Financial Accounting

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Chapter 18

Accounting for
income taxes

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Introduction to accounting for income taxes

Understand the difference between accounting profit and taxable income

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Some differences between accounting and tax rules

Item	Generally accepted accounting rule	Tax rule
Many accrued expenses (e.g. long-service leave, warranty costs)	An expense when accrued	Recognised as a tax deduction when paid
Many prepaid expenses (e.g. prepaid rent)	Initially an asset—expensed when economic benefits used	Typically a tax deduction when paid
Revenue received in advance (e.g. rental revenue)	Treated as a liability and recognised as revenue when earned	Typically taxed when received
Entertainment and goodwill impairment	Treated as an expense	Not a tax deduction in current or subsequent periods
Doubtful debts	Treated as an expense when recognised	Treated as a tax deduction when debtor is actually written off in subsequent period
Development expenditure	Often capitalised and subsequently amortised	Typically a tax deduction when paid for

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Balance sheet approach to accounting for taxation

Accounting for income taxes

Governed by AASB 112 Income Taxes

Balance sheet method
DTA ad DTL

Carrying Amount (CA) – Book value

Tax base – taxation rules

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Balance sheet approach to accounting for taxation

Rules and Format

TTD – taxable temporary difference – deferred tax liability

DTD – deductible temporary difference – deferred tax asset

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Balance sheet approach to accounting for taxation

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Have a read of the facts in Worked Example 18.2

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Balance sheet approach to accounting for taxation

Rules and Format

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Have a read of the following slides on your own

These are a summary of the chapter and I have already discussed the points during the Podcasts

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Measurement of DTAs and DTLs (cont.)

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Balance sheet approach to accounting for taxation (cont.)

Temporary differences can be of two types

A taxable temporary difference

will result in an increase (decrease) in income tax payable (recoverable) in future periods when the carrying amount of the asset or liability is recovered or settled

Creates a liability—deferred tax liability

A deductible temporary difference

will result in a decrease (increase) in income tax payable (recoverable) in future periods when the carrying amount of the asset or liability is recovered or settled

Creates an asset—deferred tax asset

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Balance sheet approach to accounting for taxation (cont.)

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

Example of 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 to accounting for taxation (cont.)

Deferred tax asset

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

Example of 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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Balance sheet approach to accounting for taxation (cont.)

Income tax expense

Represents the sum of the tax attributable to taxable income, plus or minus any adjustments relating to temporary differences
Income tax expense is defined in AASB 112 as:

the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax

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Balance sheet approach to accounting for taxation (cont.)

Reversal in future periods

In future periods, timing differences will reverse

Deferred tax asset will be credited

Deferred tax liability will be debited

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Temporary differences, deferred tax assets and liabilities—summary
REMEMBER THESE!

Assets	Liabilities
Carrying amount > tax base	Taxable temporary difference Deferred tax liability	Deductible temporary difference Deferred tax asset
Carrying amount < tax base	Deductible temporary difference Deferred tax asset	Taxable temporary difference Deferred tax liability

Format of the Deferred Tax WorksheetRefer to Page 752

DTADTL

CAFDAFTATBDTDTTDDifference

Assets

Cash3000030000--

Inventory8000080000--

Accounts receivable9000090000--

Prepaid insurance40004000040004000

Plant225000200000025000225000

DTADTL

CAFDAFTATBDTDTTD

Liabilities

Accounts payable5000050000--

Provision for warranty expense150001500001500015000

Loan payable154000154000--

Provision for LSL100001000001000010000

Total temp diff2500029000

DTA7500

DTL8700

ITE - Income Tax expense97800Taxable income x 30%

From this infomration construct your entry

Dr DTA7500

Dr ITE97800

Cr DTL8700

Cr Income tax payable96600

TB (Assets)CA + FDA –FTA = TBCA > TB = DTLCA < TB = DTATB (Liabilities)CA –FDA + FTA = TBCA > TB = DTA, CA < TB = DTLException –RRIA (Revenue received in advance)CA –amount of revenue received in advance that will not be subject to tax in future periods = TB