Download 19-21 Deferred tax assets and deferred tax liabilities

Chapter 19
Accounting for
income taxes
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-1
Objectives
• Understand that there is typically a difference between an
organisation’s profit or loss for accounting purposes, and its profit
or loss for taxation purposes
• Be able to identify some of the factors that will cause a difference
between profit or loss for accounting purposes and profit or loss
for taxation purposes
• Understand how deferred tax assets and deferred tax liabilities
arise
• Understand how to account for taxation losses incurred by
companies and understand how, in certain circumstances,
taxation losses can lead to the recognition of assets in the form of
deferred tax assets
• Be able to critically evaluate the balance sheet approach to
accounting for taxation and the associated asset, deferred tax
asset, and liability, deferred tax liability
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-2
Introduction to accounting for income
taxes
Taxable profit
• Profit for taxation purposes is known as taxable profit
• Determined in accordance with Australian income tax legislation,
not according to general accounting rules
• Differences between accounting principles of revenue and
expense recognition and taxation principles
• Accounting profit is therefore not the same as taxable profit
• Tax expense for accounting purposes (income statement)
calculated after applying relevant accounting standards
• Income tax payable to Tax Office (balance sheet) based on
taxable profit derived by the entity applying the rules of taxation
law
• Worked Example 19.1 (p. 661) shows the difference between
taxable profit and accounting profit
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-3
Balance sheet approach to accounting
for taxation
Accounting for income taxes
• Governed by AASB 112
• Applies the ‘balance sheet’ method—recognition of assets and
liabilities in the balance sheet based on the differences between
accounting and tax values of assets and liabilities
• 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
– effectively involves comparing the balance sheet derived using
accounting rules with balance sheet that would be derived from
taxation rules
– examples of differences between accounting and tax rules—refer to
Table 19.1 on page 660
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-4
Balance sheet approach to accounting for
taxation (cont.)
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(AASB 112)—
tax base represents the amount an asset or liability
would be recorded at if the balance sheet were
prepared applying taxation rules
• Where the carrying amount of an asset or liability is
different from the tax base a ‘temporary difference’
can arise
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-5
Balance sheet approach to accounting for
taxation (cont.)
Temporary differences can be of two types
1. A taxable 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
2. 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
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-6
Balance sheet approach to accounting for
taxation (cont.)
• 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
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-7
Balance sheet approach to accounting for
taxation (cont.)
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
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-8
Balance sheet approach to accounting for
taxation (cont.)
Justification for deferred tax liability (AASB 112, par. 16)
It is inherent in the recognition of an asset that its carrying amount will
be recovered in the form of economic benefits that flow to the entity in
future periods. When the carrying amount of the asset exceeds its tax
base, the amount of taxable economic benefits will exceed the
amount that will be allowed as a deduction for tax purposes. This
difference is a taxable temporary difference and the obligation to pay
the resulting income taxes in future periods is a deferred tax liability.
As the entity recovers the carrying amount of the asset, the taxable
temporary difference will reverse and the entity will have taxable
profit. This makes it probable that economic benefits will flow from the
entity in the form of tax payments.
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-9
Balance sheet approach to accounting for
taxation (cont.)
Deferred tax asset
– the carrying amount of an asset is less than the tax base
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
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-10
Balance sheet approach to accounting for
taxation (cont.)
Income tax expense
• Represents the sum of the tax attributable to 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
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-11
Balance sheet approach to accounting for
taxation (cont.)
Income tax payable
• The amount of tax generally expected to be paid to
the Tax Office, as a result of the year’s operations,
within the next financial period
• Under the ‘taxes payable method’ would be same as
tax expense, i.e. the amount payable to the Tax
Office is also treated as the tax expense by the
organisation
– this method not permitted in Australia
• Under balance sheet method income tax payable
does not necessarily equate to tax expense
– tax expense affected by temporary differences
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-12
Balance sheet approach to accounting for
taxation (cont.)
