topic 5 slides accounting for income tax

Learning ObjectiveACC514 Topic 5

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Slides by Miranda Dyason, adapted from ‘Understanding Australian Accounting Standards’ instructor resources prepared by Kent Wilson

Topic 5:Accounting for income tax


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Explain differences between accounting treatments and taxation treatments for a range of transactions;

Calculate taxable profit, and account for current taxation expense;

Explain that some transactions have both current and future tax consequences;

Account for movements in deferred taxation accounts, and changes in tax rates; and

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ALearning Objectives

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E Specify the disclosures required by AASB 112.


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Learning ObjectivesB

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Learning ObjectivesC

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Learning ObjectivesD

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Learning ObjectivesE

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▸ Accounting profit defined (AASB 112.5):• “Profit or loss for a period before deducting tax expense”.

▸ Taxable profit defined (AASB 112.5):• “The profit for a period determined in accordance with the rules established

by the taxation authorities, upon which income taxes are payable”.

▸ As ‘accounting profit’ and ‘taxable profit’ are determined by different principles, it is unlikely that they will be the same figure in any one period.

Differences between accounting profit & taxable profit

A

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Given the rules for determining taxable profit are different from the rules for determining accounting profit, we may encounter:

▸ Permanent differences:• Arise when amounts recognised as part of accounting profit are not

recognised as part of taxable profit (or vice versa).

▸ Temporary differences:• Arise when the period in which revenues and expenses are recognised for

accounting purposes is different from the period in which such revenues and expenses are treated as taxable income and allowable deductions for tax purposes.

Permanent & temporary differencesA

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Given these differences, how do we go about accounting for income tax in an entity’s financial reports??

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▸ AASB 112 states that the tax consequences of transactions that occur for accounting purposes during a period should be recognised as income or expense in the current period, regardless of when the tax effects will occur.

▸ So, we need to recognise both current and future tax consequences of current year transactions.

▸ Therefore, two separate calculations are performed each year:• Current tax liability. • Movements in deferred tax balances.

Accounting for income taxesB

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To understand what this means, consider an example:

▸ A Ltd recognised passive rental revenue of $20,000 in the 2015 financial year. $15,000 of this had been received in cash, and the remaining $5,000 had accrued but had not yet been paid as at 30 June 2015.

In recognising the $20,000 rental revenue for accounting purposes, there are:• Current tax consequences re the $15,000 which is assessable in the current year

for taxation purposes, and

• Future tax consequences re the $5,000 accrued rent (which will be assessable for tax purposes in the next financial year, when it is actually received).

Example:

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B


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1. Calculation of taxable profit and current tax liability

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▸ When determining taxable profit, we need to:• Start with the ‘accounting profit’ for the period.

• Make adjustments for income and expenses where there are differences in amounts to be recognised for accounting and tax purposes.

• Deduct prior year tax losses (if any) to be claimed. (- we will look at tax losses in detail later in the presentation).

▸ We therefore need a good understanding of common differences between the accounting treatment and tax treatment of various income and expense items.

• Refer to Table 7.1 on pages 202 – 203 of your text for common differences.

Calculation of current taxC

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Calculation of taxable income from accounting profit (basic format):

Accounting Profit (Loss):

Add: Accounting expenses that are not tax deductibleAdd/(Less): Differences between accounting expenses and tax deductionsAdd/(Less): Differences between taxable income and accounting revenueLess: Accounting revenues that are not taxable

= Taxable profit

Taxable profit x tax rate % = Current Tax Payable

(Refer to Illustrative Example 7.1 on pages 204 – 207 of your text.)

Calculation of current taxC

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▸ Recognition of current tax:• Refer AASB 112 paragraphs 12 and 58.

▸ Payment of tax:• Determined by legislation;• Some jurisdictions require payments in advance.

▸ Journal entry to record current tax liability:DR Income tax expense $...

CR Current tax liability $...

