferred tax asset 2,520
DTAs and DTLs shall be offset for balance sheet purposes only if (AASB 112):
The entity has a legally enforceable right to set off current tax assets and current tax liabilities; and
The DTAs and DTLs relate to taxation levied by the same taxation authority on the same taxable entity; or
Different taxable entities which intend either to settle current tax liabilities and assets on a net basis, or to realise the assets and settle the liabilities simultaneously
BFA201 Financial Accounting - Income Tax

88. Revaluation of non-current assets

89. Revaluation of Non-current Assets
Revaluations can create temporary differences according to AASB 112 para 20
Tax base not affected by revaluation as depreciation for tax purposes continues to be based on original cost
Revaluation of asset which recognises an increase in fair value implies an expected increase in future flow of economic benefits
increase can be taxable and lead to deferred tax liability if new carrying amount is greater than tax base

90. Revaluation of Non-current Assets
AASB 112 requires that, to the extent that the deferred tax relates to amounts that were previously recognised in equity as either direct credits or direct debits (as is the case with asset revaluations) the journal entry to recognise deferred tax asset or liability be adjusted against the equity account:
Dr Revaluation surplus
Cr Deferred tax liability
Entry assumes that the revalued amount of the asset will be recovered by the entity’s continued use of the asset.

91. Revaluation of Non-Current Assets Example
Tax Ltd acquired land 2 years ago for $450,000
Its fair value now is $600,000
The tax rate is 30%
Land
Revaluation surplus
Revaluation reserve
45 000
Deferred tax liability

92. Revaluation of Non-Current Assets Example
Accounting
Tax
Cost
Accumulated depreciation -
Carrying value
Tax base Or
Carrying amount + Future deductible amount – Future taxable amount = Tax base
– =
If the carrying amount of an asset $ is greater than the tax base of the asset $ , this leads to a deferred tax liability of x .30 = $45 000

93. Other movements: Revaluations
Revaluations NCA Temporary difference
Accounting CA ≠ Tax base (no change)
Acc. depreciation based on revalued amount
Tax depreciation based on original cost
Revaluation increments Equity
Related tax recognised in OCI & adjusted against equity
Dr Revaluation surplus xxx
Cr Deferred tax liability xxx
According to AASB 112 (par. 20) revaluations of non-current assets can create temporary differences
When non-current assets are revalued, the revaluation increment is not deductible for tax purposes, even though depreciation for accounting purposes will be based on the revalued amount
The tax base is not affected by the revaluation because depreciation for tax purposes will be based on the original cost of the asset
However, any increase in the carrying value of a non-current asset through a revaluation undertaken to recognise an increase in fair value implies an expected increase in the future flow of economic benefits
Para 61A requires the related deferred tax to be recognised in other comprehensive income. This increase can be taxable and can lead to a deferred tax liability if the carrying amount is greater than the tax base (refer to AASB 112, par. 20)
Unlike previous examples where the temporary difference is adjusted against income tax expense, asset reval give rise to a special case
AASB 112 requires that, to the extent that the deferred tax relates to amounts that were previously recognised in equity as either direct credits or direct debits, the journal entry to recognise the deferred tax asset or liability must also be adjusted against the equity account
AASB 112 (par. 61) current tax and deferred tax shall be charged or credited directly to equity if the tax relates to items that are credited or charged, in the same or a different period, directly to equity
As the revaluation is adjusted against equity (revaluation surplus account), the accounting entry to record the recognition of the deferred tax liability is Dr Revaluation surplus Cr Deferred tax liability
Recognition of future tax associated with an asset that has a fair value in excess of its cost as recognised by a revaluation acts to reduce the amount of the revaluation surplus account
Entry assumes that the revalued amount of the asset will be recovered by the entity’s continued use of the asset
BFA201 Financial Accounting - Income Tax

94. Unused tax losses

95. Unused tax losses
A deferred tax asset shall be recognised to the extent that:
It is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilised
Deferred tax assets can arise as a result of tax losses
Losses incurred in previous years can generally be carried forward to offset taxable income derived in future years
Tax losses can generate subsequent benefits in the form of tax payments saved in future profitable periods
for example, if we make a tax loss of $300,000 this year, but next year we make a taxable profit of $300,000 then we will be able to carry forward the loss and not have to pay tax in the next year. The prior loss has created an economic benefit in the form of tax that has been saved
Consistent with the test for deferred tax assets generated by temporary differences, deferred tax assets generated as a result of unused tax losses must also be able to satisfy the ‘probable’ test before they are recognised as assets
For a deferred tax asset to be recognised in relation to an unused tax loss it must be probable that an entity will make future taxable profits that the unused loss can be matched against (para.34).

96. Lecture example Rebel Ltd records a loss of $400,000 in Year 1.
It is expected that the company will record profits in future years.
In fact it does record accounting profits before tax of $360,000 and $500,000 in the next two years.
There are no temporary differences between the carrying amounts of the company’s assets and liabilities and their tax base.
The tax rate is 30%.

97. Solution Dr Deferred tax asset 120,000 Cr Income tax revenue 120,000
Recording tax loss 400,000 x 30% in Yr 1.
Dr Income tax expense 108,000
Cr Deferred tax asset 108,000
Recording use of tax loss in Yr 2.
Dr Income tax expense 150,000
Cr Deferred tax asset 12,000
Cr Income tax payable 138,000
Recording use of tax loss & tax payable in Yr 3.
Tax loss 400,000 x 0.3 = 120,000 This is a DTA that can be used to offset tax in future years.
Yr 2 360,000 x 0.3 = 108,000 so that amount of the DTA is applied.
Yr 3 500,000 x 0.3 = 150,000 so remainder of DTA is applied before paying tax.

98. DTA and DTL recognition
The entity will remain in business (going concern)
Taxable income will be derived in future years
Recognition of deferred tax asset same as applied to other assets —reliance on ‘probability’ test
Probable test will almost always be met with DTL

99. Theoretical consideration of DTL and DTA

100. Evaluation of AASB112 BFA201 Financial Accounting - Income Tax
Profit smoothing technique?
DTA might not be an asset under the AASB framework
No claim against the government for tax?
Does entity ‘control’ the benefit?
Benefit depends on future earnings and no legislation changes
BFA201 Financial Accounting - Income Tax

101. Evaluation of AASB112 cont.
DTL might not be a liability as entity not presently obliged to pay govt; it is a book entry
Funds will only be transferred in the future if the company earns sufficient revenue — there is a dependency on future events, not past events
Assumes no changes in tax legislation
BFA201 Financial Accounting - Income Tax

102. Next Week – Revenue recognition Copyright notice
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