Topic 5:

Accounting for income tax

Slides by Miranda Dyason, adapted from ‘Understanding Australian Accounting Standards’
instructor resources prepared by Kent Wilson

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Learning Objectives
A Explain differences between accounting treatments and taxation treatments for a
range of transactions;

B Explain that some transactions have both current and future tax consequences;

C Calculate taxable profit, and account for current taxation expense;

D Account for movements in deferred taxation accounts, and changes in tax rates; and

E Specify the disclosures required by AASB 112.

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Learning Objectives
A Explain differences between accounting treatments and taxation treatments for a
range of transactions;

B Explain that some transactions have both current and future tax consequences;

C Calculate taxable profit, and account for current taxation expense;

D Account for movements in deferred taxation accounts, and changes in tax rates; and

E Specify the disclosures required by AASB 112.

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Learning Objectives
A Explain differences between accounting treatments and taxation treatments for a
range of transactions;

B Explain that some transactions have both current and future tax consequences;

C Calculate taxable profit, and account for current taxation expense;

D Account for movements in deferred taxation accounts, and changes in tax rates; and

E Specify the disclosures required by AASB 112.

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Learning Objectives
A Explain differences between accounting treatments and taxation treatments for a
range of transactions;

B Explain that some transactions have both current and future tax consequences;

C Calculate taxable profit, and account for current taxation expense;

D Account for movements in deferred taxation accounts, and changes in tax rates; and

E Specify the disclosures required by AASB 112.

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Learning Objectives
Explain differences between accounting treatments and taxation treatments for a
A range of transactions;

Explain that some transactions have both current and future tax consequences;
B

C Calculate taxable profit, and account for current taxation expense;

Account for movements in deferred taxation accounts, and changes in tax rates; and
D

E Specify the disclosures required by AASB 112.

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Differences between accounting profit &
taxable profit
▸ Accounting profit defined (AASB 112.5):
• “Profit or loss for a period before deducting tax expense”.

▸ Taxable profit defined (AASB 112.5):

• “The profit for a period determined in accordance with the rules established
by the taxation authorities, upon which income taxes are payable”.

▸ As ‘accounting profit’ and ‘taxable profit’ are determined by different

principles, it is unlikely that they will be the same figure in any one
period.

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Permanent & temporary differences
Given the rules for determining taxable profit are different from the rules
for determining accounting profit, we may encounter:

▸ Permanent differences:
• Arise when amounts recognised as part of accounting profit are not
recognised as part of taxable profit (or vice versa).

▸ Temporary differences:
• Arise when the period in which revenues and expenses are recognised for
accounting purposes is different from the period in which such revenues and
expenses are treated as taxable income and allowable deductions for tax
purposes.

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Given these differences, how do we go about
accounting for income tax in an entity’s
financial reports??

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Accounting for income taxes
▸ AASB 112 states that the tax consequences of transactions that occur
for accounting purposes during a period should be recognised as
income or expense in the current period, regardless of when the tax
effects will occur.

▸ So, we need to recognise both current and future tax consequences of

current year transactions.

▸ Therefore, two separate calculations are performed each year:

• Current tax liability.
• Movements in deferred tax balances.
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Example:
To understand what this means, consider an example:
▸ A Ltd recognised passive rental revenue of $20,000 in the 2015 financial
year. $15,000 of this had been received in cash, and the remaining $5,000
had accrued but had not yet been paid as at 30 June 2015.
In recognising the $20,000 rental revenue for accounting purposes, there are:
• Current tax consequences re the $15,000 which is assessable in the current year
for taxation purposes, and
• Future tax consequences re the $5,000 accrued rent (which will be assessable for
tax purposes in the next financial year, when it is actually received).

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1. Calculation of taxable profit and current tax
liability

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Calculation of current tax
▸ When determining taxable profit, we need to:
• Start with the ‘accounting profit’ for the period.
• Make adjustments for income and expenses where there are differences in
amounts to be recognised for accounting and tax purposes.
• Deduct prior year tax losses (if any) to be claimed. (- we will look at tax
losses in detail later in the presentation).

▸ We therefore need a good understanding of common differences

between the accounting treatment and tax treatment of various
income and expense items.
• Refer to Table 7.1 on pages 202 – 203 of your text for common differences.
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Calculation of current tax
Calculation of taxable income from accounting profit (basic format):

Accounting Profit (Loss):

Add: Accounting expenses that are not tax deductible
Add/(Less): Differences between accounting expenses and tax deductions
Add/(Less): Differences between taxable income and accounting revenue
Less: Accounting revenues that are not taxable
= Taxable profit

Taxable profit x tax rate % = Current Tax Payable

(Refer to Illustrative Example 7.1 on pages 204 – 207 of your text.)

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Recognition & payment of tax
▸ Recognition of current tax:
• Refer AASB 112 paragraphs 12 and 58.

