11

Tax EffectAccounting

(AASB 1020)

Tax EffectAccounting

(AASB 1020)

22

Objectives

To be able to complete

the entries necessary to apply

accounting standard AASB 1020 - Tax Effect Accounting

33

AASB 1020

The standard sets out the accounting treatment of a company’s income tax in general purpose financial reports prepared by a reporting entity

The standard uses the ‘balance sheet’ approach & analyses the differences between the entity’s balance sheet prepared for general purpose financial reporting & the balance sheet for tax purposes.

44

Basis of Tax Effect Accounting

as a result of differences between accounting profit and taxable income

( Main difference because income tax treatment of some transactions based on cash flows whereas accounting based on accruals)

difference between accounting balance sheet and taxation balance sheet

(Even though tax balance sheet not actually produced)

the difference leads to recognition of deferred tax assets/liabilities in the accounting balance sheet)

55

Taxation vs Accounting Treatments

Accounting ProfitAccounting Profit

= revenue less expenses

Based on accrual accounting and requirements of accounting standards

Taxable IncomeTaxable Income

= assessable income – allowable deductions

Based on requirements of Income Tax Assessment Act

Generally follows cash flows of transactions and events

66

Taxation vs Accounting Treatments

Assessable income Assessable income Accounting revenue Accounting revenue

– Revenue not yet received is not assessable– Some revenue is exempt from tax eg Government grants

Allowable deductions Allowable deductions Accounting expenses Accounting expenses

– Accounting and taxation depreciation rates may differ– Some expenses are not deductible eg entertainment– Some expenses are not deductible until a future period eg

doubtful debts expense not deductible until debts are written off by the company as bad & long service expense not allowed as a deduction until actually paid

77

Reasons for differences between accounting & tax ‘Balance Sheets’

Item Accounting Treatment Tax Treatment

Depreciation As per AASB 1021 Often accelerated

Doubt. debts Expense when doubtful Tax ded when written off

Long Service Leave Expense when accrued Tax ded when paid

Rental Costs Prepaid until used Tax ded when paid

Rental Revenue Liability if in advance Taxed when received

Entertainment Treated as expense No deduction for tax

Research & Dev Capitalised and expensed Tax ded. when paid

Goodwill Amoristed No deduction for tax

Tax Loss No treatment Offset against future income

88

Current Tax Liability

Accounting profit

(+) expenses not deductible for tax

(-) revenues not assessable for tax

+(-) differences between accounting and tax amounts*

* This is done by adding back expenses in books and subtracting the tax deduction or subtracting revenue in the books and adding the assessable amount

= Taxable income

Taxable income * tax rate = Current tax liability

Income tax expense Dr $x

Current tax liability Cr $x

99

Determination of taxable incomeAccounting Profit $300

Add Depreciation – building (non deductible) 20

Depreciation – plant 50

Doubtful debts expense 40

410

Less

Government grant (non assessable) 120

Depreciation – plant (for tax purposes) 60

Taxable income $230

1010

Determination of taxable incomeAccounting Profit $300

Add Depreciation – building (non deductible) 20

Depreciation – plant 50

Doubtful debts expense 40

410

Less

Government grant (non assessable) 120

Depreciation – plant (for tax purposes) 60

Taxable income $230

Journal entry::Journal entry:: Assuming 30% tax rateAssuming 30% tax rateDr Income tax Expense 69Dr Income tax Expense 69 CR Current tax liability 69CR Current tax liability 69

1111

Tax effect accounting

Focuses on the future tax consequences arising as a result of the differences from the carrying amount of an entity’s net assets and the tax base of those assets.

The differences are either- deductible or assessable temporary differences DTD or ATD

Deductible temporary differences lead to less tax in the future creating a ‘deferred tax asset’

Assessable temporary differences lead to more tax in the future creating a ‘deferred tax liability’

How do we calculate the ‘tax base’???

1212

Calculation of tax base : Assets

Carrying Amount= book value

less

Assessable Amount

(Expected cash flows either through use or sale- assumed to be @ a maximum = to carrying amount)

add

Deductible amount= allowable deductions

= Tax Base

TB= CA-AA+DA

1313

Depreciable Asset - example

Asset acquired on I Jul 2000 for $10 000. For accounting purposes depreciation charged at 10% straight line per annum but for tax purposes 15% straight line.

1414

Depreciable Asset - example

Asset acquired on I Jul 2000 for $10 000. For accounting purposes depreciation charged at 10% straight line per annum but for tax purposes 15% straight line.

