AF314

Chapter 17

Accounting for company

income tax

Presenter

Associate Professor Parmod Chand

 Announcements

Contact details: (Teaching weeks only)

• Parmod – Email: [email protected]

• Eremasi – Email: [email protected]

Accounting income vs tax treatments

ACCOUNTING TAX
Basis of Accruals basis Principally cash basis
accounting
Equations Revenue – Expenses Taxable income (TI) – tax
= Accounting profit deductions (TD) =
Taxable profit
AASBs/IASs and the The Income Tax Assessment Act
Corporations Act are key determines the tax treatment of
sources that determine transactions
the appropriate
accounting treatment of
transactions

• Accounting profit does not equal taxable profit

• Difference caused by different “rules” used for accounting vs tax purposes
Fundamentals of accounting for income taxes

• Accounting for income taxes is governed by

AASB 112/IAS 12
• We need to distinguish between two types of income tax
effects:
– current income tax consequences
(income tax payable = current tax liability)
– future income tax consequences
(deferred tax assets or liabilities)
• Both are based on differences between pre-tax accounting
profit and taxable income.

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Fundamentals of accounting for income taxes
(cont’d)

• Pre-tax accounting profit is

– determined according to accounting standards
and principles;
– measured with objective of providing useful
information to investors and creditors;
– determined under accrual basis accounting.

AASBs/IASs and the Corporations Act

are key sources that determine the
appropriate accounting treatment of
transactions

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Fundamentals of accounting for income taxes
(cont’d)

• Taxable income is determined

– according to Australian (Fijian) tax legislation;
– principally, under cash basis accounting.

The Income Tax Assessment

Act determines the tax
treatment of transactions

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 Accounting vs. tax treatment – Common
differences

ITEM ACCOUNTING TAX

Recognised as revenue, with Recognised as Taxable
Revenue received corresponding asset Income (TI) when cash
in arrears
(receivable) when earned received
Rent, interest, royalties etc.
Recognised as expense Recognised as Tax
Depreciation based on useful life of asset Deductible (TD) based on
(accelerated for tax) rates prescribed by taxation
rules
Common for assets to be depreciated over a shorter life for tax purposes than for accounting purposes

Capitalised (as far as

Development costs recognition criteria met) Recognised as TD when paid
and amortised

Prepaid expenses Recognised as an asset and Recognised as TD when paid

expensed as incurred
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 Accounting vs. tax treatment – Common
differences (cont’d)

ITEM ACCOUNTING TAX

Recognised as liability when
Revenue received Recognised as TI when
received, as revenue when
in advance cash received
earned
Depreciation Recognised as expense Recognised as TD based on
(accelerated for based on useful life of asset rates prescribed by taxation
accounting) rules
Possible for accounting useful life to be shorter than tax useful life

Allowance and
Recognised as a TD when
Bad/doubtful debts expense recognised
debt physically written off
when debt doubtful

Liability and expense

Employee benefits
recognised when debt owing Recognised as TD when paid
(e.g. annual leave)
to employee
Provisions (e.g. for warranties) are treated in the same way as employee benefits
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 Question 1

• You are provided with the following information from the accounts of Big
Kahuna Ltd for the year ending 30 June 20X3.
- Cash sales $100,000
– Cost of goods sold $40,000
– Amounts received in advance for services
to be performed in August 20X3 $5,000
– Rent expense for year ended 30 June 20X3 $10,000
– Rent prepaid for two months to 31 August 20X3 $1,000
– Doubtful debts expenses $1,000
– Amount earned in 20X3 by employees for
long-service leave entitlements (= increase of provision) $3,000

You are required to calculate accounting profit and taxable income.