▸ Payment of tax:
• Determined by legislation;
• Some jurisdictions require payments in advance.

▸ Journal entry to record current tax liability:

DR Income tax expense $...
CR Current tax liability $...
(to recognise current tax liability)
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Example
Accounting profit before tax for ABC Ltd for the year to 30 June 2015 is as follows:

Sales revenue $200,000

Less: Cost of sales (100,000)
Entertainment (not tax deductible) (10,000)
Warranty expense (7,000)
Accounting profit before tax 83,000

For tax purposes:

Warranty paid 2,000

The tax rate is 30%.

Required: Calculate and journalise the current tax liability for 2015.
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Solution
Profit before tax $83 000
Add/(less):
- Entertainment (non-deductible) 10 000
- Warranty expense (accounting) 7 000
- Warranty paid (tax) (2 000)
Taxable Income: 98 000
Current tax liability (30%): 29 400

Journal entry to record current tax liability:

DR Income tax expense $29 400
CR Current tax liability $29 400
(recognise current tax liability)

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What do we do if there is a tax loss?

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Tax losses
▸ Tax losses are created when allowable deductions exceed taxable income.

▸ The Tax Act allows losses to be carried forward and used as a deduction
against future taxable income.

▸ Tax losses provide future deductions and (subject to recognition criteria)

create deferred tax assets.

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Tax losses
▸ AASB 112 paragraph 34 states:
“A deferred tax asset shall be recognised for the carry forward of unused
tax losses and unused tax credits to the extent that it is probable that future
taxable profit will be available against which the unused tax losses and
unused tax credits can be utilised.”

▸ Recoupment occurs as soon as the company earns taxable income/profit.

▸ The tax loss recouped is recorded in the calculation of taxable income, and
a journal entry raised to reverse the DTA.

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Tax losses
▸ Note: the existence of exempt income has an effect both on the creation
of a tax loss and the recoupment of a tax loss.

• Exempt income cannot contribute to carry forward losses.

• If a prior year’s loss carried forward is being recouped and there is

exempt income in the year of recoupment, the exempt income must
first be offset against the loss.

• Refer to Illustrative Example 7.2 on pages 208 – 209 of your text.

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 Example
Accounting profit before tax for ABC Ltd for the year to 30 June 2015 is as follows:
Sales revenue $20,000
Government grant (exempt income) 5,000
Less: Cost of sales (10,000)
Interest expense (30,000)
Entertainment (not tax deductible) (10,000)
Warranty expense (7,000)
Accounting profit / (loss) before tax -32,000

For tax purposes:

Warranty paid = $2,000; interest paid = $30,000

The tax rate is 30%.

Required: Calculate and journalise the current tax liability (or DTA in the event of a tax loss) for 2015.
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Solution
Profit/(loss) before tax -$32 000
Add/(less):
- Government grant (exempt income) (5 000)
- Entertainment (non-deductible) 10 000
- Warranty expense (accounting) 7 000
- Warranty paid (tax) (2 000)
Taxable Income/(loss): -22 000
Deferred tax asset (30%): 6 600

Journal entry to record current tax liability*: *Note: need to meet

recognition criteria in
DR Deferred tax asset $6 600
AASB 112.34 before
CR Income tax expense $6 600 recognising DTA
(recognise DTA re tax loss for 2015)
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2. Calculation of deferred tax assets and
deferred tax liabilities

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Calculation of deferred tax
▸ DTA’s and DTL’s arise when the period in which revenue and expenses
are recognised for accounting is different from the period in which items
are recognised for tax.

▸ The existence of temporary differences results in the carrying amounts

of an entity’s assets and liabilities being different from the amounts that
would arise if a balance sheet was prepared for the tax authorities.

▸ Carrying amount - net asset and liability balances based on accounting

balance sheet.

▸ Tax base - asset and liability balances that would appear in a “tax
balance sheet”. (Refer to AASB 112 paragraphs 7 – 8).
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Example:
ABC purchased an item of plant on 1 July 2014 for $9,000. For accounting purposes, the
item is depreciated at 33.33% p.a., and for tax purposes, it is depreciated at 50% p.a. The
estimated residual value is nil.

▸ At 30 June 2015:
• The carrying amount is: $9,000 - $3,000 = $6,000
• The tax base is: $9,000 - $4,500 = $4,500
• The temporary difference is: $1,500.

▸ At 30 June 2016:
• The carrying amount is: $9,000 - $6,000 = $3,000
• The tax base is: $9,000 - $9,000 = $ 0
• The temporary difference is: $3,000.

