Chapter 4 FAR
Chapter 4 FAR
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Introduction
Calculating the current tax liability for an entity requires careful consideration of the differences
between the tax treatment and the accounting treatment of items, before accounting for the
current tax liability in accordance with IAS 12 Income Taxes.
This worked example links to unit learning objective:
• Calculate and account for current tax.
At the end of this worked example, you will be able to calculate the current tax liability of an
entity and prepare relevant journal entries in accordance with IAS 12.
This worked example is continued in worked example 4.3, but it is recommended that you
attempt this one first.
It will take you approximately 30 minutes to complete.
Scenario
Bob Jones is the financial controller of Flip Limited (Flip).
Bob has prepared a summary of Flip’s internal financial information for the year ended 30 June
20X3, and is ready to prepare the current tax liability. The summary is as follows:
Internal statement of profit or loss for the year ended 30 June 20X3
Item Note $ $
Expenses
Depreciation 4 10,000
Warranty 5 40,000
Fines 6 5,000
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Extract of internal statement of financial position at 30 June 20X2 and 30 June 20X3
Assets
Liabilities
Notes
1. The contract liability relates to revenue that is received in advance. It is assessable for tax purposes when received.
Cash received in the year ended 30 June 20X3 is $15,000. When the item is recognised for accounting purposes under
IFRS 15 Revenue from Contracts with Customers, it is included in sales revenue.
2. Interest revenue includes $45,000 that is not assessable for tax purposes until the year ending 30 June 20X4.
3. A government business incentive grant totalling $20,000 was accounted for correctly as income during the year.
The grant is never assessable for tax purposes.
4. The tax written-down value at 30 June 20X3 is $60,000 and $30,000 at 30 June 20X2. There have been no disposals
of plant and equipment during the year and the tax depreciation deduction is $20,000 for the year ended
30 June 20X3.
5. Warranty costs are deductible for tax purposes when paid.
6. Fines are not deductible for tax purposes.
7. The accounting treatment of accounts or transactions is assumed to be the same as the taxation treatment unless
otherwise indicated.
Flip’s tax rate is 30%.
Task
The directors of Flip have asked Bob to calculate and prepare the journal entry to record Flip’s
current tax liability for the year ended 30 June 20X3.
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Solution
Bob worked through the following steps to complete the task.
Item $ $
Taxable income
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1. Non-temporary difference
adjustments
(15,000)
2. Temporary difference
adjustments
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Contract liability from 20X2 and The contract liability balance (8,000)
recognised in 20X3 profit at 30 June 20X2 was assessable
for tax in the 30 June 20X2
year when it was received. It
is recognised as revenue in
accounting profit in the year
ended 30 June 20X3. It should
not be included in the taxable
income as it has already been
taxed and needs to be subtracted
to undo the revenue recognised
in the accounting profit
(26,000)
Note 1.
Calculation of the warranty amounts paid during 20X3:
Warranty provision
$ $
60,000 60,000
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Alternatively, the warranty amounts paid during 20X3 can be calculated as:
Step 5 – Prepare the journal entry to record the current tax liability
Using the figure calculated in the worksheet, Bob was able to record the journal entry for the
current tax liability at 30 June 20X3.
Note 1. The debit is made to income tax expense. This is because the underlying transactions
were all recognised in profit (and not in other comprehensive income or equity).
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Introduction
Accounting for deferred tax assets (DTAs) and deferred tax liabilities (DTLs) requires
consideration of temporary differences and any opening deferred tax balances calculated in
accordance with IAS 12 Income Taxes. As a Chartered Accountant, you may be required to
account for deferred tax in accordance with IAS 12.
This worked example links to unit learning objective:
• Calculate and account for deferred tax.
This worked example follows on from worked example 4.1. It is recommended that you attempt
worked example 4.1 first as you will need that information to complete this worked example.
At the end of this worked example, you will be able to calculate and record DTAs and DTLs
arising from temporary differences, in accordance with IAS 12.
It will take you approximately 45 minutes to complete.
Scenario
Bob Jones is the financial controller of Flip Limited (Flip).
