BACHELOR OF ACCOUNTING

ADVANCED FINANCIAL ACCOUNTING AND REPORTING 1

ACC 723
TOPIC 1
TAX EFFECT ACCOUNTING

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 INTRODUCTION

The purpose of this lecture is to

determine the amount for income
tax expense to report in the
Statement of Profit or Loss and
Other Comprehensive Income.
-The amount of income tax
expense that is determined in
accordance with IAS 12 Income
Taxes.
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 THE NATURE OF INCOME TAX

Accounting profit is usually different from taxable profit, because they are determined by
different principles and rules. The difference arise from a number of common transactions and
may be either permanent or temporary in nature.

Permanent difference- in accounting and tax profit arise when the treatment of a transaction
by taxation legislation and accounting standard is such that amount recognized as part of
accounting profit are never recognized as part of taxable profit or vice versa.
- this includes income never subject to taxation and expenditure incurred by an entity that will
never be an allowable deduction. where such difference exist, taxable profit will never equal
accounting profit.

Temporary difference- in accounting and tax profit arise when the period in which revenue
and expenses are recognized for accounting purposes is different from the period in which
such revenues and expenses are treated as taxable income and allowable deduction for tax
purposes.
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 INCOME TAX EXPENSE

Accounting for income taxes -

recognizes both the current tax
consequences of transactions and
events and the future tax
consequences of the future
recovery or settlement of the
carrying amount of an entity's
assets and liabilities.

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 INCOME TAX EXPENSE

In accordance with IAS 12, income tax expense includes:

Current tax = income tax payable for current period

Deferred tax = future tax consequences

The recognition of current tax and deferred tax provides

more complete or relevant information for economic
decision making than current tax alone
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 CURRENT TAX

Taxable profit
Profit for taxation purposes is known as taxable profit.

Determined in accordance with each Country’s own income tax

legislation, not according to general accounting rules.

There are differences between accounting principles of revenue

and expense recognition and taxation principles.

Accounting profit is, therefore, not the same as taxable profit

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 ACCOUNTING PROFIT vs TAXABLE PROFIT
ACCOUNTING TAX

Basis of accounting Accruals basis Principally cash basis

Some are exceptions to this

Equation Revenue – Expenses Taxable income (TI) – Tax

= Accounting profit Deductions (TD) = Taxable
profit

-Accounting profit does not equal taxable profit

-Difference caused by different “rules” used for accounting vs. tax 7
 ACCOUNTING INCOME Vs. TAX TREATMENT
ITEM
Many accrued expenses (e.g.
employee benefits such annual
leave)
Prepaid expenses (e.g. prepaid
insurance)
Revenue received in advance
(e.g. rental revenue)
Bad/doubtful debts
ACCOUNTING TAX
An expense is recognized when Recognised as a tax deduction when
accrued paid
Recorded as an asset when pre- Recognised as a tax deduction when
paid and expensed as incurred paid
Liability recognised for Typically taxed when cash is received
unearned revenue and then
allocated to revenue as services
are performed
Allowance raised and expense Recognised as a tax deduction when
recorded when debt considered debts are written off as bad
doubtful 8
 ACCOUNTING INCOME Vs. TAX TREATMENT
ITEM ACCOUNTING TAX
Fines and penalties and Recognised as an expense Not deductible
entertainment costs when payable

Depreciation of a depreciable Recognised as expense based Recognised as a tax deduction based on

asset on useful life of asset depreciation rates set in the tax rules

Development costs (intangible Capitalised (asset) and Typically a tax deduction when paid
asset) amortised

Tax losses No recognition Carried forward and offset against

future taxable income 9
 ACCOUNTING INCOME Vs. TAX TREATMENT
ITEM ACCOUNTING TAX
Fines and penalties and Recognised as an expense Not deductible
entertainment costs when payable

Depreciation of a depreciable Recognised as expense based Recognised as a tax deduction based on

asset on useful life of asset depreciation rates set in the tax rules

Development costs (intangible Capitalised (asset) and Typically a tax deduction when paid
asset) amortised

Tax losses No recognition Carried forward and offset against

future taxable income
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 EXAMPLE 1: CURRENT TAX PAYABLE
• The following information's are from the accounts of Smartco Ltd for the year ending 31
December 2017. you are to calculate accounting profit and taxable profit
cash sales $200 000;
cost of goods sold $60 000;
amounts received in advance for services to be performed in February 2018 $15 000;
Rent expense for year ended 31 December 2017 $12 000;
Rent prepaid for three months to 31st March 2018 $6000;
Fines and penalties expenses for 2017 $5000
Doubtful debts expenses $2 000;
Amount provided in 2017 for employees’ long-service leave entitlements $5 000 and
Goodwill impairment expense $7 000.
If the company income tax rate is 30%, how much taxes will be payable to IRD for the financial year
ending on 31 December 2018?
what journal entry would you pass in the accounts of Smartco to account for current taxes payable?