Calculation of income tax payable
• Income tax payable is based on taxable income, not
accounting profit
• Necessary to make adjustments to accounting profit to
determine tax profit, e.g.
– add back accounting depreciation
– deduct depreciation for taxation purposes
• Calculation of income tax payable
– Tax rate multiplied by tax profit
Refer to Worked Example 19.2 on pp. 663–66—Temporary
differences caused by the depreciation of a non-current asset
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-13
Balance sheet approach to accounting for
taxation (cont.)
• Journal entry if temporary differences result in
deferred tax asset
– to recognise tax expense that relates to the temporary
difference
Dr Deferred tax asset (temp. difference x tax rate)
Cr
Tax expense
– to recognise tax expense that relates to the entity’s taxable
profit
Dr Taxation expense
Cr
Income tax payable
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-14
Balance sheet approach to accounting for
taxation (cont.)
• Journal entry if temporary differences result in deferred
tax liability
– to recognise tax expense that relates to the temporary
difference
Dr Tax expense
Cr
Deferred tax liability (temp. difference x tax rate)
– to recognise tax expense that relates to the entity’s taxable
profit
Dr Taxation expense
Cr
Income tax payable
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-15
Balance sheet approach to accounting for
taxation (cont.)
Reversal in future periods
• In future periods, timing differences will reverse
– deferred tax asset will be credited
– deferred tax liability will be debited
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-16
Tax base of asset and liabilities:
further consideration
Calculation of tax base for assets
• Carrying amount + future deductible amount—future
assessable amount
• Although an asset might be expected to give rise to
future assessable amounts that exceed the asset’s
carrying amount, AASB 112 focuses on the tax
consequences of recovering an asset to the extent of its
carrying amount only
• Where carrying amount of asset exceeds tax base there
is a deferred tax liability
• If the carrying amount of the asset is less than the tax
base there is will be a deferred tax asset
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-17
Tax base of asset and liabilities:
further consideration (cont.)
• Consideration of doubtful debts when examining
accounts receivable
– amounts provided for doubtful debts are not deductible for tax
purposes
 deductible only when the account receivable is actually written off
– any provision for doubtful debts will result in a difference between
carrying amount and tax base
 this will result in a deferred tax asset
Refer to Worked Example 19.3 on page 667—Determining the
tax base of assets
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-18
Tax base of asset and liabilities:
further consideration (cont.)
Calculation of tax base for liabilities
• Carrying amount – future deductible amount +
future assessable amount
• Exception to the rule
– tax base of a liability that is in the nature of ‘revenue received in
advance’ must be calculated as the liability’s carrying amount less
any amount of the revenue received in advance that has been
included in assessable amounts in the current or a previous
reporting period
– this will result in a deferred tax asset
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-19
Tax base of asset and liabilities:
further consideration (cont.)
• Tax base of a liability for ‘revenue received in
advance’
– tax base of the liability is equal to the carrying amount of
the liability where the ‘revenue received in advance’ is
taxed in a reporting period subsequent to the reporting
period in which received
– the tax base of the liability is equal to zero where ‘revenue
received in advance’ is taxed in the reporting period when
received
– carrying amount – amount of revenue received in advance
that will not be subject to tax in future periods = tax base
Refer to Worked Example 19.4 on pp. 669—Determining the
tax base of liabilities
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-20
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
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-21
Deferred tax assets and deferred tax
liabilities (cont.)
Summary
• Carrying amount of assets or liabilities – tax bases of assets or
liabilities = taxable or deductible temporary differences
• Taxable or deductible temporary differences x tax rate =
deferred tax liabilities or deferred tax assets
– assessable temporary difference results in increase in tax
payable in future years
– deductible temporary difference results in decrease in tax
payable in future years
Refer to Worked Example 19.5 on pp. 671—Temporary
differences and the recognition of a deferred tax liability
Refer to Worked Example 19.6 on page 671-2—A deductible
temporary difference resulting in a deferred tax asset
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-22
Deferred tax assets and deferred tax
liabilities (cont.)