(to recognise current tax liability)

Recognition & payment of taxC

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ExampleAccounting profit before tax for ABC Ltd for the year to 30 June 2015 is as follows:

Sales revenue $200,000Less: Cost of sales (100,000)Entertainment (not tax deductible) (10,000)Warranty expense (7,000)Accounting profit before tax 83,000

For tax purposes:Warranty paid 2,000

The tax rate is 30%.Required: Calculate and journalise the current tax liability for 2015.

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C


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SolutionProfit before tax $83 000Add/(less):- Entertainment (non-deductible) 10 000- Warranty expense (accounting) 7 000- Warranty paid (tax) (2 000)Taxable Income: 98 000

Current tax liability (30%): 29 400

Journal entry to record current tax liability: DR Income tax expense $29 400 CR Current tax liability $29 400 (recognise current tax liability)

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C


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What do we do if there is a tax loss?

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▸ Tax losses are created when allowable deductions exceed taxable 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.

Tax lossesD

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▸ AASB 112 paragraph 34 states:“A deferred tax asset shall be recognised for the carry forward of unused tax losses and unused tax credits 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.”

▸ Recoupment occurs as soon as the company earns taxable income/profit.

▸ The tax loss recouped is recorded in the calculation of taxable income, and a journal entry raised to reverse the DTA.

Tax lossesD

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▸ Note: the existence of exempt income has an effect both on the creation of a tax loss and the recoupment of a tax loss.

• Exempt income cannot contribute to carry forward losses.

• 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.

• Refer to Illustrative Example 7.2 on pages 208 – 209 of your text.

Tax lossesD

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ExampleAccounting profit before tax for ABC Ltd for the year to 30 June 2015 is as follows:

Sales revenue $20,000

Government grant (exempt income) 5,000

Less: Cost of sales (10,000)

Interest expense (30,000)

Entertainment (not tax deductible) (10,000)

Warranty expense (7,000)

Accounting profit / (loss) before tax -32,000

For tax purposes:Warranty paid = $2,000; interest paid = $30,000

The tax rate is 30%.Required: Calculate and journalise the current tax liability (or DTA in the event of a tax loss) for 2015.

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D


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SolutionProfit/(loss) before tax -$32 000Add/(less):- Government grant (exempt income) (5 000)- Entertainment (non-deductible) 10 000- Warranty expense (accounting) 7 000- Warranty paid (tax) (2 000)Taxable Income/(loss): -22 000

Deferred tax asset (30%): 6 600

Journal entry to record current tax liability*: DR Deferred tax asset $6 600 CR Income tax expense $6 600 (recognise DTA re tax loss for 2015)

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D

*Note: need to meet recognition criteria in AASB 112.34 before recognising DTA


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2. Calculation of deferred tax assets and deferred tax liabilities

D

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▸ DTA’s and DTL’s 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.

▸ 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 the tax authorities.

▸ Carrying amount - net asset and liability balances based on accounting balance sheet.

▸ Tax base - asset and liability balances that would appear in a “tax balance sheet”. (Refer to AASB 112 paragraphs 7 – 8).

Calculation of deferred taxD

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ABC purchased an item of plant on 1 July 2014 for $9,000. For accounting purposes, the item is depreciated at 33.33% p.a., and for tax purposes, it is depreciated at 50% p.a. The estimated residual value is nil.

▸ At 30 June 2015:• The carrying amount is: $9,000 - $3,000 = $6,000• The tax base is: $9,000 - $4,500 = $4,500• The temporary difference is:

$1,500.

▸ At 30 June 2016:• The carrying amount is: $9,000 - $6,000 = $3,000• The tax base is: $9,000 - $9,000 = $ 0• The temporary difference is:

$3,000.

▸ At 30 June 2017:• The carrying amount is: $9,000 - $9,000 = $ 0• The tax base is: $9,000 - $9,000 = $ 0• The temporary difference is:

$0.