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 Question 1 Solutions…

Accounting Taxable
profit income
– Cash sales $100,000
$100,000
– Cost of goods sold ($40,000)
(40,000)
– Amounts received in advance by Big Kahuna Ltd
for services to be performed in August 20X3 –
$5,000
– Rent expense for year ended 30 June 20X3 ($10,000)
($10,000)
– Rent prepaid for two months to 31 August 20X3 _
($1,000)
– Doubtful debts costs ($1,000)
–
– Amount earned in 20X3 by employees
for long-service leave entitlements ($3,000)
–
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– Total $46,000
 Two types of differences

• The differences between accounting and taxable income we discussed so

far are all of a temporary nature:
– temporary differences reverse over time, i.e. they will increase or
decrease taxable income in the future;
– therefore, they give rise to deferred taxes;
– taxable amounts increase taxable income in future years:
• a deferred tax liability is recognised;
– deductible amounts decrease taxable income in future years:
• a deferred tax asset is recognised.

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 Two types of differences (cont’d)

• Some other differences are permanent:

– e.g. entertainment expenses must be recognised for accounting purposes,
however, they are never deductible for tax purposes;
– they will not reverse over time.
• Since permanent differences affect only the period in which they occur,
they do not give rise to future taxable or deductible amounts:
– no future tax consequences,
– no need for deferred taxes.
• However, details of permanent differences must be disclosed in a note.

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 Permanent differences

• In general, permanent differences are caused by

items that:
– Enter into pre-tax accounting profit but never into
taxable profit, or
– enter into taxable income but never into pre-tax
accounting profit.

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 Permanent differences –
Common examples

ITEM ACCOUNTING TAX

Fines and Recognised as expense
penalties when incurred Commonly not deductible

Entertainment Recognised as expense

costs when incurred Not deductible

Goodwill Recognised as expense

impairments when incurred Not deductible

Non-taxable
(exempt) income Recognised as income
Not taxable
when earned
e.g. government grants

Research & Under certain conditions

Only 100% of R&D costs
development > 100% of R&D costs
expensed over time
(R&D) allowances deductible
Not recognised Allowed to be offset against
Tax losses
future taxable income
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 Accounting for current tax consequences

• Calculation of
income tax payable = current tax liability:
– Income tax payable is based on taxable income, not
accounting profit;
– necessary to adjust accounting profit to taxable income
for all differences, e.g.:
• add back accounting depreciation;
• deduct depreciation for taxation purposes;
– calculation of income tax payable:
• tax rate multiplied by taxable income.
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 Question 2
Profit before tax for ABC Ltd for the year to
30 June 20X3 is as follows: Additional information:
• $60 allowed as a tax deduction for
Sales 1,000 plant.
• Interest has not yet been received.
Interest revenue 40
• Bad debts of $20 were written off
Government grant 80 during the year.
• Payments of $30 were made to
COGS (450) employees in relation to annual leave
taken during the year.
Depreciation (50)
• The tax rate is 30%
Goodwill impairment (20) Required:
• Calculate the current tax liability of ABC
Bad debts (30)
Ltd as at 30 June 20X3 and prepare the
Annual leave (10) required journal entry.

Other expenses (260)

Profit before income tax 300

 Question 2 Solutions

Accounting profit before tax 300

Government grant exempt income (80) permanent
differences
Goodwill impairment not deductible 20
Interest not yet received (40)
Adjustment for plant depreciation (10) temporary
differences
Adjustment for bad debt write-offs 10
Adjustment for annual leave paid (20)
Taxable income 180
Current tax liability (CTL) (30%) 54

Acctg depn 50 B/debts expense-acctg 30 A/L expense- acctg 10

Tax depn (60) B/debts w/off- tax (20) Paid- tax (30)
Adj req (10) Adj req 10 Adj req (20)

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 Q2 Solutions cont’d…

The journal entry at 30 June 20X3 for the current tax consequences only would
be:

Dr Income tax expense 54 000

Cr Current tax liability = Income tax payable 54 000

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 Accounting for
future tax consequences
• Accounting for future tax consequences = deferred
taxes:
– AASB/IAS 112 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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 Balance sheet approach

• Carrying amount (CA) vs tax base (TB)

of asset or liability
– Carrying amount is the amount the asset or liability is recorded at in
the accounting records;
– Tax base is defined as the amount that is attributed to an asset or
liability for tax purposes (AASB 112/IAS 12):
• tax base represents the amount an asset or liability would be
recorded at if the balance sheet (statement of financial position)
were prepared applying taxation rules;
– Where the carrying amount of an asset or liability is different from the
tax base a ‘temporary difference’ can arise.

