# Topic 9 Accounting for Income Taxes Financial Accounting

• Slides: 102

Topic 9: Accounting for Income Taxes Financial Accounting BFA 201_13

Readings and references • Deegan Chapter 18 • AASB 112 Income Taxes 2

Independent Study Tasks Tutorial questions (for workbooks) • Tutorial Question 1 Deegan 7 th ed, Ch. 18, Review Question 6 (p. 655) • Tutorial Question 2 Deegan 7 th ed, Ch. 18, Review Question 10 (p. 655) • Tutorial Question 3: Deegan 7 th ed, Ch. 18, Challenging Question 22 (p. 657) • Tutorial Question 4: Deegan 7 th ed, Ch. 18, Challenging Question 23 (p. 658) Independent study questions • Chapter 18 – Review Question 1 • Chapter 18 – Review Question 9 • Chapter 18 - Review Question 13 • Chapter 18 – Review Question 17 3

Learning Objectives • Identify differences between tax and accounting • Understand DTA and DTL • Understand how to account for – changes in tax rates; – tax effect of revaluations; – tax losses • Evaluation of tax effect accounting 4

Key Concepts • Temporary differences • Balance sheet approach • Deferred tax assets/liabilities • Carrying amount • Tax base 5

The Tax Payable Method 6

Tax Payable Method • The method taught in BFA 104 (but now we have to learn about tax effect accounting under AASB 112) • This method is based on the view that the amount paid to the ATO is an appropriation of profits by the government. • The income tax expense for the period is the same amount as the income tax payable for the same period. • A balance day adjustment is recorded for income tax based on an estimate of the tax liability at the end of the financial year. • Any over/under provision of tax is accounted for when an assessment is received from the ATO 7

Tax Payable Method • Example: Assume that Freds Ltd has estimated tax payable for the year to be \$12, 500 as at 30 June 20 xx. Date 30 June \$ Income Tax Expense Income Tax Payable (L) \$ 12 500 An ATO assessment notice assesses the tax to be paid by Fred Ltd at \$13, 000. This is payable on 10 September: • 10 Income tax Payable (L) 13 000 Sept Cash 13 000 10 Sept Underprovision of Income. Tax Payable (E) Income tax payable (L) 500 8

Why a Revised Tax Effect Standard? • Development of a conceptual framework in which a balance sheet approach was adopted. • The definition of expense and revenue is dependent on the definition of assets and liabilities. • Equity is a function of the definition of assets and liabilities (ie. a residual) • AASB 112 adopts the balance sheet approach • The approaches adopted de-emphasise the matching process 9

Why is Net Profit according to GAAP different from Taxable Income? 10

Accounting for Income Tax Accounting Profit (Accounting Standards) =/ Taxable Income (Income Tax Legislation) 11

Accounting Profit and Taxable Income • Income tax payable is based on assessable/taxable income in accord with the Income tax Assessment Act 1997. • Accounting profit is determined in line with various accounting rules (AASB conceptual framework, accounting standards, accepted accounting principles) • Rules are therefore different (eg revenue received in advance) 12

Accounting versus Taxation Income • Income for taxation purposes is known as taxable income • Determined in accordance with Australian income tax legislation, not according to general accounting rules • Differences in accounting and taxation revenue and expenses recognition principles • Governed by AASB 112 13

Tax Accounting • Revenue • Less expenses • =Accounting Profit (NPBT) • X tax rate = • INCOME TAX EXPENSE • Assessable income • Less allowable deductions • = Taxable Income • X tax rate (less offsets) • TAX PAYABLE 14

Reconciliation statement • Need to reconcile accounting profit and taxable income – Differences in: • Accounting and assessable income • Depreciation • Non deductible expenditure • Exempt income • Special deductions 15

Lecture Example 9 -1 16

Accounting profit and taxable income – examples of differences Transactions Accounting treatment Taxation treatment Rental revenues Recorded as a liability if received in advance Assessable when cash is received Interest revenue Recorded as revenue as it accrues Assessable when received Depreciation of assets Expense Deduction allowed, usually at an accelerated rate to accounting, no scrap value included in calculation Long service leave/sick leave Recorded as an expense as it accrues overtime A deduction is allowed when the leave is taken Entertainment and Treated as an expense Not a tax deduction in current or subsequent periods Recorded as an expense when incurred A deduction is not allowed Goodwill impairment Fines and penalties 17