After 2 years:-

Accounting Tax

Cost 10 000 10 000

Accumulated depreciation 2 000 3 000

Carrying amount 8 000 7 000

1515

Depreciable Asset

Calculation of tax base :TB=CA-AA+DA = 8 000-8000(expected cash flows) +7000 ( allowable

deduction)=7000 (from previous page do you have to calculate

the tax base or do you already know it?)CA Tax Base ATD DTD --------------------------------------------------------------------8 000 7 000 1 000

Results in a deferred tax liability - because the future tax deductions $7 000 are less than the future assessable income $8 000- Hence more tax in the future

1616

Accounts Receivable - example

As per accounts

Accounts Receivable 40 000

Allowance for doubtful debts 2 000

Carrying amount 38 000

For taxation purposes doubtful debts are not allowed as a deduction until they are actually written off

1717

Accounts ReceivableCalculation of tax base :TB= CA-AA+DA

= 3 8 000-0 (no cash inflows)+ 2000 (deduction for bad debt)

= 40 000 (once again do you have to calculate this if tax does not allow deduction until written off IE would they have put entry in tax balance sheet?)

CV Tax Base ATD DTD

--------------------------------------------------------------------

38 000 40 000 2 000

Results in a deferred tax asset - because the future tax deductions of $2 000 and hence less tax will be paid in the future when written off .

1818

Rent or Interest receivable - example

Rent owed at end of the year $15 000 and recorded as rent receivable.

Dr Rent receivable

Cr Rent Income

Not assessable for tax until received

1919

Rent receivable

Calculation of tax base :

TB=CA-AA+DA= 15 000-15000 (assessable when received)+0

= 0 ( If not allowed until paid - the tax balance sheet would not make the provision therefore Zero in tax Balance sheet)

CV Tax Base ATD DTD

--------------------------------------------------------------------

15 000 0 15 000

Results in a deferred tax liability - because will be assessable in future when received

2020

Prepayments - example

Prepaid rental :

Signed and paid for 3 years rent $12 000.

current expense $3 000 and prepaid expense $9 000.

The taxation office allow a deduction for the amount paid.

2121

PrepaymentsCalculation of tax base :

TB=CA-AA+DA= 9 000-9000(increase assessable income as next year

expensed but not allowable)+0=0 (Once again prepaid expenses allowed for tax therefore tax balance

sheet would not record any prepayments)

CV Tax Base ATD DTD

--------------------------------------------------------------------

9 000 0 9 000

Results in a deferred tax liability - because the expense claimed in the future will not be allowed for tax- Hence more tax in the future

2222

Cash

Calculation of tax base :

TB=CA-AA+DA= 20 000-0+0

= 20 000

No difference between carrying amount & tax base

2323

Inventory

Calculation of tax base :

TB=CA+AA-DA= 208 000+208000-208000

= 208 000

No difference between tax base and carrying amount

2424

Calculation of tax base : Liabilities

Carrying Amount

add

Assessable Amount

(Any further amounts expected to arise from settling liability)

less

Deductible amount

(Any further deductible amount)

= Tax Base

TB=CA+AA-DA

2525

Provision for Employee Entitlements

Long Service Leave :

Provision for Long Service Leave $16 000

The taxation office allow a deduction for the amount only when it is paid , however, accounting standards state that the provision must be raised.

Dr Long Service Leave Expense

Cr Provision for Long Service Leave

2626

Provisions for employee entitlements

Calculation of tax base :TB=CA+AA-DA= 16 000+0-16000=0 (if not allowed until paid the tax balance sheet would not

record)CV Tax Base ATD DTD

--------------------------------------------------------------------(16 000) 0 16 000

Results in a deferred tax asset - because an additional deduction will be allowed in the future decreasing tax liability

2727

Accounts & Loans Payable

Calculation of tax base :TB=CA+AA-DA

(Assume $75 000 accounts payable)=75 000+0-0

=75000

No difference between carrying amount & tax base

2828

Excluded temporary differences

GoodwillGoodwill would create a deferred tax liability as the

amortisation is not allowed as a tax deduction

however

as per para 6.1 of AASB 1020 not permitted

Temporary Difference for buildings – if non-depreciable for tax purposes these are also

excluded

2929

Worksheet CA TB ATD DTDCash @ Bank 80 000 80 000 Receivables 38 000 40 000 2 000Inventory 100 000 100 000Prepayments 9 000 0 9 000Rent Receivable 15 000 0 15 000Plant 8 000 7 000 1 000Buildings 70 000 exemptGoodwill 5 000 exemptLiabilities 20 000 20 000Long Service Leave 16 000 0 16 000 25 000 18 000Tax 30% 7 500 5 400Beginning balances 5 000 5 000Adjustment $2 500 $400

