HI5020 Corporate Accounting

Lecture 5 :Accounting for income taxesHI5020 Corporate AccountingHolmes InstituteApplied Business Statistics for ManagersTopics covered in this session▪ Understand that there is typically a difference between an organisation’sprofit or loss for accounting purposes, and its profit or loss for taxationpurposes▪ Be able to identify some of the factors that will cause a differencebetween profit or loss for accounting purposes and profit or loss fortaxation purposes▪ Understand how deferred tax assets and deferred tax liabilities arise▪ Understand how to account for taxation losses incurred by companiesand understand how, in certain circumstances, taxation losses can leadto the recognition of assets in the form of deferred tax assets▪ Be able to critically evaluate the balance sheet approach to accountingfor taxation and the associated asset, deferred tax asset, and liability,deferred tax liabilityHolmes InstituteApplied Business Statistics for ManagersIntroduction to accounting for income taxesTaxable profit▪ Profit for taxation purposes is known as taxable profit▪ Determined in accordance with Australian income taxlegislation, not according to general accounting rules▪ There are differences between accounting principles of revenueand expense recognition and taxation principlesAccounting profit is therefore not the same as taxable profit▪ Tax expense for accounting purposes (shown in the statementof profit or loss and other comprehensive income) calculatedafter applying relevant accounting standards▪ Income tax payable to tax office (statement of financial position)based on taxable profit derived by the entity applying the rulesof taxation lawHolmes InstituteApplied Business Statistics for ManagersDifference between accounting profit andtaxable incomeHolmes InstituteApplied Business Statistics for ManagersSome differences between accounting and tax rulesHolmes InstituteApplied Business Statistics for ManagersWorked Example 18.1—Calculating taxable profitand accounting profitYou are provided with the following information from the accounts of Big Kahuna Ltd for the year ending 30 June 2019. You are to calculateaccounting profit and taxable profit. Cash salesCost of goods soldAmounts received in advance for services to be performed in August 2019Rent expense for year ended 30 June 2019Rent prepaid for two months to 31 August 2019Doubtful debts expensesAmount provided in 2019 for employees’ long-service leave entitlementsGoodwill impairment expense$100 000$40 000$10 000$10 000$1 000$1 000$6 000$6 000 Accountingprofit$100 000($40 000)Taxableprofit$100 000(40 000)Cash salesCost of goods soldAmounts received in advance by Big Kahuna Ltd for servicesto be performed in August 2019Rent expense for year ended 30 June 2019Rent prepaid for two months to 31 August 2019Doubtful debts costsAmount provided in 2019 for employees’ long-service leaveentitlementsGoodwill impairment expense–($10 000)_($1 000)$10 000($10 000)($1 000)–($6 000)($6 000)–– $37 000 $59 000Holmes InstituteApplied Business Statistics for ManagersBalance sheet approach to accounting for taxationAccounting for income taxes▪ Governed by AASB 112▪ Applies the ‘balance sheet’ method—this means the recognition of tax-relatedassets and liabilities in the balance sheet (statement of financial position) isbased on the differences between accounting and tax values of assets andliabilities▪ Focuses on comparing the carrying amount of an entity’s assets and liabilities(determined by accounting rules) with the tax base for those assets andliabilities➢ Effectively involves comparing the balance sheet derived using accountingrules with the balance sheet that would be derived from taxation rulesHolmes InstituteApplied Business Statistics for ManagersBalance sheet approach to accounting for taxation (cont.)Carrying amount vs tax base of asset or liability▪ Carrying amount is the amount the asset or liability isrecorded at in the accounting records▪ Tax base is defined as the amount that is attributed to anasset or liability for tax purposes (AASB 112)—tax baserepresents the amount an asset or liability would be recordedat if the balance sheet (statement of financial position) wereprepared applying taxation rules▪ Where the carrying amount of an asset or liability is differentfrom the tax base a ‘temporary difference’ can ariseHolmes InstituteApplied Business Statistics for ManagersBalance sheet approach to accounting for taxation (cont.)Temporary differences can be of two types1. A taxable temporary difference➢ will result in an increase (decrease) in income tax payable (recoverable) infuture periods when the carrying amount of the asset or