Bob is preparing the financial statements for the year ended 30 June 20X3 and is currently
working on the tax calculations. Bob has calculated a taxable income of $104,000 by adjusting
the accounting profit before tax. Based on this, he has prepared the journal entry for the current
tax liability of $31,200.
At 30 June 20X2, the DTL and DTA were $9,000 and $8,400 respectively, both of which satisfied
the IAS 12 recognition criteria.
Flip’s tax rate is 30%.
Task
The directors have asked Bob to prepare the deferred tax journal entry for Flip for the year
ended 30 June 20X3.
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Solution
Bob worked through the following steps to complete the task.
To identify the assets and liabilities at 30 June 20X3 where the tax base and the accounting
carrying amount were different, giving rise to a temporary difference, Bob examined the
following items:
• The assets and liabilities included in the extract of the internal statement of financial
position at 30 June 20X3.
• The worksheet to calculate the current tax liability at 30 June 20X3 as item 2 in the
worksheet were temporary difference adjustments.
He identified that the treatment of the items included as cash and trade payables is the same
for tax and accounting purposes for Flip; and therefore, these items did not give rise to a
temporary difference.
He established that the items which would have a temporary difference were:
• Interest receivable
• Plant and equipment
• Contract liability
• Warranty provision.
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Bob calculated the temporary differences at 30 June 20X3 by subtracting the tax base of the item
from its carrying amount, as follows:
2. Plant and equipment, $100,000 carrying amount – If a tax balance sheet was
$60,000 tax base $100,000 future taxable amounts prepared, the plant and
(capped at the asset’s carrying equipment’s $60,000 tax written
amount) + $60,000 in future down value would be recognised
deductible amounts
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$ $
DTL 16,500
Note 1. The debit is made to income tax expense. This is because the underlying transactions
were all recognised in profit, and not in other comprehensive income or equity.
Note to candidates: The following information was not needed to answer the required:
Therefore, the balances in the DTL and DTA accounts after recording this journal entry are:
DTL DTA
$ $
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Introduction
A tax loss can be carried forward for recovery in future periods. As a Chartered Accountant,
you may have to record the carryforward of a tax loss and account for the recovery of that loss
in a future period.
This worked example links to unit learning objective:
• Calculate and account for deferred tax.
At the end of this worked example, you will be able to account for a tax loss in accordance with
IAS 12 Income Taxes.
It will take you approximately 10 minutes to complete.
Scenario
Trish Mondal is the financial accountant for Sprint Surf Limited (Sprint Surf).
During the year ended 30 June 20X2, Sprint Surf incurred a tax loss of $20,000. The loss was due
to a write-off of a major debtor, and Sprint Surf anticipated that sufficient taxable profits would
be generated in future periods to utilise the loss.
The tax rate for Sprint Surf is 30%.
Tasks
Kevin Morphus, the chief financial officer (CFO) of Sprint Surf, has asked Trish to prepare the
journal entries to:
A. Recognise the deferred tax relating to the tax loss as at 30 June 20X2.
B. Record the recoupment of the tax loss during the year ended 30 June 20X3, assuming that the
tax loss carried forward is offset against the taxable income for the year ended 30 June 20X3.
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Solution
Trish worked through the following steps to complete the task.
Part A
Step 1 – Review the Standard
Trish reviewed IAS 12 and noted that paras 34–36 are relevant to the task.
Step 2 – Determine the deferred tax balance arising from the tax loss incurred
Trish determined that the tax loss gives rise to a deferred tax asset (DTA), as the recovery of the
tax loss will result in lower tax in the future. She anticipated that sufficient taxable profits will
be generated in future periods to utilise the tax loss and, therefore, the DTA can be recognised.
The amount of the DTA arising as a result of the tax loss incurred is $6,000 ($20,000 × 30%).
