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Introduction
The law today has deemed it mandatory for entities and individuals to pay tax. The
AASB112(IAS12) has currently adopted he tax-effect method of accounting for income tax
which contains both current and future tax consequences. The tax-effect method is largely
focused on the future tax consequences which can be seen as the difference in the balance
sheet within the accounting standards. These future tax consequences would then come to be
recognized as deferred tax which comprises of deferred tax assets (DTA) or deferred tax
liability (DTL). (Leo, Hoggett, Sweeting, & Radford, 2012).
The purpose of this essay is to analyse the the arguments and choices made by the
directors of Shady Sheds Ltd. when drawing up their annual report. Among the decisions
made by the directors of Shady Sheds Ltd. was the recognition of DTA arising from the
provision of long service leave and tax loss due to retrenchment. Therefore, this essay seeks to
dixuss, in accordance to AASB112, that we can only allow tax lossess to be recognised as
DTA if the items listed aboce meets the recognition criteria and definition as set by the
accounting boards. Furthermore, it will also address the specific conditions in recognising
DTA from tax lossess and wether or not Shady Sheds Ltd. has made the right decision in
recognising DTA.
Provision for Long-Service Leave and Retrenchment causing DTA
DTA is measured and recorded based on the future tax consequences when the
underlying temporary timing differences generate future taxable income deductions
(deductible temporary differences) (Petree, Gregory & Vitray, 1995). As stated in AASB112,
DTA is the amount of income taxes recoverable in future periods in respect of deductible
temporary differenced (DTD), the carry forward of unused tax losses, and unused tax credits.
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(Compiled AASB Standard, 2010). However, DTA can be recognised from both assets and
liabilities by determining the carrying amount and the tax base of that asset of liability.
The current method of recognising a deferred tax asset or liability is illustrated in the
diagram below.
Source: CPA Australia, 2007
According to IAS37, a provision of an item is a liability of an uncertain timing or
amount of the future expenditure required to finance a certain settlement. In order for an item
to be recognised as a liability, it must first satisfy the recognition criteria of a liability,
whereby there are probable future sacrifices of economic benefits arising from present
obligations of a particular entity to transfer assets or provide services to other entities in the
future as a result of past transactions or events (Compiled AASB Framework, 2009). The key
principle established by the Standard is that a provision should be recognised only when there
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is a liability i.e. a present obligation resulting from past events (IAS37,1999). IAS 37 also
states that:
An entity must recognise a provision if, and only if: [IAS 37.14]
o a present obligation (legal or constructive) has arisen as a result of a past event (the
obligating event),
o payment is probable ('more likely than not'), and
o the amount can be estimated reliably.
Therefore, provisions are recognised as a liability. Furthermore, AASB 112 also states that
any tax-related contingent liability and contingent assets that accordance with AASB 137
Provision, Contingent Liability and Contingent Assets would lead to DTAs.
As shown in the previous diagram, DTA arises from DTD form an asset or a liability.
However, in the light of provision of long service leave and retrenchment, this essay will
discuss about DTA arising due to liabilities. The accounting treatment for these provision is
that it is only recognised as an expense only when incurred. For tax purposes, these provisions
are recognised as allowable deductions only when the expense is incurred. According to this
recognition criteria, we can determine that the tax base for these provisions would be zero as
it has not been dispensed as an expense yet as it has not been incurred. Therefore, the carrying
amount of the provision would be more than the tax base which for liabilities, would from
DTD. When multiplied with the tax rate, DTA is formed.
Difference (DTD) = Carrying amount Tax base
For liability, if CA>TB = DTD
DTD x Tax Rate = DTA
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Deferred Tax Assets Arising From the Provision for Long-Service Leave and
Retrenchment
As per AASB 112, It is inherent in the recognition of a liability that the carrying
amount will be settled in future periods through an outflow from the entity of resources
embodying economic benefits. When resources flow from the entity, part or all of their
amounts may be deductible in determining taxable profit of a period later than the period in
which the liability is recognised. (AASB112). As discussed in the previous section, this would
give rise to a DTD due to the difference in the carrying amount and tax base thus giving rise
to DTD and DTA. It is proven that the provisions for long service leave and retrenchment
satisfies the recognition criteria of liability. For one, the existence of a present obligation as a
result of a past event. Here, we can see that Shady Sheds Ltd. has recognised expenses for
long-service leave and potential redundancy payouts for the past several years this showing
that it is a past event and they are also have a present obligation to payout when the time
comes. Furthermore, the second recognition would be an outflow of economic benefits.
Previously, the company had expensed the provision of long service leave and redundancy
payouts when paid. This shows there is an outflow of economic benefits by the company
when the pay back the employees when the time is right. Therefore, I disagree with the
auditors of Shady Sheds Ltd. and DTA asrising from the provision for long-service leave and
retrenchment should be recognised as it satisfy the recognition criteria of a liability.
Tax Losses and recognition of DTA
Tax loss is permitted under Australian income tax law that tax losses can be carried
forward for as a DTA to reduce future tax liabilities. However, according to AASB 112,
A deferred tax asset shall be recognised for all deductible temporary differences to the
extent that it is probable that taxable profit will be available against which the deductible
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temporary difference can be utilised, unless the deferred tax asset arises from the initial
recognition of an asset or liability in a transaction that:
(a) is not a business combination; and
(b) at the time of the transaction, affects neither accounting profit nor taxable profit
(tax loss).
Therfore, there are two ways we can assess this situation. First and foremost, we can
look at Shady Sheds Ltds past prior the lost of their client. They have made satisfactory
profits which would show that it is probable that there will be future taxable income will arise.
Therefore, they should recognise DTA. However, the client that Shade Sheds Ltd. lost is also
one of their major clients. We can argue that this client was the reason behind the large
percentage of Shady Sheds Ltds satisfactory profits and the loss of this client would cause the
company to continue to operate at a loss. If this was the case, then it is not probable that
taxable income will be available against which the deductible temporary difference can be
utilised. If that was the case, DTA should not be recognised.

Conclusion
In conclusion, provision for long service leave and retrenchment can be recognised to create
DTA as long as it meets the recognition criteria of a liability under AASB 112. Furthermore,
the recognition of DTA from tax loss can only be recognised if it abides by recognition
criteria where by it is recognised if there is probable future taxable income. Therefore, Shady
Sheds Ltd should review their financial statement to determine the main contributors to their
satisfactory financial profits. If their client that left their company, then future taxable profits
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is not probable. In this case, to recognise DTA, Shady Sheds Ltd. Should quickly find a
replacement client to fill the void in the company.