Accounting profit and taxable income – cont. Transactions Accounting treatment Taxation treatment Insurance costs Recorded as an asset and expensed over time of cover A deduction is allowed when paid Product warranties Recorded as an expense and A deduction is allowed when liability on sale of goods warranty costs are incurred Bad and doubtful debts Recorded as an expense if doubtful Revaluation of non-current assets Recorded depreciation as an A deduction is only allowed expense on the revalued on the original cost, not the carrying amount revalued amount Tax losses Not recognised A deduction is allowed when written off An offset is allowed against future taxable inccome. 18

The Balance Sheet Approach under AASB 112: Tax Effect Accounting 19

The Balance Sheet Approach Under AASB 112 • Focuses on comparing the carrying value of an entity’s assets and liabilities (determined by accounting rules) with the tax base for those assets and liabilities (determined by taxation rules) • comparing balance sheet derived using accounting rules with balance sheet derived from taxation rules • Recognises Deferred Tax Assets and Deferred Tax Liabilities – – i. e. benefits we will get from having paid more tax now – have an asset to use against any expense we might have in later years – DTA; – on the other hand we might have an obligation to pay more tax in the future – that obligation is a liability so we are deferring that liability until later- DTL 20

AASB 112 prescribes accounting treatment for income taxes In Balance Sheet: • CURRENT income tax (Tax Legislation) • FUTURE tax consequences** – “Tax Effect Accounting”…. because accounting and tax rules differ In Income Statement: • Income tax expense (based on acc profit) In Other Comprehensive Income Statement: • Tax related to OCI 21

AASB 112 • Accounting for the differences between accounting and tax rules: • Two separate calculations are performed each year: 1. 2. Current tax liability (tax payable) Movements in deferred tax balances 22

Calculation of current tax Accounting profit/loss - accounting revenue not assessable for tax + accounting expenses not deductible for tax +/(-) differences between accounting revenue and tax income +/(-) differences between accounting expenses and tax deductions = Taxable profit (Taxable Income) x tax rate % = Current tax liability (Tax Payable) 23

Lecture Example 9 -2 24

Calculation of current tax - example Profit before tax for PQR Ltd for the year to 30 June 2010 is as follows: Sales 1, 000 Interest revenue 40 Government grant 80 COGS (50) Goodwill impairment (20) Bad debts (30) Annual leave (10) NPBT • • • (450) Depreciation Other expenses • • • (260) 300 • Depreciation allowed for tax \$60. Interest has not yet been received. Bad debts of \$20 were written off during the year. Payments of \$30 were made to employees in relation to annual leave taken during the year. Govt grant exempt for tax. The tax rate is 30% Required: Calculate the current tax liability of PQR Ltd for 2010 25

Calculation of current tax example Accounting Profit 300 Add (back) Acctg depn 50 Tax depn (60) Adj req (10) B/debts expense-acctg 30 B/debts w/off- tax (20) Adj req 10 A/L expense- acctg 10 Paid- tax (30) Adj req (20) Goodwill impairment (not deductible ) Depreciation of plant (Acc NOT Tax) Bad debts expense Annual leave expense 20 50 30 10 not deductible 110 Deduct Government grant (tax exempt) Interest (not yet received) Depreciation of plant (for tax purposes) Write off bad debts Annual leave PAID (80) (40) (60) (20) (30) exempt income (230) Taxable income Current tax liability at 30% 180 54

Recording Current Tax Liability Journal entry: Dr Current income tax expense 54 Cr Current tax liability (or tax payable) 54 • Recognising the current tax liability, based on the current tax income for the year • Note: Income Tax Expense (accounting) = Current + deferred tax expense 27

Carrying Amount Vs Tax Base of Asset or Liability • Carrying amount is the amount the asset or liability is recorded at in the accounting records • Tax base is defined as the amount that is attributed to an asset or liability for tax purposes • Where the tax base is different from the carrying amount a ‘temporary difference’ can arise 28

Temporary Differences • An assessable temporary difference: – will result in an increase (decrease) in income tax payable (recoverable) in future periods when the carrying amount of the asset or liability is recovered or settled • creates a liability - deferred tax liability • A deductible temporary difference: – will result in a decrease (increase) in income tax payable (recoverable) in future periods when the carrying amount of the asset or liability is recovered or settled • creates an asset - deferred tax asset 29

Deferred Tax Liability Vs Deferred Tax Asset • Deferred tax liability: – the carrying amount of the asset exceeds the tax base – taxation payments have effectively been deferred to future periods – tax is reduced or ‘saved’ in early years, but additional tax will need to be paid later • Deferred tax asset: – the carrying amount of an asset is less than the tax base – Income tax expense has been higher in the early periods – In a future period, there will be a tax benefit because the carrying amount will be zero, but there will still be a tax 30 deduction.

