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Explanation of Product Warranty
Explanation of Product Warranty
0 Introduction
Taxes are amount of money which will be charged by the government in one’s
company as long as there is cash inflow occur in the business transaction. When
there is cash outflow, there will be tax reduction. AASB112 is an accounting
standard that focuses on accounting treatment for income taxes. Income tax
under the tax-effect method is divided into two categories known as current tax
consequences and future tax consequences. In this essay, the main emphasis will
be on one of the component of future tax consequences, which is deferred tax
asset (DTA). It will be tested on how DTA is created in provision for product
warranty, whether to recognize DTA arising from provision for product
warranty, and also whether the company should recognize DTA from their tax
losses. Thus, it is important to know on how the provision for product warranty
creates a DTA and also whether it is required or a must to be recognized as
deferred tax under accounting standards.
2.0 Discussion
2.1 Explain how provision for product warranty creates a deferred tax
asset.
DTA is the estimated future tax savings related to book income and it represents
temporary differences in the timing of cash flows (Harrington, Smith & Trippeer,
2012). It is also an asset that is used to decrease the amount of tax that a
company will have to pay in a later tax period. It is often used as a future write-
off if the next tax period is expected to produce positive income.
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from the taxable income unless the warranty cost is realized in the future. The
differences between accounting and tax treatment results in temporary
differences. In the case of provision for product warranty, it is deductible
temporary differences. This means that the carrying amount is larger than the
tax base, which is zero, when the warranty cost has not been paid in that current
accounting period. This results in higher taxable income for the current
accounting year than the future taxable income, thus creating DTA.
2.2 Do you agree with the auditors of Surewin Ltd that the deferred tax
assets arising from the provision for product warranty should not
have been recognized? Discuss in light of the requirements of AASB
112.
Hence, to decide whether to recognize DTA arising from provision for product
warranty, there are things that need to be identified such as are there sufficient
taxable temporary differences for the entity to use against the deductible
temporary differences or is there probability that the entity will have sufficient
future taxable profit against which the tax loss can be offset.
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In my opinion, I agree with the auditors of Surewin Ltd that the DTA arising from
the provision for product warranty should not have been recognized because
there’s no sufficient evidence that there would be probable taxable profit that
will be available against which the deductible temporary difference can be
utilized.
A tax loss occurs when total expenses are greater than total revenues under the
tax reporting rules. Tax loss may be carried forward as a deduction against
taxable income in future periods (Leo, Hoggett & Sweeting, 2012). However, it
does not apply for current period and regarded as a tax saving occurring from
past transactions. Furthermore, tax loss shelter future economic income from tax
and will create DTA (Fleischer, 2012).
According to AASB112 paragraph 35, an entity can recognise DTA from tax
losses only to the extent that it has sufficient taxable temporary difference, or
there is other definite evidence that sufficient taxable profits will be available in
future against the unused tax losses.
Thus, based on this case, I think that Surewin Ltd should not recognise DTA from
their tax losses as there were no convincing evidence that sufficient taxable
profits will be available in future to use against the tax losses based on the
reasons above. However, if the company wants to recognise DTA from their tax
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losses, the company need to find more clients or modify their products to suit
consumers’ demand so that it will help the company to generate more profit.
3.0 Conclusion
In conclusion, companies must have the knowledge of current and future tax
consequences required by AASB112 and must recognise them if the item satisfy
the accounting standard. Provision for product warranty creates a DTA due to
deductible temporary difference which lead to higher tax paid in current
accounting year compared to future years. DTA arising from the provision for
product warranty should not have been recognized if there’s no sufficient
evidence that there would be probable taxable profit that will be available
against which the deductible temporary difference can be utilized. Furthermore,
it is also important to understand the effect of tax loss and when to recognise the
DTA as DTA cannot be recognised from tax loss if there is no sufficient taxable
profit in future to offset the tax losses.
(1010 words)
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References
Fleischer, V. (2012). Not All Companies Would Welcome a Lower Tax Rate.
DealBook. Retrieved September 24, 2014, from
dealbook.nytimes.com/2012/12/11/not-all-companies-would-welcome-
a-lower-tax-rate/?_r=0
Harrington, C., Smith, W., & Trippeer, D. (2012). Deferred tax assets and
liabilities: Tax benefits, obligations and corporate debt policy. Journal of
Finance and Accountancy, 11, 1-18. Retrieved September 24, 2014, from
http://search.proquest.com/docview/1059655602?accountid=12528
Leo, K. J., Hoggett, J., & Sweeting, J. (2012). Company accounting (9th ed.). Milton,
Qld.: John Wiley and Sons Australia.