Karachi Institute of Economics and Technology, Karachi

Course: AFAA
Faculty: Sir Jalal Khan
Examination: Assignment 06

Name:
Muhammad Adil

Student Id:
63727
Question no. 1:
Jonquil Co buys equipment for $50,000 and depreciates it on a straight line basis over its expected
useful life of five years. For tax purposes, the equipment is depreciated at 25% per annum on a
straight line basis. Tax losses may be carried back against taxable profit of the previous five years. In
year 20X0, the entity's taxable profit was $25,000. The tax rate is 40%.
Required
Assuming nil profits/losses after depreciation in years 20X1 to 20X5 show the current and deferred
tax impact in years 20X1 to 20X5 of the acquisition of the equipment.

Ans
Jonquil Co will recover the carrying amount of the equipment by using it to manufacture goods for
resale.
Therefore, the entity's current tax computation is as follows.

Year
20X1 20X2 20X3 20X4 20X5
$ $ $ $ $
Taxable income* 10,000 10,000 10,000 10,000 10,000

Depreciation for tax purposes 12,500 12,500 12,500 12,500 0

Taxable profit (tax loss) (2,500) (2,500) (2,500) (2,500) 10,000

Current tax expense (income) at 40% (1,000) (1,000) (1,000) (1,000) 4,000
* ie nil profit plus ($50,000 / 5) depreciation add-back.

The entity recognizes a current tax asset at the end of years 20X1 to 20X4 because it recovers the
benefit of the tax loss against the taxable profit of year 20X0.

The temporary differences associated with the equipment and the resulting deferred tax asset and
liability and deferred tax expense and income are as follows.
 Year
20X1 20X2 20X3 20X4 20X5
$ $ $ $ $
Carrying amount 40,000 30,000 20,000 10,000 0
Tax base 37,500 25,000 12,500 0 0
Taxable temporary difference 2,500 5,000 7,500 10,000 0
Opening deferred tax liability 0 1,000 2,000 3,000 4,000
Deferred tax expense (income): bal fig 1,000 1,000 1,000 1,000 (4,000)
Closing deferred tax liability @ 40% 1,000 2,000 3,000 4,000 0
The entity recognizes the deferred tax liability in years 20X1 to 20X4 because the reversal of the
taxable temporary difference will create taxable income in subsequent years. The entity's statement of
profit or loss and other comprehensive income is as follows.
Year
20X1 20X2 20X3 20X4 20X5
$ $ $ $ $
Income 10,000 10,000 10,000 10,000 10,000
Depreciation 10,000 10,000 10,000 10,000 10,000
Profit before tax 0 0 0 0 0
Current tax expense (income) (1,000) (1,000) (1,000) (1,000) 4,000
Deferred tax expense (income) 1,000 1,000 1,000 1,000 (4,000)
Total tax expense (income) 0 0 0 0 0
Net profit for the year 0 0 0 0 0

Question No. 2:
An entity has investment property overseas that is currently out on rental. The entity has decided that
it may sell the property. The property is measured at fair value under IAS 40. In the overseas country,
there are different tax rates depending on whether an entity recovers an asset through use (30%) or
sale (20%). The entity anticipates that it will recover 40% of the property's economic benefits through
use. The fair value/carrying amount of the property is $5m, $2.5m of which is the land value. The tax
base is $3m, which is split equally over land and buildings.
Temporary difference Tax rate Deferred tax liability
Land $1m 20% $200,000
Building recover through use $400,000 30% $120,000
Building recover through sale $600,000 20% $120,000
Total $2m $440,000
Answer:
Given that the entity has a dual intention of use and sale with respect to the recovery of the asset, the
deferred tax calculation could reflect that dual intention. Part of the buildings may be recovered
through usage, in which case the deferred tax liability for that part would be calculated using a 30%
tax rate.
Note that the expected manner of recovery for land with an unlimited life is always through sale.
However, the exposure draft proposals have a rebuttable presumption that the carrying amount of the
property will be recovered through sale, so the deferred tax liability would be calculated in total as
$(5-3)m @ 20%, i.e. $400,000. The entity could use the tax rate applicable for recovery through use
of 30% only to the extent it had clear evidence that it would recover the carrying amount of the
investment property through usage.
It is clear that the exposure draft proposals could result in a significant change in the deferred tax
calculation. A series of piecemeal changes to IAS 12 could have a significant impact on deferred
taxation balances
Question No. 3:
In 20X8 Darton Co had taxable profits of $120,000. In the previous year (20X7) income tax on 20X7
profits had been estimated as $30,000. The tax rate is 33%.
Required
Calculate tax payable and the charge for 20X8 if the tax due on 20X7 profits was subsequently agreed
with the tax authorities as:
(a) $35,000
(b) $25,000
Any under- or over-payments are not settled until the following year's tax payment is due.
Answer:
(a) $35,000
$
Tax due on 20X8 profits ($120,000 * 33%) 40,000
Underpayment for 20X7 5,000
Tax charge and liability 45,000
(b) $25,000
$
Tax due on 20X8 profits (as above) 40,000
Overpayment for 20X7 (5,000)
Tax charge and liability 35,000
Alternatively, the rebate due could be shown separately as income in the statement of profit or loss
and other comprehensive income and as an asset in the statement of financial position. An offset
approach like this is, however, most likely.

