ACCOUNTING FOR TAXES ON INCOME 973 CONCEPT QUESTIONS CQILA1 Explain how a deferred tax liability and a deferred tax asset conform to the definitions of liability and an asset in the IFRS Framework. CQI1.2 Explain the concept of a taxable temporary difference. CQI1.3 Explain the concept of a deductible temporary difference. CQI14 In your view, is tax expense ain “expense or a “distribution of income"? Explain. CQI1.5 Describe, in your own words, the methodology of deferred tax accounting, CQI1.6 What may cause the “effective tax rate” of an entity to be different from the entity’s statutory tax rate? : CQI17 Provide examples of situations where the taxable or deductible temporary difference should not be recognized. cQ11.8 Explain the rationale for the treatment of tax losses under IAS 12, C@11.9. How may an investor use the information on deferred taxes in financial analysis of an entity? the information reported on deferred taxes relevant for decision-making? Q11.10. In your opinion, Explain. PROBLEMS PIi1_ Balance sheet liability approcch and anclytcal check Details of assets and lisbilities of Company XYZ. are as follows: (a) Fixed assets Date purchased 1 January 20x1 Cost $1,000,000 Use fe sees io years Residual value. $100,000 Scanned with CamScanner een974 ADVANCED FINANCIAL ACCOUNTING Depreciation is on a straight line basis. Capital allowances of $1,000,000 are recognized in full in 20x1. Recovery of residual value will be taxed when the fixed assets are disposed of. (b) Development expenditures Completion of development ... 1 January 20x) Cost of development 600,000, Useful life. 3 years from 1 January 20:3 Development expenditures qualify as an asset under IAS 38 Intangible Assets and are'not tax deductible. Amortization is on a straight line basis. (¢) Provision for warranties Be eee Balance at 1 Janury...cesesss $60.00 $75,000 Expense «. '50,000 60,000 Utilization eo... (35,000) (45,000) Balance at 31 December... 375; 390,000 Warranties are deductible for tax purposes when claims are made. (@) Interest receivable : 31 December 20:2° 31 December 20x3 . Balance at 1 January $60,000 $75,000 Expense : 0,000 60,000 Usiization (35,000) (45,000) Balance at 31 December...... $75,000 $90,000 Interest income is taxed when earned, (€) Rental revenue received in advance pL ee Balance at 1 January. ‘360,000 $20,000 Cash receives ‘480,000 600,000 Revenue earned... (620,000) (680,000) Balance at 31 December, ‘Revenue is taxed at the point of receipt. Scanned with CamScanner(© Investment property Balance at 1 Januarye.ss++ ‘Acquired at cost. Fair value adjustment... 31 December 20x2 31 December 20x3 S80 $5,500,000 a 5,000,000 ° '500,000 (700,000) S400 Balance at 31 December. 00,000 0 Investment property is carried at fair value. Changes in fair value are takeri to Income Statement. Unrealized change in fair value is not taxed. Profit on sale is tax-exempt, Assume that the business ‘model is to primarily hold the property to collect rents. (g) Disallowed items included in net income Aer Poros Capital expenses $60,000 $72,000 . (h) Tax exemptions and reliefs granted Reed Pees) ‘Taxcexempt interest... $25,000 $30,000 (i) Profit before tax Ae Pe Profit before tax... $1,000,000 $1,200,000, () Current tax payable and tax rates pce Pees 03% Current tax payable... $132,000 453,400 TK IMS. ass iee receeetee 2% 2 “Tax rates for 20x1 was also 22% Required: 1. Using the balance sheet liability approach, and showing the carrying amount and the tax base for each asset and liability, determine the deferred tax liability (asset) balance as at 31 December 20x1, 31 December 20x2, and 31 December 20x3 for Company XYZ. Explain the tax base in each instance. 2. Determine the tax expense for 20x2 and 20x3. 