liability isrecovered or settled• Creates a liability—deferred tax liability2. A deductible temporary difference➢ will result in a decrease (increase) in income tax payable (recoverable) infuture periods when the carrying amount of the asset or liability isrecovered or settled• Creates an asset—deferred tax assetHolmes InstituteApplied Business Statistics for ManagersBalance sheet approach to accounting for taxation (cont.)Deferred tax liability– 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 bepaid laterExample of deferred tax liability▪ Carrying amount of a non-current depreciable asset exceeds the tax base inearly years, as depreciation allowable as a deduction for tax purposes is greaterthan depreciation for accounting purposes▪ This will be reversed in later years when no depreciation is allowable for taxpurposesHolmes InstituteApplied Business Statistics for ManagersBalance sheet approach to accounting for taxation (cont.)Deferred tax asset➢ The carrying amount of an asset is less than the tax baseExample 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 thandepreciation for accounting purposes▪ This will be reversed in later years when the asset is fully depreciated foraccounting purposes, but depreciation is still allowable as a deduction for taxpurposesHolmes InstituteApplied Business Statistics for ManagersBalance sheet approach to accounting for taxation (cont.)Income tax expense▪ Represents the sum of the tax attributable to taxable income, plus or minusany adjustments relating to temporary differences▪ Defined in AASB 112 as:➢ the aggregate amount included in the determination of profit or lossfor the period in respect of current tax and deferred taxHolmes InstituteApplied Business Statistics for ManagersBalance sheet approach to accounting for taxationIncome tax payable (cont.)▪ The amount of tax generally expected to be paid to the tax office, as a result ofthe year’s operations, within the next financial period▪ Under the ‘taxes payable method’ would be same as tax expense, that is, theamount payable to the tax office is also treated as the tax expense by theorganisation➢ But … this method not permitted in Australia▪ Under balance sheet method, income tax payable does not necessarily equateto tax expense➢ Tax expense affected by temporary differencesHolmes InstituteApplied Business Statistics for ManagersBalance sheet approach to accounting for taxation (cont.)Calculation of income tax payable▪ Income tax payable is based on taxable income, not accounting profit▪ Necessary to make adjustments to accounting profit to determine tax profit, forexample:➢ add back accounting depreciation➢ deduct depreciation for taxation purposes▪ Calculation of income tax payable➢ tax rate multiplied by tax profitHolmes InstituteApplied Business Statistics for ManagersWorked Example 18.2—Temporary differences caused by the depreciation of a non-currentasset▪ Robert August Ltd commences operations on 1 July 2016.▪ On the same date, it purchases a fibreglassing machine at a cost of $600 000.▪ The machine is expected to have a useful life of four years, with benefits being uniformthroughout its life. It will have no residual value at the end of four years.▪ Hence, for accounting purposes the depreciation expense would be $150 000 peryear.▪ For taxation purposes, the ATO allows the company to depreciate the asset over threeyears—that is, $200 000 per year.▪ The profit before tax of the company for each of the next four years (for years ending30 June) is $500 000, $600 000, $700 000 and $800 000 respectively.▪ The tax rate is 30 per cent.Holmes InstituteApplied Business Statistics for ManagersWorked Example 18.2—SolutionYear 1 (ending 30 June 2017)Carrying Temporaryamount Tax base difference($) ($) ($)Fibreglassing machine: cost 600 000 600 000Accumulated depreciation 150 000 200 000450 000 400 000 50 000Holmes InstituteApplied Business Statistics for ManagersWorked Example 18.2—Solution (cont.) Accounting profit before taxAdd back accounting depreciation$500 000$150 000Subtract depreciation for taxation purposes ($200 000)Taxable profitTax at 30%$450 000$135 000 The journal entries at 30 June 2017 would be: Dr Income tax expenseCr Deferred tax liability15 00015 000 Dr Income tax expenseCr Income tax payable135 000135 000 Holmes InstituteApplied Business Statistics for ManagersWorked Example 18.2—Solution (cont.)Year 2 (ending 30 June 2018) CarryingTemporaryamount Tax basedifference($)600 000($)600 000($)Fibreglassing machine: costAccumulated depreciation300 000400 000 300 000 200 000 100 000The temporary difference at 30 June 2018 totals $100 000. Applying the tax rate of 30 per centprovides a deferred tax