Financial Accounting 2

ACC203 Financial Accounting 2

Workshop 8 Income Tax

COMMONWEALTH OF AUSTRALIA Copyright Regulations 1969

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Material adapted from Financial reporting in Australia / Janice Loftus, Ken Leo, Sorin Daniliuc, Noel Boys, Belinda Luke, Hong Ang, Karyn Byrnes. Second edition.

John Wiley & Sons Australia, Ltd

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Learning objectives

1. Discuss the reason for a standard on income taxes 2. Discuss differences in accounting treatments and

taxation treatments for a range of transactions 3. Explain that some transactions and other events have

both current and future tax consequences 4. Calculate and account for current tax 5. Calculate and account for deferred tax

Class Discussion • Working in pairs, answer the following questions –

– What do you understand by the terms current tax and deferred tax?

– Can you identify any two transactions/events that would have deferred tax consequences?

– Is it important to recognise deferred tax consequences in the current financial year?

Learning objectives

1. Discuss the reason for a standard on income taxes 2. Discuss differences in accounting treatments and

taxation treatments for a range of transactions 3. Explain that some transactions and other events have

both current and future tax consequences 4. Calculate and account for current tax 5. Calculate and account for deferred tax

Why is there a need to account for income taxes in the accounting books ?

Income tax incurred by organisation are based on the Australian Tax Regulations.

The financial reports and the accounting books of an entity are based on the Australian Accounting Standards.

Cash Basis Accruals Basis

Therefore adjustments are required in the accounting books

What is general rule prescribed in AASB 112/IAS ?

If an accounting transaction has occurred in the current accounting period and it contains components of both current and future taxes, those tax consequences should be recognised as income or expenses in the net profit/loss for the current accounting period.

If we recognised revenue for $21000, we need recognise tax on the full amount of $21000, irrespective of what the tax effects on this amount is.

What does this mean?

Class Activity

What is the main principle of tax-effect accounting as outlined in AASB 112/IAS 12?

Learning objectives

1. Discuss the reason for a standard on income taxes 2. Discuss differences in accounting treatments and

taxation treatments for a range of transactions 3. Explain that some transactions and other events have

both current and future tax consequences 4. Calculate and account for current tax 5. Calculate and account for deferred tax

Differences between accounting profit and taxable profit

• Accounting profit is measured as the difference between accounting revenues and accounting expenses.

• The accounting revenues and expenses are determined in accordance with the rules established by accounting standards, normally based on accrual accounting.

• Taxable profit is calculated as the difference between taxable revenues over taxation deductions allowable against those revenues.

Differences between accounting profit and taxable profit

Class Activity

• Working in pairs, answer the following questions – – Explain how accounting profit and taxable profit differ,

and how each is treated when accounting for income taxes.

Learning objectives

1. Discuss the reason for a standard on income taxes 2. Discuss differences in accounting treatments and

taxation treatments for a range of transactions 3. Explain that some transactions and other events have

both current and future tax consequences 4. Calculate and account for current tax 5. Calculate and account for deferred tax

• Some transactions may not have any consequences for taxation.

For example, an entity that pays $5000 in cash entertainment expenses for the current period is not entitled to a tax deduction on that amount in the current period or in the future.

• Other transactions have only current period consequences for taxation.

For example, if an entity pays $10 000 cash for rent of a building for the current period, a tax deduction of $10 000 is received. There is a current tax effect but no future tax effect.

What is the principle adjustment that is required in the books?

Accounting adjustments for the current and future tax consequences

Source: Adapted from Loftus et al (2018), p. 460

What is the principle adjustment that is required in the books?

For example: Assume an entity recognises interest revenue od $21000 for the current year ended 30 June 2020. Of this amount, $15000 has been received in cash and a receivable asset has been raised for the remaining $6000.

The entity will pay tax only on $15000 in the current year. Therefore: Current tax consequence = 30% x $15000 = $4500

Future tax consequence will be incurred on the $6000 in the following year. Therefore: Future tax consequence = 30% x $6000 = $1800

Even though taxes are collected in different periods, both amounts should be recognised in the current books as the latter have recorded revenue to be $21000.

Note: Remember in accounting we use accruals basis, we record our revenue when they occur not when we receive cash.

Source: Adapted from Loftus et al (2018), p. 460

What is the principle adjustment that is required in the books?

Accounting for the current and future tax consequences

Some transactions may have both current and future tax consequences for taxation

For example: Assume an entity recognises interest revenue od $21000 for the current year ended 30 June 2020. Of this amount, $15000 has been received in cash and a receivable asset has been raised for the remaining $6000.

The entity will pay tax only on $15000 in the current year. Therefore: Current tax consequence = 30% x $15000 = $4500

Future tax consequence will be incurred on the $6000 in the following year. Therefore: Future tax consequence = 30% x $6000 = $1800

Even though taxes are collected in different periods, both amounts should be recognised in the current books as the latter have recorded revenue to be $21000.

Note: Remember in accounting we use accruals basis, we record our revenue when they occur not when we receive cash.

Source: Adapted from Loftus et al (2018), p. 460

Class Activity

Explain the meaning of a temporary difference as it relates to deferred tax calculations and give three examples.