3, Perform the analytical check on tax expense for 20x2 and 20x3. Scanned with CamScanner ACCOUNTING FOR TAXES ON INCOME 975 | | \ | |976 ADVANCED FINANCIAL ACCOUNTING PI1.2 Comprehensive problem Company A recorded a profit before tax of $2,500,000 for the year ended 31 December 20x3, The tax rate for 20x3 was 24% while that of 20x2 was 2296, Deferred tax liability as at 31 December 20x2 was $26,400. (a) On 1 January 20x1, Company A purchased plant and machinery costing $120,000. The useful life of the plant and machinery was five years, but the capital allowances were to be claimed over a three- year period. (b) On 1 July 20x2, Company A purchased specialized equipment costing $150,000. The useful life of the equipment was five years from the date of acquisition. However, for tax purposes, capital allowances were claimed in fall during 2022. (©) Company A completed the development phase of a new drug on 1 January 20x2, which amounted to $50,000. The expenditures were not deductible for tax purposes but were deemed to have an economic useful life of five years for accounting purposes. (4) The movement in the provision for impairment losses is as follows: Bee Balance at 1 January. $55,000 Expense .... 30,000 Utilization (60,000) Balance at 31 December... $35,000 Impairment losses were allowable for tax purposes in the period of utilization. (©) Dividends received during 20x3 amounted to $50,000 while dividend income for 20x3 was $60,000. ~ Dividends receivable as at 1 January 20x3 were $20,000. Dividend income was taxed when received. (© Unearned revenue balance arising from service fees collected in advance as at 31 December 20x3 was $14,000. Cash received during the year in respect of unearned revenue was $32,000. Earned revenue from service fees for 20x3 was $30,000. Service fees were taxable during the year when the proceeds were received. (@) Disallowed items are as follows: Entertainment expenses... $ 9,600 Donations to non-qualfying charities. 9500 Disallowed transport expenses.......cssseseee 13,000 (h) Tax-exempt income and reliefs granted are as follows: Tax-exempt income. $14,000 Double-deductions 65,000 Scanned with CamScannerACCOUNTING FOR TAXES ON INCOME 977, Required: 1. Prepare the tax 6 tax c 2 Using ane an computation for the year ended 31 December 20x3 bated onthe sbove information, ice sheet liability approach, show the cumulative taxable (deductible) : a jutible) tem : perineal arising from each asset or liability as at 31 December 20x3. S a Ae tmine the deferred tax liability as at 31 December 20x3. form the analytical check ori tax expense. for 20x3. PIL3 Accounting for tox losses Refer t¢ ts a fo Probie 11.2. If instead of a profit, Company A recorded a loss of $1,000,000 for 20x3, what Words, cee ti exPense or credit for 20x3 assuming that future profitability is not asured? In your own » explain how the accounting of deferred tax assets differ from that of deferred tax liabilities. PI14 Comprehensive problem You have been assigned to i 1ed to prepare the deferred tax computations for Co A for the years ended 31 December 20x2 and 20x3. The following details relate to Co As assets and liabilities. (a) Fixed assets Date purchased. 1 January 20x1 Cost... $100,000 Useful life, 5 years Residual value... $10,000 Depreciation is on a straight line basis. Capital allowances of $100,000 are claimed in full in 20:1. ‘Since fall capital allowances are given on the cost of the asset, any residual value recovered on disposal is taxable. (b) Development expenditures $200,000 Cost of development . 4 years from 1 January 203 Useful life... Development expenditures ae capitalized as intangible assets. Amortization is on 2 straight line bass. ‘The following tax deductions are allowed: (@_ $100,000 on 1 January 20x3 i) $100,000 on 1 January 20x4 Scanned with CamScanner978 ADVANCED FINANCIAL ACCOUNTING (©) Provision for warranties Se ee I Balance at 1 January.. é $30,000 $25,000 i Expense . . 45,000 50,000 Usiization * (0600) (60,000) i Balance at 31 December, 525.000 315,000 : Warranties are deductible for tax purposes when claims are made: (d) Interest receivable Sue Balance at 1 Januar $200,000 Interest income... 100000 Interest received... (230,000) Balance at 31 December 5 70900 Interest income is taxed when received, (©) Unearned reventie Balance at 1 January... $100,000 $40,000 [ Cash received. * 60,000 60,000 t Revenue earned........, (120,000) (70,000) Balance at 31 December. 5 40,000 $30,000 Revenue is taxed at the point of receipt. (f) Financial assets peo pod Balance, a cost... $ 80,000 $ 80,000 | Fair value adjustment 20,000 40,000 | Balance, a far value 5100.000 Scanned with CamScannerACCOUNTING FOR TAXES ON INCOME 979° ‘The asset was acquired during 20x2. Fair value adjustment of $20,000 was taken to income statement in each ofthe two years. Income from the sale of financial assets is taxable. As of 31 December 203, no sale has been made of the financial assets. : (@) Disallowed items included in net income Bone Poe Penalties and fines. $ 5,000 $ 1,400 Entertainment expenses .. 