Tax

TaxEffect
Effect
Accounting
Accounting
(AASB
(AASB1020)
1020)
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 Objectives

 Tobe able to complete

the entries necessary to apply
accounting standard
AASB 1020 - Tax Effect Accounting

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 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.

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 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)

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 Taxation vs Accounting Treatments

 Accounting Profit
= revenue less expenses
Based on accrual accounting and requirements of
accounting standards

 Taxable Income
= assessable income – allowable deductions
Based on requirements of Income Tax Assessment Act
Generally follows cash flows of transactions and events

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Taxation vs Accounting Treatments
 Assessable income  Accounting revenue

– Revenue not yet received is not assessable

– Some revenue is exempt from tax eg Government grants

 Allowable deductions  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

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 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

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 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

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 Determination of taxable income
Accounting 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

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 Determination of taxable income
Accounting Profit $300
Add Depreciation – building (non deductible) 20
Depreciation – plant 50
Doubtful debts expense 40
410
Less
Journal
Government grant (nonentry::
assessable) 120
Assuming 30% tax rate
Depreciation – planttax
Dr Income (for tax purposes)
Expense 69 60
CR Current tax liability 69
Taxable income $230

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 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’???

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 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

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 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.

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 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

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 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

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 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

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 Accounts Receivable
Calculation 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 .
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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

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 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

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 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.

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 Prepayments
Calculation 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
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 Cash
Calculation of tax base :
TB=CA-AA+DA
= 20 000-0+0
= 20 000

No difference between carrying amount & tax base

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 Inventory
Calculation of tax base :
TB=CA+AA-DA
= 208 000+208000-208000
= 208 000
No difference between tax base and carrying amount

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 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

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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

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 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

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 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

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 Excluded temporary differences

 Goodwill
Goodwill 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

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

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 Worksheet
CA TB ATD DTD
Cash @ Bank 80 000 80 000
Receivables 38 000 40 000 2 000
Inventory 100 000 100 000
Prepayments 9 000 0 9 000
Rent Receivable Tax effect journal
15 000 0 15 000
Plant DR Deferred
8 000 Tax Asset
7 000 400 1 000
Buildings CR70 Deferred
000 Tax Liab
exempt 2 500
Goodwill Dr Income
5 000Tax Expense
exempt2 100
Liabilities (in addition
20 000 to the20current
000 tax lib entry)
Long Service Leave 16 000 0 16 000
25 000 18 000
Tax 30% 7 500 5 400
Beginning balances 5 000 5 000
Adjustment $2 500 $400

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 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

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 Tax Losses

 Taxlosses 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
 Thesize of the tax loss to be
carried forward depends on the
exempt income which must be
deducted from the loss forward.

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 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)

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 Tax Losses- example

Determination of tax
Accty profit/(loss) (15 000)
add Journal entry
Dr Deferred tax Asset 14 400
depn-plant 34tax000
Cr Income Revenue 14 400
less
depn plant (67 000)
Tax Loss ($48 000)

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 Tax Losses recouped- example

Determination of tax- subsequent years

Accty profit/(loss) 148 000
less
Tax loss recovered (48 000)
Taxable Income $100 000

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 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 :

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

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 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

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 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 entry
Deferred tax asset Dr $2
Expense on rate change Dr $3
Deferred tax liability Cr $5

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 Tutorial Questions

 Problem 4.1
 Problem 4.2
 Problem 4.4A
 Problem 4.5A
 Exercise 4.8

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