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 EXAMPLE 1: CURRENT TAX PAYABLE

Accounting profit Taxable Profit

Cash sales $200, 000 $200,000
Cost of Goods sold ($60,000) ( $60,000)
Amounts received in advance for services to be - $15,000
performed in February 2018
Rent expense for end ended 31 December 2017 ($12,000) ($12,000)
Rent Prepaid for 3 months to 31st March 2018 ($ 6,000)
Fines and penalties expenses ($5000)
Doubtful debts costs ($2000)
Long service leave ($5000)
Good will Impairment expense ($7000)
$109,000 $137,000
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 EXAMPLE 1: CURRENT TAX PAYABLE

If the company income tax rate is 30%, how much taxes will be payable to IRD for the
financial year ending on 31 December 2017?
What Journal entry would you pass in the accounts of Smart Co Ltd to account for
current taxes payable?
Current taxes payable = tax rate * taxable profit
= 30 % * $137 000
= $ 41, 100
journal entry:
31/12/17 Income tax expense Dr 41,100
Current tax liability Cr 41,100
(recognition of current tax liability, based
on the taxable income for the year)

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 DEFERRED TAX

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 purposes

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 DEFERRED TAX

Arise principally due to the accruals vs. cash basis of

recognising transactions. Differences either result in:
1. The company paying more tax in the future
-result in deferred tax liabilities (DTLs)

2. The company paying less tax in the future

-result in deferred tax assets (DTAs)

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 DEFERRED TAX ASSET
ACCOUNTING FOR DEFERRED TAXES:
AASB 112/IAS 12 APPLIES THE ‘BALANCE SHEET’ APPROACH:
-this means the recognition of deferred tax assets and liabilities is based
on the differences between accounting and tax values of assets and
liabilities;

Focuses on comparing the carrying amount of an entity’s assets and

liabilities (determined by accounting rules) with the tax base for those
assets and liabilities:
-effectively involves comparing the balance sheet derived using
accounting rules with the balance sheet that would be derived from
taxation rules.
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 DEFERRED TAX ASSET

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”
where the carrying amount of an asset or liability is different
from the tax base a ‘temporary difference’ can arise.

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 TEMPORARY DIFFERENCES

Temporary differences can be either:

-taxable temporary difference or
-deductible temporary difference

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 TAXABLE TEMPORARY DIFFERENCES

A taxable temporary difference will lead to more tax

payments in the future.
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.
Results when:
Asset: when CA > TB
Liability: when CA < TB
a taxable temporary difference will lead to the
recognition of a deferred tax liability (DTL)
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 DEDUCTIBLE TEMPORARY DIFFERENCES

A DEDUCTIBLE TEMPORARY DIFFERENCE will lead to less

tax payments in the future.
TAXATION PAYMENTS have been made ‘IN ADVANCE’;
TAX IS REDUCED OR ‘SAVED’ IN LATER YEARS.
Results when:
ASSET: WHEN CA < TB
LIABILITY: WHEN CA > TB
A DEDUCTIBLE TEMPORARY DIFFERENCE will lead to the
recognition of A DEFERRED TAX ASSET (DTA)
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 Example 2: Calculating DTLs and DTAs
Assets ( Assuming that CA TB Tem Diff DTL DTA
the tax rate is 30%
Cash 15,000 15,000 0
Prepaid insurance 35,000 0 35,000 10,500
$35,000
Interest receivable $1500 1,500 0 1,500 450
Trade receivable : $4000 3,800 4,000 200 60
allowable for DD $200
Plant: Cost $10,000 7,500 5,000 2,500 750
Accountng depn $, 2500
Tax accum Dep$5000
Development asset 12,000 0 12,000 3,600
$12,000

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 Example 2: Calculating DTLs and DTAs

Liabilities ( Assuming CA TB Tem Diff DTL DTA

that the tax rate is 30%
Accounts Payable 7,500 7,500
$7,500
Accrued rent $300 300 0 300 90
Fines payable$2000 2,000 2,000 0
Accrued leave liability: 1,600 0 1,600 480
$1600
Warranty Provision $ 800 800 0 800 240
Unearned revenue 2,500 0 2,500 750
$2500
Loan Payable: $17,000 17, 000 17,000 0
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 THE END

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