Learning objectives

1. Discuss the reason for a standard on income taxes 2. Discuss differences in accounting treatments and

taxation treatments for a range of transactions 3. Explain that some transactions and other events have

both current and future tax consequences 4. Calculate and account for current tax 5. Calculate and account for deferred tax

Calculation of current tax

• The current tax liability is the recognition of the taxes payable to the taxation authorities in relation to the current year.

• The calculation of this liability involves measuring the taxable profit and multiplying it by the current tax rate (30%).

• Taxable profit can be measured based on accounting profit adjusted for the different treatment of accounting revenues and expenses for taxation purposes.

Calculation of current tax

This process can be performed in a worksheet — referred to as the current tax worksheet — and can be expressed as follows: Accounting profit

+ accounting expenses or losses where the amounts differ from deductible amounts + taxable revenues where the amounts differ from accounting revenues or gains − deductible amounts where the amounts differ from accounting expenses or losses − accounting revenues or gains where the amounts differ from taxable revenues

= Taxable profit

Class Activity

Class Activity

Learning objectives

1. Discuss the reason for a standard on income taxes 2. Discuss differences in accounting treatments and

taxation treatments for a range of transactions 3. Explain that some transactions and other events have

both current and future tax consequences 4. Calculate and account for current tax 5. Calculate and account for deferred tax

Calculation of deferred tax

1. Deferred tax involves comparing the carrying amount of assets and liabilities in the accounting statement of financial position to that of the tax statement of financial position.

2. The tax statement of financial position is known as Tax Base.

How to calculate deferred tax?

• Step 1: Determining carrying amounts • Carrying amounts are asset and liability balances after

valuation allowances, accumulated depreciation/amortisation amounts and impairment losses have been netted off.

• For example, the carrying amount of accounts receivable is the balance of accounts receivable less any allowance for doubtful debts.

• These amounts can be read from the trial balance at the end of the financial year.

Calculation of deferred tax

• Step 2: Determining tax bases • Tax bases need to be determined for both assets and

liabilities. • Tax base of an asset • Two ways in which the tax base of an asset can be

calculated, dependent on whether the asset generates economic benefits that are taxable:

Calculation of deferred tax

• Step 2: Determining tax bases • Tax base of a liability • The tax base of such a liability equals the carrying

amount less any amount that will be deductible for tax purposes in respect of that liability in future periods. The formula is:

• As such, the difference between the tax base of a liability excluding revenue received in advance and its carrying amount can be written as follows:

Calculation of deferred tax

• Step 3: Determining and classifying temporary differences – Determining temporary differences

• Defines temporary differences as differences between the carrying amount of an asset or liability in the statement of financial position and the asset’s or liability’s tax base. – Classifying temporary differences

• Deductible temporary differences result in amounts that are deductible in determining taxable profit of future periods when the carrying amount of the asset or liability is recovered or settled.

Calculation of deferred tax

• Step 3: Determining and classifying temporary differences

• Classifying temporary differences:

Calculation of deferred tax

• Step 3: Determining and classifying temporary differences

• Taxable temporary differences result in amounts that are taxable in determining taxable profit of future periods when the carrying amount of the asset or liability is recovered or settled.

Calculation of deferred tax

• Step 3: Determining and classifying temporary differences – Excluded temporary differences

• Paragraphs 15 and 24 of AASB 112/IAS 12 note some exceptions to the requirement that deferred tax assets and liabilities must be recognised for all taxable and deductible temporary differences.

Calculation of deferred tax

Calculation of deferred tax

• Step 4(a): Determining the closing balances of deferred • tax assets and deferred tax liabilities

– Deferred tax liabilities • Deferred tax liabilities arise from the existence of taxable

temporary differences; that is, where the future taxable amount is greater than the future deductible amount. – Deferred tax assets

• Deferred tax assets arise from the existence of deductible temporary differences, where the future deductible amount is greater than the future taxable amount.

Calculation of deferred tax

• Step 4(a): Determining the closing balances of deferred • tax assets and deferred tax liabilities • Using the last line from figure 12.7, having calculated the

net temporary differences existing at the end of the period, the balances of deferred tax asset and deferred tax liability can be determined by multiplying the amount of the differences by the tax rate:

Calculation of deferred tax

• Step 4(b): Determining the movement in deferred tax • asset and deferred tax liability accounts • The opening balances of the deferred tax accounts are

available from the previous year’s financial statements. • A comparison of the opening and closing balances will

give the movement that has occurred in the current period.

• The movement shows the adjustment necessary in the current period to change the opening balance into the required closing balance.

Calculation of deferred tax

Calculation of deferred tax

• Step 4(c): Determining the deferred tax adjustment entry • The adjusting journal entry at the end of the period is

read from the last line of the deferred tax worksheet. • The income tax expense (deferred) is a net of the

movements in the deferred tax asset and liability accounts.

Class Activity

References

Loftus, J. , Ken, L., Sorin D., Boys N., Luke B., Hong A. and Byrnes K., (2018) Financial Reporting, 2nd edn. Australia: John Wiley, pp..

Australian Accounting Standard Board (2015) , AASB 112 Income Taxes. [Online] Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB112_08- 15.pdf(Accessed 2 October 2019)

End of the Workshop