Example of Deferred Tax Liability • Carrying amount of a non-current depreciable asset exceeds the tax base in early years, as depreciation allowable as a deduction for tax purposes is greater than depreciation for accounting purposes • This will be reversed in later years when no depreciation is allowable for tax purposes 31

Example of Deferred Tax Asset • Tax base of a depreciable asset exceeds the carrying amount in early years, as depreciation allowable as a deduction for tax purposes is less than depreciation for accounting purposes • This will be reversed in later years when the asset is fully depreciated for accounting purposes, but depreciation is still allowable as a deduction for tax purposes 32

Income Tax Expense • Represents the sum of the tax attributable to the taxable income, plus or minus any adjustments relating to temporary differences • Defined in AASB 112 as: – the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax 33

Income Tax Payable • The amount of tax generally expected to be paid, as a result of the year’s operations, within the next financial period • Under balance sheet method income tax payable does not necessarily equate to tax expense • tax expense is affected by temporary differences 34

Calculation of Income Tax Payable • Income tax payable is based on taxable income • Calculation of income tax payable: – tax rate multiplied by taxable income 35

Journal Entry to Record Income Tax Expense • If deferred tax asset: – to recognise tax expense that relates to the temporary difference: Dr Deferred tax asset (temp. difference x tax rate) Cr Income tax expense – to recognise tax expense that relates to the entity’s taxable income: Dr Income tax expense Cr Income tax payable 36

Journal Entry to Record Income Tax Expense • If deferred tax liability: – to recognise tax expense that relates to the temporary difference: Dr. Income tax expense Cr Deferred tax liability (temp. difference x tax rate) – to recognise tax expense that relates to the entity’s taxable income: Dr. Income tax expense Cr Income tax payable 37

Reversal in Future Periods • In future periods, timing differences will reverse – deferred tax asset will be credited – deferred tax liability will be debited 38

Deferred Tax: Differences • Permanent or temporary • Permanent differences = transactions are NEVER recognised as part of taxable profit (or vice versa) – No accounting required for permanent differences other than disclosure in the notes 39

Deferred Tax: Temporary differences • Deferred tax liabilities (DTLs) and deferred tax assets (DTAs): – Arise because of temporary differences between the carrying amount and tax base of an asset – They are removed from the accounts on reversal of the temporary differences 40

Temporary Differences • These differences are either: – Taxable or deductible 1. The company paying more tax in the future • • Taxable temporary differences (TTDs) Result in deferred tax liabilities (DTLs) 2. The company paying less tax in the future • • Deductible temporary differences (DTDs) Result in deferred tax assets (DTAs) 41

Depreciation example • Captain Ltd had a depreciable asset costing \$100, 000 and a zero residual value: – For accounting purposes: • The asset was depreciated over 4 years on a straight-line basis – For taxation purposes: • The asset had an effective life of 4 years and was depreciated on a diminishing value basis. 42

Temporary differences • Depreciation expenses for accounting and tax purposes: 43

AASB 112: Balance Sheet approach COMPARES: 1. carrying amounts for assets and liabilities (determined by accounting rules) WITH 2. the value that those assets and liabilities would have if a balance sheet was prepared following income tax rules (their tax base). 44

Balance sheet approach: depreciation • Yr 1 end: Accounting records: Cost \$100, 000 Accum dep (25, 000) Carrying amt \$75, 000 n Yr 1 end: TAX records: Cost \$100, 000 Accum dep (50, 000) TAX BASE = \$50, 000 Difference = \$ 25, 000 Temporary difference 45

Another Small Example of Tax Effect Accounting 46

Example: Deferred Tax Liability Example • • Machine cost \$200, 000 in 2000 Depreciation for accounting purposes: 5 years, no residual, straight line basis Tax rate 30% Depreciation for tax purposes: 4 years, no residual, straight line basis After One Year Cost Less Acc. Depn Carrying Amount Tax Base 200, 000 40, 000 50, 000 160, 000 150, 000 47

Second year After Two Years Cost Less Acc. Depn Carrying Amount Tax Base 200, 000 80, 000 100, 000 120, 000 100, 000 48

