ACW2491 Financial Accounting

Semester 2 2016
Lecture Handout/Illustrative Examples
Topic 4: Accounting for Income Tax: Future Tax Issues
Illustrative Example 1: PQ6.5 Tax bases and adjusting entries for deferred tax (parts 1 and 2)
Assuming an income tax rate of 30%, in each of the following independent situations prepare the end-of-
period adjustment journal entries to account for income tax on the initial appearance or reversal of any
temporary differences.
1. The company purchased as asset at the beginning of the current year for $100 000. For accounting
purposes, an annual depreciation rate of 20% straight line is used, whereas for taxation the rate is
30% straight line.
2. The company’s provision for Long Service Leave payable account at the beginning and end of the
current year are $160 000 and $155 000 respectively. In the current year, $20 000 in long service
leave was paid to a long-standing employee.

Solution
1. Depreciable asset

Time Carrying Amount Tax Base Difference Adjustment

Begin Y1 100k 100k - -
End Y1 80k 70k 10k Dr ITE 3k
TB < CA Cr DTL 3k

End Y2 60k 40k 20k Dr ITE 3k

TB < CA Cr DTL 3k

A deferred tax liability of ($10 000 x 30%) $3 000 must be recognised as follows:

Income Tax Expense Dr 3 000

Deferred Tax Liability Cr 3 000

2. Long service leave provision

Long service leave is usually accrued in the accounting records before any tax deduction can be claimed.
Tax deductions are available on payment of long service leave to employees. Hence prior to any payment
for long serve leave, the company would have established a deferred tax asset for deductible temporary
differences, representing future tax deductions available to the company.

Time Carrying Amount Tax Base Difference Adjustment

Begin Y1 160k 0 160k Dr DTA 48k
TB < CA Cr ITE 48k

End Y1 155k 0 155k Dr ITE 1.5k

TB < CA Cr DTA 1.5k

The entry to record the adjustment is:

Income Tax Expense Dr 1 500
Deferred Tax Asset Cr 1 500

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 ACW2491 Financial Accounting
Semester 2 2016
Lecture Handout/Illustrative Examples
Topic 4: Accounting for Income Tax: Future Tax Issues
Illustrative Example 2: That’s All Right Ltd (part C, continued from last week…)
The draft accounts of That’s All RIght Ltd for the year ended 30 June 2017, which showed a profit before
tax of $22,240, included the following items of income and expense:

Government grant (exempt of tax) 5,000

Proceeds of sale of plant 23,000
Carrying amount of plant sold 20,000
Impairment of goodwill 11,100
Bad debts expense 8,100
Depreciation expense – plant 14,000
Insurance expense 12,900
Annual leave expense 14,500

The draft annual statements of financial position at 30 June 2017 and 2016 contained the following
assets and liabilities
2017 2016
Assets
Cash 6,000 18,000
Receivables 96,000 85,000
Allowance for doubtful debts (6,800) (5,200)
Prepaid insurance 3,400 5,600
Plant 140,000 170,000
Accumulated depreciation – plant (32,000) (28,000)
Goodwill 11,100 22,200
Deferred tax asset ? 9,540
Liabilities
Accounts payable 78,000 76,000
Annual leave payable 13,200 9,700
Current tax liability ? -
Deferred tax liability ? 3,780
Additional Information:
(a) For tax purposes the carrying amount of plant sold was $15,000
(b) The tax deduction for plant depreciation was $20,250. The accumulated depreciation on plant for
tax purposes was $40,250 (2016: $35,000) at 30 June 2017.
(c) In the year ended 30 June 2016, Glasshouse Ltd suffered a tax loss. At 1 July 2016 carry-forward
tax losses amounted to $16,900. Glasshouse Ltd recognised a deferred tax asset in respect of
these losses at 30 June 2016.
(d) Tax losses carried forward must be offset against any exempt income before being used to
reduce taxable income
(e) The company does not set off deferred tax liabilities and assets and the corporate tax rate is 30%.
Required
A. What factors would That’s All Right Ltd have considered before recognising a deferred tax asset
with respect to the tax loss incurred in the year ended 30 June 2016?
B. Calculate and record the balance of any current tax liability for That’s All Right Ltd as at 30 June
2017 using an appropriate worksheet. Show all workings.
C. Determine and record the movement in deferred tax assets and liabilities for That’s All Right Ltd
for the year ended 30 June 2017 using an appropriate worksheet.

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 ACW2491 Financial Accounting
Semester 2 2016
Lecture Handout/Illustrative Examples
Topic 4: Accounting for Income Tax: Future Tax Issues
Solution
TB for Assets = Carrying amount – taxable amount + deductible amount
TB for Liabilities = Carrying amount – deductible amount

THAT’S ALL RIGHT LTD

Calculation of deferred tax as at 30 June 2014
Future Taxable Deductible
Carrying
Deductible Tax Base Temporary Temporary
Amount
Amount Diffs Diffs
$ $ $ $ $
Assets
Cash 6 000 0 6 000
Receivables 89 200 6 800 96 000 6 800
Prepaid ins 3 400 0 0 3 400
Plant (*) 108 000 99 750 99 750 8 250 -
Goodwill 11 100 0 0 11 100
Liabilities
Acc payable 78 000 0 78 000
A/L payable 13 200 (13 200) 0 13 200
Temp diffs 22 750 20 000
Excluded diffs 11 100 -
Net temp differences 11 650 20 000
DTL (end) 3 495 Cr
DTA (end) 6 000 Dr
Op balances 3 780 Cr 9 540 Dr
Movement during year - **5 070 Cr
Adjustment 285 Dr 1 530 Dr

* Plant:
CA for acc = $140 000 (cost) - $32 000 (acc depn) = $108 000
CA for tax = $140 000 (cost) – $40 250 (acc depn) = $99 750
** $5 070 (tax loss) from parts a and b

Journal entries to record deferred tax:

Deferred tax liability 285
Income tax income 285
(Recognition of movement in deferred tax liability)

Deferred tax asset 1 530

Income tax income 1 530
(Recognition of movement in deferred tax assets)

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 ACW2491 Financial Accounting
Semester 2 2016
Lecture Handout/Illustrative Examples
Topic 4: Accounting for Income Tax: Future Tax Issues
Illustrative Example 3: Change in Tax Rate
Using the figures from the previous example, if the current balances of the deferred tax asset and liability
are $6,000 and $3,495 respectively and the treasurer announced a lifting in the tax rate from 30% to 34%,
what adjustment needs to be made to the accounts?

DTA Adj = [(N – O) / O] x A

=[ (0.34 – 0.30) / 0.30] x $6 000 = +$800...Dr

DTL Adj =[ (N – O) / O] x A
= [(0.34 – 0.30) / 0.30] x $3 495 = +$466…Cr

Deferred tax asset Dr $800

Income tax income (deferred) Cr $800

Income tax expense (deferred) Dr $466

Deferred tax liability Cr $466