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 Balance sheet approach (cont’d)

• Taxable temporary difference = future taxable amount (FTA)

→ 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 be paid later.

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 Balance sheet approach (cont’d)

• Example of a deferred tax liability:

– Carrying amount of a non-current depreciable asset

exceeds the tax base in early years, as depreciation
allowable as a deduction for tax purposes is greater than
depreciation for accounting purposes;
– this will be reversed in later years when no depreciation is
allowable for tax purposes.

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 Balance sheet approach (cont’d)

• Deductible temporary difference = future deductible amount

(FDA) → deferred tax asset

– The carrying amount of an asset is less than the tax base;

– taxation payments have been made ‘in advance’;
– tax is reduced or ‘saved’ in later years.

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 Balance sheet approach (cont’d)

• Example of a 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 than depreciation for
accounting purposes;
– this will be reversed in later years when the asset is fully
depreciated for accounting purposes, but depreciation is
still allowable as a deduction for tax purposes.

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 Example: Calculating and identifying
temporary differences
With an assumed tax
Difference is a** rate of 30%, this leads
Examples CA - TB* = to a

FTA or FDA DTL DTA

Prepayment: $3,000 3,000 - 0 = 3,000 900
Interest receivable: $1,000 1,000 - 0 = 1,000 300
Plant: cost $10,000,
acctg acc./depn. $4,600, 5,400 - 3,500 = 1,900 570
tax acc./depn. $6,500.
Trade receivables: $52,000
50,000 - 52,000 = 2,000 600
Allowance for dbtf.debts: $2,000
Trade payables: $30,000 30,000 - 0 = 30,000 9,000
Annual leave liability: $3,900 3,900 - 0 = 3,900 1,170

* The textbook shows a formula to calculate the tax base; we recommend that you just use common sense: What
would be the value of the asset or liability in a balance sheet prepared under taxation rules?
** This column shows the total of all FTA and FDA relating to the asset or liability being either a FTA or a FDA
depending on the sign. Don’t confuse these totals with the individual FTAs and FDAs the textbook uses to calculate25
the tax base.
 Question 3

• Robert August Ltd commences operations on 1 July 2015.

• 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
uniform throughout 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
per year (600,000/4 years).
• For taxation purposes, the ATO allows the company to depreciate the asset over
three years – that is $200,000 per year.
• The profit before tax of the company for each of the next four years (for years
ending 30 June) is $500,000, $600,000, $700,000 and $800,000 respectively.
• The tax rate is 30%.
You are required to calculate the temporary differences caused by the depreciation
and show the resulting entries.

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 Question 3 Solutions

• Year 1 (ending 30 June 2016)

Carrying Temporary
value Tax base difference
($) ($) ($)
Fibre glassing machine: cost 600,000 600,000
Accumulated depreciation 150,000 200,000
450,000 400,000 50 000

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 Q3 Solutions cont’d…

The tax on the taxable income would be determined as follows:

Accounting profit before tax $500,000
Add back accounting depreciation $150,000
Subtract depreciation for taxation purposes ($200,000)
Taxable income $450,000
Tax at 30% $135,000

The journal entries at 30 June 2016 would be:

Dr Income tax expense 15,000 (50,000 x 30%)

Cr Deferred tax liability 15,000

Dr Income tax expense 135,000

Cr Income tax payable 135,000

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 Q3 Solutions cont’d…

• Year 2 (ending 30 June 2017)

Carrying Temporary
value Tax base difference
($) ($) ($)
Fibre glassing machine: cost 600,000 600,000
Accumulated depreciation 300,000 400,000
300,000 200,000 100,000

– The temporary difference at 30 June 2017 totals $100,000. Applying the tax
rate of 30% provides a deferred tax liability of $30,000.
– Because $15,000 has already been recognised in 2016, an increase (or ‘top
up’) of $15,000 is required.