liability of $30 000. Because $15 000 has already been recognised in2017, an increase (or ‘top up’) of $15 000 is required.Holmes InstituteApplied Business Statistics for ManagersWorked Example 18.2—Solution (cont.) Accounting profit before taxAdd back accounting depreciation$600 000$150 000Subtract depreciation for taxation purposes ($200 000)Taxable profitTax at 30%$550 000$165 000 The journal entries at 30 June 2018 would be: Dr Income tax expenseCr Deferred tax liability15 00015 000 Dr Income tax expenseCr Income tax payable165 000165 000 Holmes InstituteApplied Business Statistics for ManagersWorked Example 18.2—Solution (cont.)Year 3 (ending 30 June 2019) Carryingamount($)600 000Temporarydifference($)Tax base($)600 000Fibreglassing machine: costAccumulated depreciation450 000600 000 150 000 0 150 000The temporary difference at 30 June 2019 is $150 000. Applying the tax rate of 30 per centprovides a deferred tax liability of $45 000. Because $30 000 has already been recognised in2017 and 2018, an increase of $15 000 is required.Holmes InstituteApplied Business Statistics for ManagersWorked Example 18.2—Solution (cont.)The tax on the taxable income would be determined as follows: Accounting profit before taxAdd back accounting depreciation$700 000$150 000Subtract depreciation for taxation purposes ($200 000)Taxable profitTax at 30%$650 000$195 000 The journal entries at 30 June 2019 would be: Dr Income tax expenseCr Deferred tax liability15 00015 000 Dr Income tax expenseCr Income tax payable195 000195 000 Holmes InstituteApplied Business Statistics for ManagersWorked Example 18.2—Solution (cont.)Year 4 (ending 30 June 2020) Carryingamount($)600 000Temporarydifference($)Tax base($)600 000Fibreglassing machine: costAccumulated depreciation600 000600 000 0 0 0The temporary difference at 30 June 2020 is $nil, which means that there should be nodeferred tax liability or deferred tax asset recorded in relation to this asset. This meansthe balance accrued in the deferred tax liability must be reversed in 2020.Holmes InstituteApplied Business Statistics for ManagersWorked Example 18.2—Solution (cont.)The tax on the taxable income would be determined as follows: Accounting profit before taxAdd back accounting depreciationSubtract depreciation for taxation purposesTaxable profitTax at 30%$800 000$150 0000$950 000$285 000 The journal entries at 30 June 2020 would be: Dr Deferred tax liabilityCr Income tax expense45 00045 000 Dr Income tax expenseCr Income tax payable285 000285 000 Holmes InstituteApplied Business Statistics for ManagersWorked Example 18.2—Solution (cont.)A review of Worked Example 18.2 indicates that the balance sheet approach to accountingfor income tax ‘smooths’ the tax expenses across the four years, as indicated below: Year 1($)Year 2($)Year 3($)Year 4($)Total($)Tax expense based on taxable profit135 000165 000195 000285 000 780 000Adjustment for ‘temporary’ difference15 00015 00015 000(45 000)– Total taxation expense 150 000 180 000 210 000 240 000 780 000Holmes InstituteApplied Business Statistics for ManagersTax base of asset and liabilities: further considerationCalculation of tax base for assets◼ Carrying amount + future deductible amount – future assessable amount◼ Although an asset might be expected to give rise to future assessableamounts that exceed the asset’s carrying amount, AASB 112 focuses on thetax consequences of recovering an asset to the extent of its carrying amountonly◼ Where the carrying amount of an asset exceeds the tax base there is adeferred tax liability◼ If the carrying amount of the asset is less than the tax base there will be adeferred tax assetHolmes InstituteApplied Business Statistics for ManagersTax base of asset and liabilities: further consideration(cont.)▪ Consideration of doubtful debts when examining accounts receivable➢ amounts provided for doubtful debts are not deductible for tax purposes• deductible only when the account receivable is actually written off➢ any allowance for doubtful debts will result in a difference between carryingamount and tax base• this will result in a deferred tax assetHolmes InstituteApplied Business Statistics for ManagersTax base of asset and liabilities: further considerationCalculation of tax base for liabilities (cont.)