Third year After Three Years Carrying Amount Tax Base Cost 200, 000 Less Acc. Depn 120, 000 150, 000 80, 000 50, 000 49

Fourth Year After Four Years Carrying Amount Tax Base Cost 200, 000 Less Acc. Depn 160, 000 200, 000 40, 000 0 50

Fifth Year After Five Years Carrying Amount Tax Base Cost 200, 000 Less Acc. Depn 200, 000 0 0 51

In this situation the tax office has granted a greater deduction relative to the consumption of the economic benefit BUT the tax deduction is over 4 years – in the 5 th there is NO deduction. In the last year, there will be no deduction for tax purposes, 2001 2002 2003 2004 2005 500, 000 650, 000 700, 000 800, 000 40, 000 40, 000 Less Tax Depreciation (50, 000) Taxable Income 490, 000 590, 000 640, 000 690, 000 840, 000 Tax Payable 147, 000 177, 000 192, 000 207, 000 252, 000 Accounting Profit Add Accounting Depreciation 52

• What you gain in the first 4 years you lose in the 5 th • Reduced tax years 1 to 4 - \$10, 000 @ 30% = \$3, 000 per year • In the fifth year you have run out of tax deductions for depreciation. • So therefore the tax liability is deferred not eliminated. 53

First Year Income tax expense 3, 000 Deferred tax liability 3, 000 Income tax expense 147, 000 Income tax payable 147, 000 54

Second Year Income tax expense 3, 000 Deferred tax liability Income tax expense Income tax payable 3, 000 177, 000 55

Third Year Income tax expense 3, 000 Deferred tax liability 3, 000 Income tax expense 192, 000 Income tax payable 192, 000 56

Fourth Year Income tax expense 3, 000 Deferred tax liability Income tax expense Income tax payable 3, 000 207, 000 57

Fifth Year Deferred tax liability 12, 000 Income tax expense 252, 000 Income tax payable 252, 000 58

Calculation of deferred tax CA – TB = TTD / (DTD) • Carrying amount (CA) = asset and liability balances (net of accumulated depreciation, allowances etc) based on ACCOUNTING balance sheet • Tax Base (TB) – asset and liability balances that would appear in a “TAX” balance sheet 59

Calculating the tax base • For an asset: CA – future taxable amounts + future deductible amounts = TB • For a liability: CA + future taxable amounts - future deductible amounts = TB 60

Calculating the tax bases of assets and working out the temporary differences 61

Example – tax base for assets • A depreciable asset, not revalued, intended for use in the business. • Hairy Co purchased an asset on 1 July 2011 for \$100, 000. For accounting purposes depreciation is charged at 10% pa straight line and the rate for tax purposes is 25% straight line. Residual value is zero. • One year later, at 30 June 2012, depreciation is as follows: Accounting Cost Tax 100, 000 Less Depreciation 10, 000 25, 000 Carrying Amount 90, 000 Tax Base 75, 000 OR Tax Base = carrying amount – future taxable amount + future deductible amount = 90, 000 – 90, 000 + 75, 000 = 75, 000 62

Example – tax base for assets • Carrying amount – tax base • 90, 000 – 75, 000 = temporary difference \$15, 000 • DTL \$4, 500 (\$15, 000 x 30% tax rate) • Deferred tax liability = taxable temporary difference x tax rate • The future taxable amount is greater than the future deductible amount therefore more tax is payable in the future. • Payment of tax is reduced or ‘saved’ in early years, but additional tax will need to be paid later 63

Calculating the tax bases of liabilities and working out the temporary differences 64

Example – tax base for liabilities • Provisions for employee benefits such as long service leave • Hairy Co has a balance in the provision for long service leave of \$40, 000 at 30 June 2010. This amount is fully deductible when paid. Accounting Carrying Amount Tax Base Tax 40, 000 ------ OR Tax Base = carrying amount – future deductible amount + future taxable amount = 40, 000 – 40, 000 + 0 = 0 65

Example – tax base for liabilities • Carrying amount – tax base • 40, 000 – 0 = temporary difference \$40, 000 • DTA \$12, 000 (\$40, 000 x 30% tax rate) • The future taxable amount is less than the future deductible amount so less tax will be paid in the future 66

