Tax Effect Accounting (AASB 1020)

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 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.

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 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’???

12. 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

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 : 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

16. Accounts Receivable - example As per accounts Accounts Receivable 40 000 Allowance for doubtful debts 2 000 Carrying amount 38 000 For taxation purposesdoubtful debts are not allowed as a deduction until they are actually written off

17. 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 .

18. 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 : 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

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 : 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

22. Cash Calculation of tax base : TB=CA-AA+DA = 20 000-0+0 = 20 000 No difference between carrying amount & tax base

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

24. 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

25. 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

26. 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

27. 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

28. 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

29. 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

30. 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 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 CA=0 & the TB=10,000 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

40. Tutorial Questions • Problem 4.1 • Problem 4.2 • Problem 4.4A • Problem 4.5A • Exercise 4.8