▪ Carrying amount – future deductible amount + future assessable amount▪ Tax base of a liability for ‘revenue received in advance’➢ Tax base of the liability is equal to the carrying amount of the liability where the ‘revenuereceived in advance’ is taxed in a reporting period subsequent to the reporting period inwhich received➢ The tax base of the liability is equal to zero where ‘revenue received in advance’ istaxed in the reporting period when received➢ Carrying amount – amount of revenue received in advance that will not be subject to taxin future periods = tax baseHolmes InstituteApplied Business Statistics for ManagersTemporary differences, deferred tax assets and liabilities—summaryHolmes InstituteApplied Business Statistics for ManagersDeferred tax assets and deferred tax liabilitiesDeferred tax asset—Recognition criteria▪ A number of assumptions are made:➢ 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’ testHolmes InstituteApplied Business Statistics for ManagersUnused tax losses▪ Deferred tax assets can arise as a result of tax losses➢ Losses incurred in previous years can generally be carried forward to offset taxable incomederived in future years▪ Tax losses can generate subsequent benefits in the form of tax payments saved in futureprofitable periods➢ For example, if we make a tax loss of $300 000 this year, but next year we make a taxableprofit of $300 000 then we will be able to carry forward the loss and not have to pay tax inthe next year. The prior loss has created an economic benefit in the form of tax that hasbeen saved▪ Consistent with the test for deferred tax assets generated by temporary differences, deferred taxassets generated as a result of unused tax losses must also be able to satisfy the ‘probable’ testbefore they are recognised as assetsHolmes InstituteApplied Business Statistics for ManagersUnused tax lossesAASB 112 (par. 34)▪ A deferred tax asset shall be recognised arising from the carry-forward of unused taxlosses and unused tax credits to the extent that it is probable that future taxable profitwill be available against which the unused tax losses and unused tax credits can beutilised▪ As a general principle applicable to all deferred tax assets it is a requirement that theybe reviewed at each reporting date to ensure that the assets are not overstatedHolmes InstituteApplied Business Statistics for ManagersWorked Example 18.7—Utilisation of unused taxlosses◼ Grommit Ltd commenced operations in 2019.◼ In the year ending 30 June 2019 it incurred a loss of $1 million.◼ It is expected that the company will not incur losses again and will generate taxable profit insubsequent years. ◼The profits before tax in the following years are as follows:YearProfit before tax 2020 $300 0002021 $400 0002022 $600 000◼ It is assumed that there are no temporary differences between the carrying values of GrommitLtd’s assets and liabilities and the respective tax bases.◼ The tax rate is 30 per cent.REQUIREDProvide the journal entries to show the recognition of the asset associated with the tax loss, aswell as the journal entries to recognise the use of the loss.Holmes InstituteApplied Business Statistics for ManagersWorked Example 18.7—Solution2019Accepting that it is probable that the entity will be able to recoup the benefits associated with the taxloss, the entry in 2019 would be: DrDeferred tax asset300 000CrIncome tax revenue300 000 2020In 2020 the entity generates a profit of $300 000. In the absence of a tax loss, $90 000 would bepayable. We still recognise tax expense, but rather than crediting income tax payable, we credit thedeferred tax asset. This will reduce the balance of the deferred tax asset account to $210 000, andno amount will be payable to the ATO. DrIncome tax expense90 000CrDeferred tax asset90 000 Holmes InstituteApplied Business Statistics for ManagersWorked Example 18.7—Solution (cont.)2021In 2021 the entity generates a profit of $400 000. In the absence of a tax loss, $120 000 would bepayable. As noted above, we still recognise tax expense, but rather than crediting income taxpayable, we credit the deferred tax asset. This will reduce the balance of the deferred tax assetaccount to $90 000. DrIncome tax expense120 000CrDeferred tax asset120 000 2022In 2022 the entity generates a profit of $600 000. In the absence of a tax loss, $180 000 would bepayable. We can use the balance of the previously unused tax loss ($90 000) and the remainingamount will then be treated as income tax payable—a current liability. DrIncome tax expense180 000CrDeferred tax asset90 000CrIncome tax payable90 000 Holmes InstituteApplied Business Statistics for ManagersRevaluation of non-current assets◼ According to AASB 112 (par. 20), revaluations of non-current assets can createtemporary differences◼ When non-current assets are revalued, the revaluation increment is not deductible fortax purposes, even though depreciation for accounting purposes will be based on therevalued amount◼ The tax base is not affected by the revaluation because depreciation for tax purposeswill be based on the original cost of the asset◼ However, any increase in the carrying value of a non-current asset through arevaluation undertaken to recognise an increase in fair value implies an expectedincrease in the future flow of economic benefits◼ This increase can be taxable and can lead to a deferred tax liability if the carryingamount is greater than the tax baseHolmes InstituteApplied Business Statistics for ManagersRevaluation of non-current assets (cont.)