Deferred tax asset—Recognition criteria
• A number of assumptions are made
– 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
 AASB 112 provides the general rule that a deferred tax asset must
be recognised for all deductible temporary differences that reflect
the future tax consequences of transactions and other events to the
extent that it is probable that future taxable amounts within the entity
will be available, against which the deductible temporary differences
can be utilised
• AASB 112 notes that the ‘probable’ test will always be met in
relation to deferred tax liabilities
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-23
Unused tax losses
• Deferred tax assets can arise as a result of tax losses
– losses incurred in previous years can generally be carried forward
to offset taxable income derived in future years
• Tax losses can generate subsequent benefits in the form of tax
payments saved in future profitable periods
– for example, if we make a tax loss of $300,000 this year, but next
year we make a taxable profit of $300,000 then we will be able to
carry forward the loss and not have to pay tax in the next year.
The prior loss has created an economic benefit in the form of tax
that has been saved
• Consistent with the test for deferred tax assets generated by
temporary differences, deferred tax assets generated as a
result of unused tax losses must also be able to satisfy the
‘probable’ test before they are recognised as assets
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-24
Unused tax losses (cont.)
AASB 112 (par. 34)
• A deferred tax asset shall be recognised arising from the carryforward 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
• As a general principle applicable to all deferred tax assets it is
a requirement that they be reviewed at each reporting date to
ensure that the assets are not overstated (refer to AASB 112,
par. 56)
• Refer to Worked Example 19.7 on pp. 674, which illustrates
the utilisation of unused tax losses
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-25
Transfer of tax losses to other
entities within a group
• Transfer of tax losses within a group or economic entity is not
addressed in AASB 112
• Importance of this issue diminished following introduction (from
1 July 2001) of tax consolidation regime in Australia
• Loss transfer rules in the Income Tax Assessment Act 1997 no
longer apply to most entities (other than in relation to certain
transfers Australian branches of foreign banks)
• New legislation requires corporate groups to form a ‘tax
consolidated group’ if they want to be treated as a single entity
for income and capital gains tax purposes
• Election to form a ‘tax consolidated group’ is optional—if entity
elects not to form such a group the individual companies will
be treated separately and tax losses in one company will not
be available to offset taxes payable by another
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-26
Revaluation of non-current assets
• According to AASB 112 (par. 20) revaluations of non-current
assets can create temporary differences
• When non-current assets are revalued, the revaluation
increment is not deductible for tax purposes, even though
depreciation for accounting purposes will be based on the
revalued amount
• The tax base is not affected by the revaluation because
depreciation for tax purposes will be based on the original cost
of the asset
• However, any increase in the carrying value of a non-current
asset through a revaluation undertaken to recognise an
increase in fair value implies an expected increase in the future
flow of economic benefits
• This increase can be taxable and can lead to a deferred tax
liability if the carrying amount is greater than the tax base
(refer to AASB 112, par. 20)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-27
Revaluation of non-current assets (cont.)
• Unlike previous examples where the temporary difference is
adjusted against income tax expense, asset revaluations give rise
to a special case
• 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, the journal entry to recognise the
deferred tax asset or liability must also be adjusted against the
equity account
• AASB 112 (par. 61)
– current tax and deferred tax shall be charged or credited directly to
equity if the tax relates to items that are credited or charged, in the
same or a different period, directly to equity
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-28
Revaluation of non-current assets (cont.)
• As the revaluation is adjusted against equity
(revaluation reserve account), the accounting entry to
record the recognition of the deferred tax liability is
Dr
Revaluation reserve
Cr
Deferred tax liability
• Recognition of future tax associated with an asset that
has a fair value in excess of its cost as recognised by
a revaluation acts to reduce the amount of the
revaluation reserve account
• Entry assumes that the revalued amount of the asset
will be recovered by the entity’s continued use of the
asset
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-29
Revaluation of non-current assets (cont.)