1,200 10,000 Motor vehicles expenses. 14000 12,000 (b) ‘Tax exemptions and reliefs granted 31 December 20x2 |) ) 31 December 20x3 Double deduction on trade fait expenses... eee $16,200 $30,000 Taxcexempt interest. 5,700 12,000 (Profit before tax Boers eee Reported profit. $850,000 $900,000 @) Tax rates Eien Pena! SS 25% 20% Current tax rates... Deferred tax liability balance as at 31 December 20x1 was $38,000. The tax rate was 2596 as at 31 December 20x1. Required: F 1, Prepare the tax computation for the years ended 31 December 20x2 and 20x3. 2. Using the balance sheet liability approach, and showing the carrying amount and the tax base for each asset and liability, determine the deferred tax liability balance as at: i (a) 31 December 20x2; and (b) 31 December 20x3. : 3, Prepare the journal entries to record the tax expense for 20x2 and 20x3. ‘4, Perform the analytical check on tax expense for 20x2 and 20x3. Scanned with CamScanner980 ADVANCED FINANCIAL ACCOUNTING P11.5 Comprehensive problem Co X was incorporated on 1 January 20x0. Details of assets and liabilities of Co X as at 31 December 20x1 were as folléws: (a) Fixed assets Date purchased. 1 January 20x1 Gort cesses $240,000, Useful life. S 10 years, Residual value (taxable when sold) - $20,000 Depreciation is on a straight line basis. The capital allowances are as follows: ($80,000 in 20x1 Gi) $80,000 in 20x2 (ii) $80,000 in 20x3 (b) Intangible asset . Date of purchase Cost of development Useful lie 1 January 20x1 $400,000 5 years Amortization is on a straight line basis. No tax deductions are allowed on the asset. (©) Accounts receivable Bee Be eed Balance at year-end $100,000 $200,000 Revenue is taxed in the year when sales are made, (d) Provision for impairment losses Beemer Bord Balance at 1 January....+++ $ 20,000. § 25,000 Impairment expense. 30,000 60,000 Utilization of provision. (25,000) (70,000) Balance at 31, December.......- § 25,000 § 15,000 ‘Tax deduction is allowed on actual utilization of the provision. Scanned with CamScannerACCOUNTING FOR TAXES ON INCOME 9B (© Loan payable pe Aro Balance at yearend essesssese $1,000,000 $650,000 Repayment of loans is a capital transaction and is not tax deductible, (O). Interest payable Ae peed Balance at 1 January $240,000 $130000 Interest expense. 190,000 60,000 Interest paid (300,000) (150,000) Balance at 31 December... ‘5130000 $40,000 Interest expense is deductible when paid. (6) Uniealized exchange gain Bees Unrealized exchange gain included in year-end debtors $20,000 $18,000 Exchange gain is realized in the following year and is taxed in the period of realization. (h) Profit before tax $1,000,000 Profit before tax for 20x1 .. Profit before tax for 20:2. 750,000 (@, Tax rates 5 {As at 31 December 20%0.....++ se 186 . {is at 31 December 20x1 20% ‘as at 31 December 20%2..... fee 2286 Required: 1. Prepare the tax computation for the years ended 31 December 201 and 20x2. 2. Using the balance sheet liability approach, and showing the carrying amount and the tax base for each ” eget and liability above, determiné the'deferred tax liability balance as at: Scanned with CamScanner982 ADVANCED FINANCIAL ACCOUNTING, : (a) 31 December 203 (b) 31 December 20x1; and (©) 31 December 20x2. ‘ 3, Show the journal entries to record tax expense. 4, Show the analytical check on tax expense for 20x1 and 20x2, P11.6 Accounting for tax losses Refer to P11.5. If the financial statements for 20x2 showed a pre-tax loss of $600,000 instead of a profit of $750,000, what would be the journal entry for tax expense for 20x2? Assume that there is no reasonable assurance of future profitability and that the company will continue to be loss-making in the foreseeable future. PIL.7 Comprehensive problem Co Q requires your assistance to complete its deferred tax and tax expense calculation for the year ended 31 December 20x2. The following schedules are provided to you below: (a) Tax computation for the year ended 31 December 20x2. (b) Schedule of taxable (deductible) temporary differences for 20x2 Required: 1. Complete the schedule of taxable (deductible), temporary differences by indicating on the blanks whether the item is a taxable temporary difference (TTD) or a deductible temporary difference (DTD) and the amount for that item. If the temporary difference is not to be recognized under IAS 12 Income Taxes, state clearly. If the statutory tax rate for 201 is 20%, and if there are no additions or disposals of fixed assets, show the journal entries for Co Q for.20x2. 