▪ As the revaluation is adjusted against equity (revaluation surplus account), theaccounting entry to record the recognition of the deferred tax liability is DrRevaluation surplusCrDeferred tax liability ▪ Recognition of future tax associated with an asset that has a fair value in excess ofits cost as recognised by a revaluation acts to reduce the amount of the revaluationsurplus account▪ Entry assumes that the revalued amount of the asset will be recovered by theentity’s continued use of the assetHolmes InstituteApplied Business Statistics for ManagersRevaluation of non-current assets (cont.)As an example, assume the following:◼ Tax Ltd acquired land two years ago for $450 000◼ Its fair value is now $600 000◼ The tax rate is 30 per centThe entries to recognise a revaluation would be: DrLand150 000CrRevaluation surplus150 000 DrRevaluation surplus45 000CrDeferred tax liability45 000 Holmes InstituteApplied Business Statistics for ManagersRevaluation of non-current assets (cont.)◼ If there is an expectation that the revalued asset is to be sold◼ Journal entries to record the deferred tax liability will be different if the entity operates in acountry with capital gains tax indexation◼ If a non-current asset is sold there is often a ‘tax break’ given to the organisation as thetax base is increased by an index that reflects general price increases◼ If the tax that will be assessed in future is to be reduced because of capital gainsindexation, the reduction in the amount of tax that would be paid is accounted for bydebiting the deferred tax liability and crediting the revaluation reserve◼ Result—the tax base of an asset can depend on the manner in which the entity’smanagement expects to recover the benefits inherent in the assetHolmes InstituteApplied Business Statistics for ManagersChange of tax rates◼ Tax rates will change across time◼ Will have implications for value to be attributed to pre-existing deferred tax assetsand deferred tax liabilities◼ An increase in tax rates will create an expense (which will be of the nature ofincome tax expense) when an entity has deferred tax liabilities, and will createincome in the presence of deferred tax assets◼ Conversely, a decrease in tax rates will create income when an entity has deferredtax liabilities, whereas a decrease will create an expense in the presence ofdeferred tax assetsHolmes InstituteApplied Business Statistics for ManagersWorked Example 18.12—Impact of changing tax ratesTaxi Ltd has the following deferred tax balances as at 30 June 2019: Deferred tax assetDeferred tax liability$500 000$300 000 The above balances were calculated when the tax rate was 30 per cent. On 1 August2019, the government reduced the corporate tax rate to 25 per cent.REQUIREDProvide the journal entries to adjust the carry-forward balances of the deferred tax assetand deferred tax liability.Holmes InstituteApplied Business Statistics for ManagersWorked Example 18.2—Solution Balance atBalance at30 June 2019Change1 August 2019 Deferred tax assetDeferred tax liability$500 000$300 000$500 000 × 25/30 = $416 667$300 000 × 25/30 = $250 000($83 333)($50 000) The accounting entry at 1 August 2019 would be: Dr Deferred tax liability50 000Dr Income tax expenseCr Deferred tax asset33 333 83 333Holmes InstituteApplied Business Statistics for ManagersLecture summary▪ Understand that there is typically a difference between an organisation’s profit or lossfor accounting purposes, and its profit or loss for taxation purposes▪ Be able to identify some of the factors that will cause a difference between profit orloss for accounting purposes and profit or loss for taxation purposes▪ Understand how deferred tax assets and deferred tax liabilities arise▪ Understand how to account for taxation losses incurred by companies and understandhow, in certain circumstances, taxation losses can lead to the recognition of assets inthe form of deferred tax assets▪ Be able to critically evaluate the balance sheet approach to accounting for taxation andthe associated asset, deferred tax asset, and liability, deferred tax liability

QUALITY: 100% ORIGINAL PAPER – NO PLAGIARISM – CUSTOM PAPER

Leave a Reply

Your email address will not be published. Required fields are marked *