Calculating the tax base - examples Hairy Co CA FTA Prepayment: \$3, 000 - 3, 000 + - = - Interest receivable: \$1, 000 - 1, 000 + - = - Plant: cost \$10, 000, acctg a/depn \$4, 600, tax a/depn \$6, 500 5, 400 - 5, 400 + Trade receivables: \$52, 000 allowance for b/debts: \$2, 000 50, 000 - - + 2, 000 = 52, 000 30, 000 + - - = 30, 000 3, 900 + - - Trade payables: \$30, 000 Annual leave liability: \$3, 900 FDA TB 3, 500 = 3, 500 3, 900 = -

Important rules 68

Tax base of an asset = Carrying amount + Future deductible amount – Future assessable amount Tax base of a liability = Carrying amount – Future deductible amount + Future assessable amount Assets Liabilities Deferred tax liability Carrying amount > Tax base Carrying amount < Tax base 69 Deferred tax asset Carrying amount < Tax base Carrying amount > Tax base

Deferred Tax Assets and Deferred Tax Liabilities • Assets: – deferred tax liability arises when: • carrying amount > tax base – deferred tax asset arises when: • carrying amount < tax base • Liabilities: – deferred tax liability arises when: • carrying amount < tax base – deferred tax asset arises when: • carrying amount > tax base 70

Classification of temporary differences and measurement of deferred tax balances. A B C D Carrying Amount of asset > Tax base of asset Carrying Amount of asset < Tax base of asset Carrying Amount of liability > Tax base of liability Carrying Amount of liability < Tax base of liability Difference = Assessable temporary difference times the tax rate = Deferred tax liability = Deferred tax asset = Deferred tax liability Examples: depreciation, rent/interest receivable, prepaid rent/insurance, assets revalued upwards from original cost. Examples: accounts receivable with a provision for doubtful debts Examples: provision for long service leave, annual leave, warranties, rent paid in arrears, rent received in advance Examples: hybrid securities such as convertible notes that are apportioned between debt and equity components for accounting purposes but treated as wholly debt for tax purposes.

Summary • Assets: – DTL = Carrying amount > Tax base – DTA = Tax base > Carrying amount • Liabilities: – DTA = Carrying amount > Tax base – DTL = Tax base > Carrying amount 72

Deferred tax assets and liabilities Calculating a deferred tax asset (DTA) DTD x tax rate % = DTA Calculating a deferred tax liability (DTL) TTD x tax rate % = DTL The tax rate % is that which is expected to apply when the asset will be realised or the liability settled Recording a DTA/DTL Dr Deferred tax asset Dr/Cr Income tax expense (deferred) Cr Deferred tax liability BALANCING ITEM 73

Worksheet Methodology 74

Lecture Example 9 -3 75

Calculation of deferred tax example The balance sheet of PQR Ltd at 30 June 2010 is as follows: Assets Liabilities Cash 260 Trade payables 296 Loan 485 270 A/L liability 15 Interest receivable 40 Deferred tax liability 9 Inventory 100 Trade receivables 300 Allowance for b/debts (30) Plant Accum dep’n 500 (300) 805 Equity 200 Share capital 700 Goodwill 800 R/earnings 175 Deferred tax asset 10 1, 680 • Accumulated depreciation of plant for tax purposes is \$360 • Calculate DTA & DTL for 2010 and prepare the journal entries to record deferred tax movements for the 30 June 2010 year. 875

Calculation of deferred tax example Relevant assets & liabilities CA FTA FDA TB DTD Trade receivables 270 - 30 30 Interest receivable 40 40 - - 40 Plant 200 140 60 Goodwill 800 - - 800 Annual Leave liability 15 15 0 15 - Total temporary differences 45 900 Less: excluded differences - (800) Temporary differences 45 100 DTA; DTL (@ 30%) 13 30 Less: opening balances 10 9 3 21 Adjustment

Calculation of deferred tax example Entry to record deferred tax movement: Dr Dr Deferred tax asset 3 Income tax expense (deferred) 18 Cr Deferred tax liability Summary: Current tax liability (slide 35) 54 Deferred tax movement 18 Total income tax expense 72 BALANCE 21 NOTE (from slide 34) : Accounting Profit 300 - (Permanent differences 80 +(20)) = 240 x 30% = 72 (Income tax expense) 78

Changes in tax rates 79

Tax Rate Changes Tax rate BFA 201_13 Existing DTL Expense Existing DTA Income Existing DTL Existing DTA Income Expense 80

Tax rate changes example For tax purposes AGRO Co has the following deferred tax balances as at 1 July 2015: Deferred tax asset \$500 000 Deferred tax liability \$300 000 The above balances were calculated when the tax rate was 30%. On 1 August 2015 the government reduced the corporate tax rate to 28%. Provide the journal entries to adjust the carryforward balances of the deferred tax asset and deferred tax liability. BFA 201_13 81