3. If the profit before tax of $750,000 was’a loss of $1,000,000, show the journal entries for Co Q for 20x2. EO ROR Secu tes : Profit before taX...sscessseeesseeeee $750,000 ‘Add back depreciation on plant and equipment ... $100,000 Less: Capital allowances 0 100,000 ‘Add back depreciation on motor vehicles esses $12,000 Less: Capital allowances eaeettaeheeaea Q 12,000 ‘Add back warranty expense.. $ 80,000 Less: Actual claims........ (100,000) (20,000) Earned income......see016 sesee$(95;000) ‘Add: Unearned income received. = 45,000 (50,000) Taxable income .. $792,000 Tax rate. 22% $174,240 Current tax payable Scanned with CamScannerACCOUNTING FOR TAXES ON INCOME 983 Ain jeductible) temporary diff 1. Plant and equipment 31 Dec 2032 Carrying amount. ‘$300,000 Toxbase. ase Captl allowances were fly camed inthe yar of purchase 2 Motor vehicles 31 Dec 20a Canying amount $6,000 Tar base Cepia atowances are not granted on these veils, 3. Loan payable 31 Dec 2022, Carrying amount... $200,000 Tax base Loan payable isthe principal amount repayable at the end of 20x6. 4. Provision for waranties cary 31 Dec 2012 rrying amoun . s20.00| ‘Tax base... se Tox deduction isclloned on acu utitzavon of the provon 5. Prepaid expense 31 Dec 202 Carrying amount. 7 $5,000 Tax base The expenses deductible inthe year when expense. 6. Unearned revenue : 31 Dec 2012 Carrying amount. 20000 Tax base Revenue is taxed when received. P11.8. Comprehensive. problem Company X seeks your assistance to determine its tax expense under IAS 12 Income Taxes, The accountant has provided you with a schedule below of carrying amounts of assets and liabilities and information relating to the tax treatments of the items..The accountant also provided the: tax X computation for the financial year ended 31 December 2033, ., Scanned with CamScanner984 ADVANCED FINANCIAL ACCOUNTING Comp! Item 1. Construction Work-In-progress Construction costs to date .. $12,000,000 Construction profit to date... 700,000 512,700,000 Construction workin-progress. Carrying amount... $12,700,000 Tax base .. 2. Provision for restructuring costs Carrying amount. Tax base .. $150,000 3. Fixed assets Net book value ... Tax base «+. $300,000, 4: Interest receivable Carrying amount. Tax base +... $70,000 5. Rent receivable Carrying amount. Tax base .. $80,000 6. Unearned income Carrying amount. Tax base sesso $90,000 7. Financial assets at fair value through profit or loss Carrying amount at fair value ... ea Tax base .. $150,000 8. Deferred development costs (FRS 38) Carrying amount. . Tax base $40,000 ete the schedule dicatt ledly whither tAtable¢ deuueible temporary differerice exists for t to be Fecognized ‘under LAS 12, state cleatly. each item. If the temporafy ‘difference is not ‘Schedule of balances as at 31 December 20x3 ‘Amount ‘Tax treatment Construction profit is taxed at the point of completion of project. Restructuring costs are not deductible for tax purposes. Capital allowances were fully claimed in the first year of purchase. Original cost was $500,000. Interest is tax-exempt. Rental income is taxed in the period when earned, Unearned income is taxed at the point of receipt. Gains are taxed at the point of sale. The original purchase price of the asset is $120,000, Non-deductible expense Scanned with CamScanner —_ACCOUNTING FOR TAXES ON INCOME 985 ‘The tax computation for Company X for the yea ended 31 Dec’ 2x3 is chown below: ‘Tax computation for the year ended 31 December 20x3 Profit before tax. + $1,000/000 Less: Construction profit. we (500,000) ‘Add back depreciation on fixed assets J00,000 ‘Less: Capital allowances o ‘Taxexempt interest. are Eamed income. . = £70,000) ‘dt: Unearned income received during the year vsvsccssesseee ‘90,000 ‘Less: Gain in fair value of financlal assets... (30,000) ‘Add: Loss in fair value of financial assets. 