Chapter 6

Accounting for company

income tax
Prepared by
Jenny James

Learning objectives
1. Explain the benefit of having information about current and
deferred tax in the financial statements
2. Describe how income tax is included in the financial statements
3. Explain the general principles of current and deferred tax set
out in AASB 112
4. Explain how taxable profit differs from accounting profit
5. Prepare a current tax worksheet reconciling accounting profit to
taxable profit and record the journal entries for current tax
6. Prepare a deferred tax worksheet to determine the differences
between the accounting and tax values for assets and liabilities
and use the worksheet to record the entries for deferred tax

Learning objectives
7. Determine the tax bases of various assets and liabilities included
in the statement of financial position
8. Calculate the taxable and deductible temporary differences of
various assets and liabilities and identify items that are excluded
from the calculation of deferred tax liabilities and assets
9. Describe the criteria for the recognition of deferred tax liabilities
and assets and how these balances may reverse over time
10. Describe the other disclosures relating to income tax in the
financial statements
11. Explain some of the additional issues that arise in accounting for
income tax

The benefit of information on

current and deferred tax
The recognition of current tax and deferred tax
provides more complete or relevant information for
economic decision making than current tax alone
Current tax = income tax payable for current period
Deferred tax = future tax consequences

Recognising deferred tax as required by AASB 112

accounts for the future tax consequences
for the assets and liabilities shown in the statement of
financial position at the end of the reporting period

LO1

Income tax in the financial

statements
Statement of financial position
Disclose current tax and deferred tax balances
Deferred tax balances disclosed in the non-current section
of assets and liabilities

Statement of profit or loss and comprehensive income

Income tax expense (includes current and deferred tax)

Current/deferred tax recognised directly against equity

Must be separately disclosed in statement of profit or loss or
in the notes
E.g. Deferred tax on the revaluation of land
LO2

Accounting for income taxes

general principles
AASB 112 requires companies to account for the
current and future tax consequences of:
Current transactions and events
The recovery and settlement of assets and liabilities

Current tax consequences = current tax liability/asset

Future tax consequences = deferred tax liability/asset
Income tax expense for period is comprised of:
Current tax liability
Movement in deferred tax liability and deferred tax asset
Movement in deferred tax liability/asset included in other
comprehensive income for period
LO3

Accounting income vs tax

treatments
ACCOUNTING
Basis of
accounting
Equations

Accruals basis

LO4

Principally cash basis

Some exceptions to this

Revenue Expenses
= Accounting profit
AASBs and the Corporations
Act are key sources that
determine the appropriate
accounting treatment of
transactions

TAX

Taxable income (TI) tax

deductions (TD) = Taxable profit
The Income Tax Assessment Act
determines the tax treatment of
transactions

Accounting profit does not equal taxable profit

Difference caused by different rules used for accounting vs tax

Accounting income vs tax

treatments
ITEM

ACCOUNTING

Employee benefits
eg annual leave

TAX

Liability recognised and expense

Recognised as TD when
accrued when debt owed to employees leave is paid to employees

Provisions (e.g . for warranties) are treated in the same way as employee benefits

Prepaid expenses

Recorded as an asset when pre-paid

and expensed as incurred

Recognised as TD when
paid

Insurance, rent, interest, royalties etc paid in advance

Cash received in
advance of services

Liability recognised for unearned

revenue and then allocated to revenue
as services are performed

Recognised as TI when cash

received

Bad/doubtful debts

Allowance raised as contra asset and

expense recorded when debt
considered doubtful

Recognised as a TD when
debts are written off as bad

LO4

Accounting income vs tax

treatments
ITEM

ACCOUNTING

TAX

Fines and penalties and

entertainment costs

Recognised as an expense when

payable

Not deductible

Depreciation of a
depreciable asset

Recognised as expense based on

useful life of asset

Recognised as TD based on
predetermined rates

Common for assets to be depreciated over a shorter life for tax purposes than for accounting purposes

R&D costs (expense)

Recognised as an expense based

on the amount of the expenditure

Concessional deduction
allowed equal to 125% of
the expenditure

Development costs
(intangible asset)

Capitalised (asset) and amortised

Recognised as TD when
paid

Tax losses

No recognition

Carried forward and offset

against future TI

Subject to conditions e.g. Reduced by exempt income

LO4

Taxable profit
Company income tax obligations are determined by its
taxable profit calculated based on IT legislation
Differences between accounting profit and taxable profit
are due to:
Accrual items; valuation adjustments; non-deductible items
and tax incentives
Tax treatment of items follows the cash flow
Accounting treatment is based on accounting standards and
principles of accrual accounting
Results in assets and liabilities having carrying amounts for
accounting purposes that differ to notional values for IT
LO4