As an example, assume the following
• Tax Ltd acquired land 2 years ago for $450,000
• Its fair value is now $600,000
• The tax rate is 30%
The entries to recognise a revaluation would be
Dr
Land
150,000
Cr
Revaluation reserve
150,000
Dr
Cr
Revaluation reserve 45,000
Deferred tax liability
45,000
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-30
Revaluation of non-current assets (cont.)
• If there is an expectation that the revalued asset is to be sold:
– journal entries to record the deferred tax liability will be different if
the entity operates in a country with capital gains tax indexation
– if a non-current asset is sold there is often a ‘tax break’ given to
the organisation as the tax base is increased by an index that
reflects general price increases
– if the tax that will be assessed in future is to be reduced because
of capital gains indexation, the reduction in the amount of tax that
would be paid is accounted for by debiting the deferred tax liability
and crediting the revaluation reserve
– result—the tax base of an asset can depend on the manner in
which the entity's management expects to recover the benefits
inherent in the asset
– refer to Worked Example 19.8 on page 677—Accounting for a
revaluation
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-31
Change of tax rates
• Tax rates will change across time
• Will have implications for value to be attributed to preexisting deferred tax assets and deferred tax liabilities
• An increase in tax rates will create an expense (which
will be of the nature of income tax expense) when an
entity has deferred tax liabilities, and will create
income in the presence of deferred tax assets
• Conversely, a decrease in tax rates will create income
when an entity has deferred tax liabilities, whereas a
decrease will create an expense in the presence of
deferred tax assets
Consider Worked Example 19.10 (p. 681)
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-32
Evaluation of the assets and liabilities
created by AASB 112
Deferred tax assets vs the AASB ‘Framework for the
Preparation and Presentation of Financial Statements’
– deferred tax asset might not meet definition of asset (under AASB
Framework)—a resource controlled by the entity as a result of
past events and from which future economic benefits are
expected to flow to the entity (par. 49)
– at balance date the company really has no claim against the
government for the value of the deferred tax asset
– the realisation of the benefit will only arise if the company earns
sufficient revenue in the future and if the relevant tax legislation
does not change
– it is questionable whether benefits are actually controlled by the
entity at balance date as there might be a contingent element
involved
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-33
Evaluation of the assets and liabilities
created by AASB 112 (cont.)
Deferred tax assets vs AASB Framework
• Definition of liability under AASB Framework—a
present obligation of the entity arising from past
events, the settlement of which is expected to result
in an outflow from the entity of resources embodying
economic benefits
– when a deferred tax liability exists the company is not presently
obliged to transfer funds of an amount equal to the balance of the
account
– funds will only be transferred in the future if the company earns
sufficient revenue—there is a dependency on future events, not
past events
– also an assumption that the relevant taxation legislation will not
change
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-34
Summary
• Main purpose of the chapter is to consider how to account
for tax
• Taxable profit and accounting profit will often be different
because expense and recognition rules used in accounting
are often different from those applied for taxation purposes
• AASB 112 ‘Income Taxes’ applies the balance sheet method
in accounting for taxes—carrying values and tax bases are
compared for assets and liabilities
• The difference between carrying values and tax bases leads
to either deductible temporary differences or taxable
(assessable) temporary differences—multiplying these
differences by the tax rate gives rise to either a deferred tax
asset or deferred tax liability
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-35
Summary (cont.)
• Generally speaking, if the carrying amount of an asset is
greater than its tax base there will be a deferred tax liability
and if the carrying amount of an asset is less than its tax
base there will be a deferred tax asset
• If the carrying amount of a liability is greater than its tax
base there will be a deferred tax asset and if the carrying
amount is less than the tax base there will be a deferred tax
liability
• For an entity to recognise deferred tax assets there is a
requirement that the derived associated economic benefits
be probable
• When a temporary difference associated with the
revaluation of a non-current asset takes place the balance
of the revaluation reserve account is reduced
Copyright  2007 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 5e by Craig Deegan
Slides prepared by Craig Deegan
19-36