Example:

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D


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Calculating the tax base for an asset:Carrying Amount

– Future taxable amounts + Future deductible amounts = Tax Base

Calculating the tax base for a liability:Carrying Amount

- Future deductible amounts = Tax Base

Calculating the tax baseD

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▸ When the carrying amount of an asset or liability is different from its tax base, a temporary difference exists. There are 2 types of temporary differences, and each temporary difference that exists needs to be classified correctly:

▸ Taxable temporary differences:• Will result in taxable amounts in future periods.• Result in the entity paying more tax in the future, and therefore a Deferred Tax

Liability.

▸ Deductible temporary differences:• Will result in deductible amounts in future periods.• Result in the entity paying less tax in the future, and therefore a Deferred Tax

Asset.

Calculating temporary differencesD

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Examples:

▸ Taxable temporary differences:• Passive revenue receivable (eg. Interest receivable)• Prepaid expenses (eg. Prepaid insurance)

▸ Deductible temporary differences:• Provisions (eg. Provision for annual leave or provision for warranties)• Unearned passive revenue (eg. Rent received in advance)

Calculating temporary differencesD

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Example: calculate the tax bases and temporary differences

CA FTA FDA TB TTD DTD

Interest receivable: $1,000Provision for warranty: $4,000

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D


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Solution:

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D

CA FTA FDA TB TTD DTD

Interest receivable: $1,000

1,000 - 1,000 + - = 0 1,000

Provision for warranty: $4,000

4,000 + 0 - 4,000 = 0 4,000


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▸ Certain temporary differences are excluded from being recognised.

▸ AASB 112 paragraph 15 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; and

• That do not affect accounting or taxable profit.

Excluded DifferencesD

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What do we do after calculating the taxable temporary differences and deductible

temporary differences that exist??

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▸ AASB 112 paragraphs 15 and 24 require that Deferred Tax Liabilities and Deferred Tax Assets be recognised for temporary differences.

▸ DTA’s and DTL’s are to be measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period. (AASB 112 paragraph 47).

▸ Consideration must be given to the recognition criteria (discussed in the next few slides).

Calculating DTA’s and DTL’sD

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Calculating a deferred tax asset (DTA):

Deductible temporary difference x tax rate % = DTA

Calculating a deferred tax liability (DTL):

Taxable temporary difference x tax rate % = DTL

Note: The “tax rate %” is the rate which is expected to apply when the asset will be realised or the liability settled.

Calculating DTA’s and DTL’sD

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Putting all the calculations together into a deferred tax worksheet:

- We use a worksheet to determine all of the temporary differences

that exist, and then movement in the deferred tax balances. From this, we can then prepare the journal entries to account for deferred tax.

D

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Deferred tax worksheet

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Carrying Amount

Future Taxable Amount

Future Deductible

Amount

Tax Base Taxable Temporary Differences

(DTL)

Deductible Temporary Differences

(DTA)

$ $ $ $ $ $AssetsCash ReceivablesPlantGoodwillLiabilitiesBank OverdraftLSL payableTemporary differences

Excluded differences

Net temp differencesDeferred tax liabilityDeferred tax assetBeginning balancesMovement during yearAdjustment

D


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After calculating deferred tax assets and liabilities, do we need to satisfy any recognition criteria before

recognising these balances in the financial statements?

D

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Deferred tax liabilities (AASB 112 paragraph 15):▸ Deferred tax liabilities must always be recognised.

Deferred tax assets (AASB 112 paragraph 24):▸ 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).

Recognition criteria for DTA’s and DTL’sD

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What do we need to do if there has been a change in tax rate??

D

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▸ 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.

Change of tax ratesD

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Disclosures

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▸ AASB 112 paragraphs 79 – 82A address disclosure requirements.

▸ Tax assets and 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 (see AASB 112 paragraph 71 and 74).

▸ Tax expense is presented on the statement of profit or loss and other comprehensive income (AASB 112 paragraph 77).

DisclosuresE

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topic 5 slides accounting for income tax

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