Payment of income tax

Company income tax is paid under the PAYG (pay as you go)
system in quarterly instalments
Companies must lodge quarterly business activity
statements (BAS) and pay tax calculated as:
Instalment income instalment rate (supplied annually by the
taxation department)

Current tax liability represents the last quarterly payment

and any adjustments necessary to reflect the fact that
annual taxable income may differ from the sum of the
quarterly returns

Current tax: reconciliation approach

Examples of reconciling items are:

Interest revenue not received

Fines and penalties expense
Unearned revenue for work not yet performed
Development costs paid recognised as an asset

Current tax liability example

Data for Allan Ltd for the year to 30 June

2017 are as follows:
Accounting profit before tax
Depreciation - plant

$150,000
20,000

Depreciation - furniture

1,000

Entertainment expenses

10,000

Long-service leave expense

Plant cost (2 years ago)
Furniture cost (6 years ago)

LO5

4,000

200,000
10,000

The ATO allows a depreciation rate

of 25% straight-line on cost to be
used
Allan Ltd applies a straight-line
rate of 10% on cost in its
accounting records
No employee has been paid longservice leave in the current year
The corporate tax rate is 30%
Required:
Determine the taxable income of
Allan Ltd for 30 June 2017 and
prepare the journal entry for
current tax.

Current tax liability example

Journal entry:
30/6/17

LO5

Income Tax Expense

Dr
40,500
Current Tax Liability
Cr
40,500
(Recognition of current tax liability, based
on the taxable income for the year)

Deferred tax
Arise when the period in which revenue and expenses
are recognised for accounting is different from the
period in which items are recognised for tax purposes
Arise principally due to the accruals vs cash basis of
recognising transactions. Differences either result in:
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)
LO6

Deferred tax worksheet info

The existence of temporary differences results in the carrying
amounts of an entitys assets and liabilities being different
from the amounts that would arise if a balance sheet was
prepared for tax authorities
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
Temporary differences are calculated as follows:
CA TB = TTD or (DTD)

LO6

The deferred tax worksheet

LO6

Deferred tax assets and liabilities

Calculating a deferred tax asset (DTA)
DTD tax rate % = DTA

Calculating a deferred tax liability (DTL)

The tax rate % is that

which is expected to
apply when the asset
will be realised or the
liability settled

TTD tax rate % = DTL

Journal entry
Deferred tax asset
Dr
Income tax expense
Dr/Cr
Deferred tax liability Cr
LO7

BALANCING ITEM

Tax bases of assets and liabilities

Calculating the tax base of an asset:
Taxable economic benefits from recovery:
tax base of asset = deductible amount in future
No taxable economic benefits from recovery:
tax base of asset = CA

Calculating the tax base of a liability:

General rule:
tax base of liability = CA deductible amount in future
Unearned revenue:
tax base of liability = CA untaxed future revenue
LO7

Calculating tax bases examples

Assets

CA

Plant: cost $10,000

acctg accum depn $2,500
tax accum depn $5,000
Accounts receivable: $4,000
allowance for d/debts: $200

3,800 +

Receivables:$1,500 cash basis

Receivables:$1,500 accrual basis
Prepayment: $900 cash basis
Prepayment: $900 accrual basis
Research costs: $12,000
LO7

1,500

FDA

TB

5,000 =

5,000

200 =

4,000

0 =

1,500

0 =

900 =

900

12,000 =

12,000

Calculating tax bases examples

Liabilities
Accounts payable: $7,500

CA

UFR

FDA

TB

7,500

0 =

7,500

300

300 =

Fines payable: $2,000

2,000

0 =

2,000

Annual leave liability: $1,600

1,600

1,600 =

Warranty provision: $800

800

800 =

Unearned revenue: $2,500

2,500

0 =

17,000

Accrued rent: $300

Loan payable: $17,000

LO7

17,000

2,500

Temporary differences
AASB 112 defines temporary differences as:
the differences between the carrying amount of an asset or
liability in the statement of financial position and its tax base.

There are two types of temporary differences:

Taxable temporary differences
Which result in taxable amounts in future periods when the
carrying amount of the asset or liability is recovered or settled

Deductible temporary differences

Which result in amounts that are deductible in future periods
when the carrying amount of the asset or liability is recovered
or settled
LO8

Taxable temporary differences

Asset: when CA > TB

leads to deferred tax liability

Liability: when CA < TB leads to deferred tax liability

Common examples include:
Depreciable plant
Revalued land
Interest receivable
Prepaid insurance
Development asset
LO8

Deductible temporary differences

Asset: when CA < TB

leads to deferred tax asset

Liability: when CA > TB leads to deferred tax asset

Common examples include:
Research costs
Accrued interest
Provision for employee benefits
Provision for warranty
Unearned revenue for rent
LO8