10000 Taxable gain on sale of financial assets. Disallowed amortization on deferred traning costs. Disallowed charge for restructuring cost... Taxable income Tax rate... Tax payable 10,000 Required: 1. Determine the tax expense of Company X for the yeat ended’31 Deceimber 2033, Tax rate for 2012 is 22%, Prepare the journal entry. 2. Perform an analytical check of the tax expense. P11.9 Comprehensive problem and disclosures Prismn Co, a magazine publisher, reported net profit before tax of $1,300,000 for the year ended 31 December 20x1, The only disallowed expenses were the depreciation on private motor vehicles and disallowed upkeep and maintenance expenses on the motor vehicle of $3,000. Tax rate as at 31 December 20x1 was 17% while the tax rate as at 31 December 20x0 was 18%, Additional informatio (2) Prism bought printing equipment on 1 January'20x0. The ofiginal cost was $480,000 and the economic: useful life was five years. Capital allowances were claimed over three years from 1 January 20x0. ; : ' (2) A motot vehicle owned by Prism did not qualify for capital allowance claims. The economic iseful life was ten years and the residual value was $50,000. As at 31 Decemiber 20x0, two years had expired from its initial purchase date. : (3) Prism Co received magazine subscriptions from customers in advance and recognized the receipts ‘as unearned revenue. Subscription revenues are taxable in the period when magazines are delivered. Prism recorded the following in 20x0 and 20x1. ‘tof unearned revenue at 31 December....... $130,000 $140,000 $140,000 § 80,000 $120,000 § 90,000 Caring amour Sa come rng the Ye Revenue received during the year Scanned with CamScanner986 ADVANCED FINANCIAL ACCOUNTING _ Required: P1110 Determine the taxable temporary differences and deductible temporary differences as at 31 December 20x0 and 31.December 20x1. 1 Determine the tax expense for the year ended 31 December 20x1. Prepare the journal entry to record the tax expense for the year ended 31 December 20xl. Prepare the disclosure requirements to show the following: (a) An explanation of the relationship between tax expense and accounting income by way of a numerical reconciliation between tax expense and the product of accounting profit multiplied by the applicable tax rate; and (b) The amount of the deferred tax assets’ and liabilities récognized ii the statement of financial position for each type of temporary differerices. Special situations Co XYZ recognized isstied compound financial instruments in accordance with IAS 32 Financial Instruments: Presentation, and purchased investment property in accordance with IAS 40 Investment Property using the fair value model and elected to carry equity instruments at Fair Value through Other Comprehensive Income (FVOCI) in accordance with IFRS 9 Financial Instruments. Compound financial instruments: : Issue date . 1 January 20x1 Proceeds from issue of bonds — $12,000,000 Fair value of the bonds without the equity option ++, $10,200,000 Principal amount .. ce - $11,000,000 Effective interest rate 676% Coupon interest rate 5% Income tax rate. | 20% Tax authorities do not recognize the separate equity options Investment property: Purchase date...... 15 July 20x0 Purchase price of investment property . $10,000,000 Fair value as at 31 December 20x0. $12,000,000 Fair value as at 31 December 20x1. $14,000,000 Basis of measurement . Fair value model Income tax rate . 20% io 10% pital gains tax rate ..... Holding assumptions: (1) Maintains rebuttable presumption that fair value is recovered through sale. (2) Does not maintain rebuttable presumption. Fair value is recovered through rental income. Scanned with CamScannerACCOUNTING FOR-TAXES ON INCOME 987, FVOCI investment: Purchase date .. ie parrot 23 July 2030 Purchase price of FVOCI equity investments ... $12,000,000 Fair value as at 31 December 20x0 . $16,000,000 Fair value as at 31 December 20x1 . re $14,000,000 20% Income tax rate Tax scenarios: (1) Not taxable (2) Taxed during year of fair value gain or loss (3) Taxed during year of sale Required: : Prepare journal entries to record the deferred tax liability and/or current tax liability during 20x0 and 20x! for each of the above three instruments under each holding assumption or tax scenario, where applicable Scanned with CamScanner