▸ At 30 June 2017:
• The carrying amount is: $9,000 - $9,000 = $ 0
• The tax base is: $9,000 - $9,000 = $ 0
• The temporary difference is: $0. 25 / 42
Calculating the tax base
Calculating the tax base for an asset:
Carrying Amount
– Future taxable amounts
+ Future deductible amounts
= Tax Base

Calculating the tax base for a liability:

Carrying Amount
- Future deductible amounts
= Tax Base

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Calculating temporary differences
▸ When the carrying amount of an asset or liability is different from its tax
base, a temporary difference exists. There are 2 types of temporary
differences, and each temporary difference that exists needs to be
classified correctly:

▸ Taxable temporary differences:

• Will result in taxable amounts in future periods.
• Result in the entity paying more tax in the future, and therefore a Deferred Tax
Liability.

▸ Deductible temporary differences:

• Will result in deductible amounts in future periods.
• Result in the entity paying less tax in the future, and therefore a Deferred Tax
Asset. 27 / 42
Calculating temporary differences
Examples:
▸ Taxable temporary differences:
• Passive revenue receivable (eg. Interest receivable)
• Prepaid expenses (eg. Prepaid insurance)

▸ Deductible temporary differences:

• Provisions (eg. Provision for annual leave or provision for warranties)
• Unearned passive revenue (eg. Rent received in advance)

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Example: calculate the tax bases and
temporary differences

CA FTA FDA TB TTD DTD

Interest receivable:
$1,000
Provision for
warranty: $4,000

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Solution:

CA FTA FDA TB TTD DTD

Interest receivable: 1,000 - 1,000 + - = 0 1,000
$1,000
Provision for 4,000 + 0 - 4,000 = 0 4,000
warranty: $4,000

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Excluded Differences
▸ Certain temporary differences are excluded from being recognised.

▸ AASB 112 paragraph 15 prohibits temporary differences from being

recognised in relation to:
• Goodwill;
• The initial recognition of assets and liabilities:
• That do not arise from a business combination; and
• That do not affect accounting or taxable profit.

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What do we do after calculating the taxable
temporary differences and deductible
temporary differences that exist??

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Calculating DTA’s and DTL’s
▸ AASB 112 paragraphs 15 and 24 require that Deferred Tax Liabilities
and Deferred Tax Assets be recognised for temporary differences.

▸ DTA’s and DTL’s are to be measured at the tax rates that are
expected to apply to the period when the asset is realised or the
liability is settled, based on tax rates (and tax laws) that have been
enacted or substantively enacted by the end of the reporting period.
(AASB 112 paragraph 47).

▸ Consideration must be given to the recognition criteria (discussed in the

next few slides).

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Calculating DTA’s and DTL’s
Calculating a deferred tax asset (DTA):
Deductible temporary difference x tax rate %
= DTA

Calculating a deferred tax liability (DTL):

Taxable temporary difference x tax rate %

= DTL

Note: The “tax rate %” is the rate which is expected to apply when the asset will be
realised or the liability settled.

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Putting all the calculations together into
a deferred tax worksheet:
- We use a worksheet to determine all of the temporary
differences that exist, and then movement in the deferred
tax balances. From this, we can then prepare the journal
entries to account for deferred tax.

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Deferred tax worksheet
Carrying Future Taxable Future Tax Base Taxable Deductible
Amount Amount Deductible Temporary Temporary
Amount Differences Differences
(DTL) (DTA)
$ $ $ $ $ $
Assets
Cash
Receivables
Plant
Goodwill
Liabilities
Bank Overdraft
LSL payable
Temporary differences
Excluded differences
Net temp differences
Deferred tax liability
Deferred tax asset
Beginning balances
Movement during year
Adjustment
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 After calculating deferred tax assets and
liabilities, do we need to satisfy any recognition
criteria before recognising these balances in
the financial statements?

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Recognition criteria for DTA’s and DTL’s
Deferred tax liabilities (AASB 112 paragraph 15):
▸ Deferred tax liabilities must always be recognised.

Deferred tax assets (AASB 112 paragraph 24):

▸ Deferred tax assets relating to temporary differences and tax losses are
recognised only if:
• There are sufficient taxable temporary differences for the entity to use
against the deductible temporary differences; OR
• If it is probable that the entity will have sufficient future taxable profit (against
which the tax benefit can be offset).

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What do we need to do if there has been a
change in tax rate??

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Change of tax rates
▸ When a new tax rate is enacted, that new rate should be applied:
• When calculating current tax liability;
• When calculating adjustments to deferred tax accounts;
• To carried forward deferred tax balances from previous years.

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Disclosures

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Disclosures
▸ AASB 112 paragraphs 79 – 82A address disclosure requirements.

▸ Tax assets and liabilities must be classified as current or non-current on

the face of the statement of financial position.

▸ Current and deferred tax assets and liabilities can be offset in most
cases (see AASB 112 paragraph 71 and 74).

▸ Tax expense is presented on the statement of profit or loss and other

comprehensive income (AASB 112 paragraph 77).

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