Excluded temporary differences

Certain temporary differences are excluded from being
recognised
AASB 112 prohibits temporary differences from being
recognised in relation to:
Goodwill
The initial recognition of assets and
liabilities that does not affect
accounting or taxable profit or loss

LO8

Recognition of DTLs
Deferred tax liabilities
Deferred tax liabilities must be recognised in full
May reverse over time e.g. when plant becomes fully
depreciated for tax purposes, but not accounting purposes

LO9

Recognition of DTAs
Deferred tax assets

Deferred tax assets relating to temporary differences and tax

losses are recognised only if:
there are sufficient taxable temporary differences for the entity

to use against the deductible temporary differences; OR

if it is probable that the entity will have sufficient future taxable
profit (against which the tax benefit can be offset)

LO9

May reverse over time e.g. with a decrease in provision for

employee benefits

Other disclosures
Companies that prepare general purpose financial statements
must disclose many aspects in relation to current and deferred
tax and tax losses
Some disclosures must appear in the financial statements and
much detail is also required in explanatory notes
Other disclosures include:

L10

Major components of IT expense or IT income

Aggregate current tax or deferred tax for items charged to equity
Reconciliation between IT expense and accounting profit
Tax rate changes, unused tax losses, deductible temporary
differences

Offsetting tax assets and liabilities

Tax assets and tax liabilities are to be offset against
each other and a net amount recognised in the
statement of financial position for example:
Deferred tax asset
Deferred tax liability

$5,000
$7,000

Journal entry shows net balance of $2,000 only

30/06/17

L1O

Income tax expense

Dr
Deferred tax liability
Cr
(Recognition of deferred tax included
in the profit or loss for the year)

2,000
2,000

Change in tax rate

When a new tax rate is enacted, the new rate is applied:
when calculating current tax liability
when calculating adjustments to deferred tax accounts
to carried forward deferred tax balances from previous years

Example DT balances based on 30% tax rate:

DT liability

$36,000

DT asset

$12,000

Journal entries to adjust tax rate (25%) on opening balances:

30/6/xx

L11

DT Liability
DT Asset
IT Expense

Dr
Cr
Cr

6,000
2,000
4,000

Income tax losses

Tax losses are created when tax deductions exceed
assessable income plus exempt income
The ITA Act allows losses to be carried forward and used as
a deduction against future taxable profit
Tax losses provide future deductions and (subject to
recognition criteria) create deferred tax assets
Exempt income cannot contribute to carry forward losses
If prima facie tax loss is $10,000 and exempt income is $2,000
the allowable carry forward tax loss would be $8,000
L11

Income tax losses

Recoupment occurs as soon as a taxable profit is earned

Recovery of tax loss reduces taxable income
Tax loss must be reduced by any exempt income
Recognition of DT assets from tax losses is required if future
taxable profits are probable
Usually requires taxable temporary differences
Strong evidence that taxable profits are soon to emerge

Recognition of DT assets from tax losses recognises the tax

benefit in the P&L of the same period
Non-recognition means tax benefit is deferred until realised
L11

Demonstration problem
The statement of financial position of ABC Ltd at 30 June 2015
Assets

Liabilities

Cash

260

Trade payables

296

Loan

485

270

Annual leave liability

15

Interest receivable

40

Deferred tax liability

Inventory

100

Trade receivables

300

Allowance for d/debts

(30)

Plant

500

Accum depn

(300)

805
Equity

200

Share capital

700

Goodwill

800

Retained earnings

175

Deferred tax asset

10
1,680

875

Demonstration problem
Additional information:
The balances in the deferred tax asset and liability
accounts are the carried forward closing balances from the
prior year

Accumulated depreciation of plant for tax purposes is $360

Current tax liability is $54

Required:
Complete the deferred tax worksheet on the following page and
prepare the journal entries to record the deferred tax
movements for the 30 June 2015 year.

Deferred tax worksheet

Relevant assets & liabilities

CA

FDA

Trade receivables

270

Interest receivable

40

Plant

200

Goodwill

800

Annual leave liability

15

30

TB

TTD

DTD

300

30
40

140

140

60
800

15

15

Total temporary differences

900

45

Less: excluded differences

(800)

Temporary differences

100

45

DTL/DTA @ 30%

30

13

Less: beginning balances

10

Increase for year

$ 21

$3

Notes and journal entries

Notes to worksheet:
1. Items where the CA = TB have been omitted from worksheet
(eg cash, payables, loan)
2. AASB 112 does not permit the recognition of a DTL relating to
goodwill. The TTD arising is referred to as an excluded
temporary difference

Journal entries to record deferred tax movement:

30/6/15

DT Asset
IT Expense
DT Liability

Dr
Dr
Cr

3
18

BALANCE

21