Question No. 4:
In 20X7 Eramu Co paid $50,000 in tax on its profits. In 20X8 the company made tax losses of
$24,000.
The local tax authority rules allow losses to be carried back to offset against current tax of prior years.
Required
Show the tax charge and tax liability for 20X8.
Answer:
Corporate tax is 30%
Tax repayment due on tax losses = 30% * $24,000 = $7,200.
The double entry will be:
DEBIT
Tax receivable (statement of financial position) $7,200
CREDIT
Tax repayment (statement of profit or loss and other comprehensive income) $7,200
The tax receivable will be shown as an asset until the repayment is received from the tax authorities.

Question No. 5:
State the tax base of each of the following assets:
(a) A machine cost $10,000. For tax purposes, depreciation of $3,000 has already been deducted in
the current and prior periods and the remaining cost will be deductible in future periods, either as
depreciation or through a deduction on disposal. Revenue generated by using the machine is taxable,
any gain on disposal of the machine will be taxable and any loss on disposal will be deductible for tax
purposes.
(b) Interest receivable has a carrying amount of $1,000. The related interest revenue will be taxed on a
cash basis.
(c) Trade receivables have a carrying amount of $10,000. The related revenue has already been
included in taxable profit (tax loss).
(d) A loan receivable has a carrying amount of $1m. The repayment of the loan will have no tax
consequences.
(e) Dividends receivable from a subsidiary have a carrying amount of $5,000. The dividends are not
taxable.
Answer:
(a) The tax base of the machine is $7,000.
(b) The tax base of the interest receivable is nil.
(c) The tax base of the trade receivables is $10,000.
(d) The tax base of the loan is $1m.
(e) The tax base of the dividend is $5,000.

Question No. 6:
State the tax base of each of the following liabilities.
(a) Current liabilities include accrued expenses with a carrying amount of $1,000. The related expense
will be deducted for tax purposes on a cash basis.
(b) Current liabilities include interest revenue received in advance, with a carrying amount of
$10,000. The related interest revenue was taxed on a cash basis.
(c) Current assets include prepaid expenses with a carrying amount of $2,000. The related expense has
already been deducted for tax purposes.
(d) Current liabilities include accrued fines and penalties with a carrying amount of $100. Fines and
penalties are not deductible for tax purposes.
(e) A loan payable has a carrying amount of $1m. The repayment of the loan will have no tax
consequences.

Answer:
(a) The tax base of the accrued expenses is nil.
(b) The tax base of the interest received in advance is nil.
(c) The tax base of the accrued expenses is $2,000.
(d) The tax base of the accrued fines and penalties is $100.
(e) The tax base of the loan is $1m.

Question No. 7:
As an example of the last paragraph, suppose Petros Co intends to use an asset which cost $10,000 in
20X7 through its useful life of five years. Its residual value will then be nil. The tax rate is 40%. Any
capital gain on disposal would not be taxable (and any capital loss not deductible). Depreciation of the
asset is not deductible for tax purposes.
Required
State the deferred tax consequences in each of years 20X7 and 20X8.
Answer:
As at 20X7, as it recovers the carrying amount of the asset, Petros Co will earn taxable income of
$10,000 and pay tax of $4,000. The resulting deferred tax liability of $4,000 would not be recognised
because it results from the initial recognition of the asset.
As at 20X8, the carrying value of the asset is now $8,000. In earning taxable income of $8,000, the
entity will pay tax of $3,200. Again, the resulting deferred tax liability of $3,200 is not recognised,
because it results from the initial recognition of the asset.

MCQS:

Answer:
A
Answer:
A

Answer:
A