3030

Worksheet CA TB ATD DTDCash @ Bank 80 000 80 000 Receivables 38 000 40 000 2 000Inventory 100 000 100 000Prepayments 9 000 0 9 000Rent Receivable 15 000 0 15 000Plant 8 000 7 000 1 000Buildings 70 000 exemptGoodwill 5 000 exemptLiabilities 20 000 20 000Long Service Leave 16 000 0 16 000 25 000 18 000Tax 30% 7 500 5 400Beginning balances 5 000 5 000Adjustment $2 500 $400

Tax effect journalTax effect journalDR Deferred Tax Asset 400DR Deferred Tax Asset 400 CR Deferred Tax Liab 2 500CR Deferred Tax Liab 2 500Dr Income Tax Expense 2 100Dr Income Tax Expense 2 100(in addition to the current tax lib entry)(in addition to the current tax lib entry)

3131

Tax base for transaction with future tax consequences

Ie Transaction that have no recognition of asset or liability in the balance sheet but an asset or liability for tax

Mining expenditure– Treated as an expense in books but an asset for tax and an

allowable deduction in future periods.

Tax Base will = the expenditure carried forward for tax purposes

Ie CA=0 & the TB=10,000 therefore DTD which creates a Deferred Tax Asset

3232

Tax Losses

Tax losses are allowed to be carried forward to future years

– therefore they create a deferred tax asset as they will reduce the tax liability in future years

The size of the tax loss to be carried forward depends on the exempt income which must be deducted from the loss forward.

3333

Tax Losses- example

Determination of tax

Accty profit/(loss) (15 000)

add

depn-plant books 34 000

less

depn plant allowable (67 000)

Tax Loss ($48 000)

3434

Tax Losses- example

Determination of tax

Accty profit/(loss) (15 000)

add

depn-plant 34 000

less

depn plant (67 000)

Tax Loss ($48 000)

Journal entryJournal entryDr Deferred tax Asset 14 400Dr Deferred tax Asset 14 400 Cr Income tax Revenue 14 400Cr Income tax Revenue 14 400

3535

Tax Losses recouped- example

Determination of tax- subsequent years

Accty profit/(loss) 148 000

less

Tax loss recovered (48 000)

Taxable Income $100 000

3636

Tax Losses recouped- example

Determination of tax- subsequent years

Accty profit/(loss) 148 000

less

Tax loss recovered (48 000)

Taxable Income $100 000

Journal entry for recovery of tax loss Journal entry for recovery of tax loss ::Dr Tax Payable 14 400Dr Tax Payable 14 400 Cr Deferred tax Asset 14 400Cr Deferred tax Asset 14 400Dr Income Tax Exp 44 400Dr Income Tax Exp 44 400 Cr Tax Payable 44 400Cr Tax Payable 44 400(note that the recouping of losses(note that the recouping of losses are first used against exempt income )are first used against exempt income )

3737

Recognition of Deferred Tax Assets(AASB 1020, paragraph 4.3)

Deferred tax assets can be recognised only to the extent that it is probable that future taxable income will be available against which deductible temporary differences can be utilized.

If DTAs from tax losses exist this provides strong evidence that ATDs may not exist or be sufficient to allow recognition of the asset

If the recognition criteria are not met then DTAs cannot be recognised and any existing DTA balance which fails the test (applied each reporting date) must be written off

Entry:

– Writedown expense DR $x

– Deferred tax asset Cr $x

3838

Offsetting tax assets and liabilities(AASB 1020, paragraphs 12.3 and 12.4)

Both current and deferred tax assets and liabilities are to be offset against each other and a net figure shown in the statement of financial position for:

– Current tax

– Deferred tax

3939

Changes in tax rates(AASB 1020, paragraph 4.6.4)

When tax rates change during the period the opening balances of DTAs and DTLs must be adjusted eg

A DTA of $12 and a DTL of $30 were raised. Assume the tax rate is increased to 35% in the next financial year from 30%

Step 1: Calculate adjustment– $12 x (5)/30 = $2 (ie increase of $2)– $30 x (5)/30 = $5 (ie increase of $5)

Step 2: Post journal entryDeferred tax asset Dr $2Expense on rate change Dr $3Deferred tax liability Cr $5

4040

Tutorial Questions

Problem 4.1Problem 4.2Problem 4.4AProblem 4.5AExercise 4.8