Tax rate changes example Balance at 1 July 2015 Balance at 1 August 2015 Change DTA \$500 000 x 28/30 = \$466 667 (\$33, 333) DTL \$300 000 × 28/30 = \$280 000 (\$20 000) OR 500 000 x (30 -28)/30 = 33, 333 300 000 x (30 -28)/30 = 20, 000 The accounting entry at 1 August 2015 would be: Dr Deferred tax liability 20 000 Dr Income tax exp. (deferred) 13 333 Cr Deferred tax asset 33 333 82

Lecture Example 9 -4 83

Lecture Case Study

Solution to Case Study • Step 1 – Calculate taxable profit BFA 201_13 85

Solution to Case Study cont. • Step 2 – Calculate temporary differences BFA 201_13 86

Lecture Case Study 87

Revaluation of non-current assets 88

Revaluation of Non-current Assets • Revaluations can create temporary differences according to AASB 112 para 20 • Tax base not affected by revaluation as depreciation for tax purposes continues to be based on original cost • Revaluation of asset which recognises an increase in fair value implies an expected increase in future flow of economic benefits – increase can be taxable and lead to deferred tax liability if new carrying amount is greater than tax base 89

Revaluation of Non-current Assets AASB 112 requires that, to the extent that the deferred tax relates to amounts that were previously recognised in equity as either direct credits or direct debits (as is the case with asset revaluations) the journal entry to recognise deferred tax asset or liability be adjusted against the equity account: Dr Revaluation surplus Cr Deferred tax liability – Entry assumes that the revalued amount of the asset will be recovered by the entity’s continued use of the asset. 90

Revaluation of Non-Current Assets Example • Tax Ltd acquired land 2 years ago for \$450, 000 • Its fair value now is \$600, 000 • The tax rate is 30% Land 150 000 Revaluation surplus 150 000 Revaluation reserve 45 000 Deferred tax liability 45 000 91

Revaluation of Non-Current Assets Example Accounting Cost 600 000 450 000 - - Accumulated depreciation Carrying value Tax 600 000 Tax base 450 000 Or Carrying amount + Future deductible amount – Future taxable amount = Tax base 600 000+ 0 – 450 000= 150 000 If the carrying amount of an asset \$600 000 is greater than the tax base of the asset \$450 000, this leads to a deferred tax liability of 150 000 x. 30 = \$45 000 92

Other movements: Revaluations • Revaluations NCA Temporary difference • Accounting CA ≠ Tax base (no change) – Acc. depreciation based on revalued amount – Tax depreciation based on original cost • Revaluation increments Equity • Related tax recognised in OCI & adjusted against equity Dr Revaluation surplus xxx Cr Deferred tax liability xxx 93

Unused tax losses 94

Unused tax losses • A deferred tax asset shall be recognised 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 95

Lecture example • Rebel Ltd records a loss of \$400, 000 in Year 1. • It is expected that the company will record profits in future years. • In fact it does record accounting profits before tax of \$360, 000 and \$500, 000 in the next two years. • • There are no temporary differences between the carrying amounts of the company’s assets and liabilities and their tax base. • The tax rate is 30%. 96

Solution Dr Deferred tax asset 120, 000 Cr Income tax revenue 120, 000 Recording tax loss 400, 000 x 30% in Yr 1. Dr Income tax expense Cr Deferred tax asset Recording use of tax loss in Yr 2. 108, 000 Dr 150, 000 Cr Cr Income tax expense Deferred tax asset Income tax payable 108, 000 12, 000 138, 000 Recording use of tax loss & tax payable in Yr 3. 97

DTA and DTL recognition • The entity will remain in business (going concern) • Taxable income will be derived in future years • Recognition of deferred tax asset same as applied to other assets —reliance on ‘probability’ test • Probable test will almost always be met with DTL 98

Theoretical consideration of DTL and DTA 99

Evaluation of AASB 112 • Profit smoothing technique? • DTA might not be an asset under the AASB framework – No claim against the government for tax? – Does entity ‘control’ the benefit? – Benefit depends on future earnings and no legislation changes 100

Evaluation of AASB 112 cont. • DTL might not be a liability as entity not presently obliged to pay govt; it is a book entry • Funds will only be transferred in the future if the company earns sufficient revenue — there is a dependency on future events, not past events • Assumes no changes in tax legislation 101

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