tax effect accounting

1
Tax Effect Accounting (AASB 1020)
2
Objectives

• To be able to complete
• the entries necessary to apply
• accounting standard
• AASB 1020 - Tax Effect Accounting

3
AASB 1020

• The standard sets out the accounting treatment of
  a companys income tax in general purpose
  financial reports prepared by a reporting entity
• The standard uses the balance sheet approach
  analyses the differences between the entitys
  balance sheet prepared for general purpose
  financial reporting the balance sheet for tax
  purposes.

4
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)

5
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

6
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

7
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

8
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

9
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
  

10
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
  

Journal entry Assuming 30 tax
rate Dr Income tax Expense 69 CR
Current tax liability 69
11
Tax effect accounting

• Focuses on the future tax consequences arising as
  a result of the differences from the carrying
  amount of an entitys 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 _at_ a maximum to carrying amount)
• add
• Deductible amount allowable deductions
• Tax Base
• TB CA-AADA

13
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.

14
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

15
Depreciable Asset

• Calculation of tax base
• TBCA-AADA
• 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

17
Accounts Receivable

• Calculation of tax base
• TB CA-AADA
• 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

19
Rent receivable

• Calculation of tax base
• TBCA-AADA
• 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

20
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.

21
Prepayments

• Calculation of tax base
• TBCA-AADA
• 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

22
Cash

• Calculation of tax base
• TBCA-AADA
• 20 000-00
• 20 000
• No difference between carrying amount tax base
  

23
Inventory

• Calculation of tax base
• TBCAAA-DA
• 208 000208000-208000
• 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
• TBCAAA-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
• TBCAAA-DA
• 16 0000-16000
• 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

27
Accounts Loans Payable

• Calculation of tax base
• TBCAAA-DA
• (Assume 75 000 accounts payable)
• 75 0000-0
• 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 _at_ 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 _at_ 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

Tax effect journal DR Deferred Tax
Asset 400 CR Deferred Tax Liab 2
500 Dr Income Tax Expense 2 100 (in addition to
the current tax lib entry)
31
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 CA0 the TB10,000 therefore DTD which
  creates a Deferred Tax Asset

32
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.

33
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)

34
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 entry Dr Deferred tax Asset 14 400
Cr Income tax Revenue 14 400
35
Tax Losses recouped- example

• Determination of tax- subsequent years
• Accty profit/(loss) 148 000
• less
• Tax loss recovered (48 000)
• Taxable Income 100 000

36
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 )
37
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

38
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

39
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