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 Q3 Solutions cont’d…

The tax on the taxable income would be determined as follows:

Accounting profit before tax $600,000
Add back accounting depreciation $150,000
Subtract depreciation for taxation purposes ($200,000)
Taxable income $550,000
Tax at 30% $165,000

The journal entries at 30 June 2017 would be:

Dr Income tax expense 15,000
Cr Deferred tax liability 15,000

Dr Income tax expense 165,000

Cr Income tax payable 165,000

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 Q3 Solutions cont’d…

• Year 3 (ending 30 June 2018)

Carrying Temporary
value Tax base difference
($) ($) ($)
Fibre glassing machine: cost 600,000 600,000
Accumulated depreciation 450,000 600,000
150,000 0 150,000

– The temporary difference at 30 June 2018 totals $150,000. Applying the tax
rate of 30% provides a deferred tax liability of $45,000.
– Because $30 000 has already been recognised in 2016 and 2017, an increase
(or ‘top up’) of $15,000 is required.

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 Q3 Solutions cont’d…

The tax on the taxable income would be determined as follows:

Accounting profit before tax $700,000
Add back accounting depreciation $150,000
Subtract depreciation for taxation purposes ($200,000)
Taxable income $650,000
Tax at 30% $195,000

The journal entries at 30 June 2018 would be:

Dr Income tax expense 15,000
Cr Deferred tax liability 15,000

Dr Income tax expense 195,000

Cr Income tax payable 195,000

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 Q3 Solutions cont’d…

• Year 4 (ending 30 June 2019)

Carrying Temporary
value Tax base difference
($) ($) ($)
Fibre glassing machine: cost 600,000 600,000
Accumulated depreciation 600,000 600,000
0 0 0

– The temporary difference at 30 June 2019 is $nil, which means that there
should be no deferred tax liability or deferred tax asset recorded in relation to
this asset.
– This means the balance accrued in the deferred tax liability must be reversed
in 2019.

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 Q3 Solutions cont’d…

The tax on the taxable income would be determined as follows:

Accounting profit before tax $800,000
Add back accounting depreciation $150,000
Subtract depreciation for taxation purposes 0
Taxable income $950,000
Tax at 30% $285,000

The journal entries at 30 June 2019 would be:

Dr Deferred tax liability 45,000

Cr Income tax expense 45,000

Dr Income tax expense 285,000

Cr Income tax payable 285,000

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 Q3 Solutions cont’d…

• A review of Q3 indicates that the balance sheet approach to

accounting for income tax ‘smoothes’ the tax expenses across the four
years, as indicated below:

Year 1 Year 2 Year 3 Year 4 Total

($) ($) ($) ($) ($)
Tax expense based
on taxable income 135,000 165,000 195,000 285,000 780,000

originating DTL reversing DTL

Adjustment for
‘temporary’ difference 15,000 15,000 15,000 (45,000) –
Total tax expense 150,000 180,000 210,000 240,000 780,000

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 Relationship between income tax payable
and income tax expense
• As you could see from the previous journal entries:
– An increase (decrease) in a deferred tax liability increases (decreases) income tax
expense
– An increase (decrease) in a deferred tax asset decreases (increases) income tax
expense
• Relationship between income tax payable and income tax expense:

Income Change in
Total income tax + deferred income
tax expense = –
payable tax

• In other words, we adjust income tax expense by deferred taxes to make it match the
accounting profit:
income tax expense =
accounting profit (after permanent differences) x tax rate.

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 Income statement presentation

• Income statement presentation of income tax expense:

CHELSEA LTD
Statement of Comprehensive Income
for the year ending 30 June 2019

Revenues $130 000

Expenses 60 000
Profit before income tax70 000
Income tax expense 21 000
Profit for the period$ 49 000
• see textbook for details.

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 Tute Questions

Leo 11e Chapter 17

1. Review Question 2
2. Review Question 6
3. Practice Question 17.1
4. Practice Question 17.7
5. Practice Question 17.8

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