Part B
Step 1 – Determine the appropriate accounting treatment
Trish noted that as the tax loss has now been utilised, the DTA in relation to the tax loss must
be derecognised. The impact of this is to reduce the current tax liability for the year ended
30 June 20X3.
Step 2 – Prepare the journal entry to record the recoupment of the tax loss
during the year ended 30 June 20X3
Trish prepared the journal entry to record the recoupment of the tax loss in the year ended
30 June 20X3.
DTA 6,000
To record the reduction in tax liability due to recoupment of the prior period tax loss
previously booked as a DTA
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Introduction
Calculating the current tax liability for an entity in accordance with IAS 12 Income Taxes (IAS 12)
usually takes place shortly after the end of the reporting period, while the entity’s income tax
return may be prepared and lodged with the taxation authority several months later. Upon
preparing the income tax return, it is possible that the current tax liability differs from the
amount calculated when the tax entries were prepared. Similarly, the taxation authority may
decide that the taxable income is different from the amount calculated by the entity that has
been used as the basis for calculating its current tax liability.
This worked example links to unit learning objective:
• Explain and account for changes in prior year taxes.
At the end of this worked example you will be able to prepare a journal entry to account for an
underprovision of income tax in accordance with IAS 12.
It will take you approximately 15 minutes to complete.
Scenario
Javier Alvarez is the financial controller of Mavis Limited (Mavis). He had calculated the
company’s current tax liability at 30 June 20X2 to be $663,500. The annual income tax return was
lodged with the relevant taxation authority on 15 December 20X2.
On 1 February 20X3, Mavis received an amended assessment notice from the taxation authority.
It stated that the actual tax liability of the company for the year ended 30 June 20X2 was
$679,250. As a result, Mavis was required to pay further tax of $15,750 by 31 March 20X3.
The difference between the amount Javier calculated for Mavis and the amount the taxation
authority assessed arose due to the following:
1. The taxation authority disallowed a deduction of $7,500 that Mavis had claimed in relation
to a donation.
2. The taxation authority assessed the appropriate tax depreciation rate for a building Mavis
held to be 5% on a straight-line basis. Mavis had applied a straight-line rate of 12.5% when
preparing the income tax return. The building was acquired on 1 January 20X2 at a cost of
$1.2 million and is being depreciated at a rate of 12.5% on a straight-line basis for financial
reporting purposes.
The tax rate is 30%.
Task
Javier needs to prepare the journal entry to recognise the impact on the current tax liability as a
result of the amended assessment Mavis received on 1 February 20X3.
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Solution
Javier worked through the following steps to complete the task.
Prior period errors are omissions from, and misstatements in, the entity’s financial statements for
one or more prior periods arising from a failure to use, or misuse of, reliable information that:
(a) was available when financial statements for those periods were authorised for issue; and
(b) could reasonably be expected to have been obtained and taken into account in the preparation
and presentation of those financial statements.
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Step 3 – Identify the nature of the errors in the current tax liability
calculation
Javier knew that, following the requirements of IAS 12 para. 12, he would need to adjust the
current tax liability that was recorded in the statement of financial position at 30 June 20X2.
The current tax liability recorded was understated and he needed to recognise, as a liability,
the full amount of current tax for the prior period to the extent that it was still unpaid.
He read the details on the amended assessment notice from the taxation authority and
categorised the impact of the adjustments, as follows:
Adjustments to current tax liability are recognised by adjusting income tax expense when:
As neither of the underlying transactions was accounted for outside of profit or loss, the
adjustment to the current tax liability would be recognised by adjusting income tax expense.
Donation not allowed Increases taxable $2,250 increase Non-temporary Income tax
as a deduction income by difference expense
$7,500 adjustment
Notes
1. Calculated as follows:
2. The carrying amount of the building for financial reporting purposes is $1,125,000 ($1,200,000 – $75,000) and does not
change as a result of the tax error. At 30 June 20X2 the tax base had also been calculated to be $1,125,000 ($1,200,000
– $75,000) and there would have been no temporary difference recognised for the building at 30 June 20X2.
However, the lower tax depreciation rate will increase the tax base of the building to $1,170,000 ($1,200,000 – $30,000)
As the $1,170,000 tax base of the building exceeds the $1,125,000 carrying amount, there is a $45,000 deductible
temporary difference. Accordingly, a $13,500 deferred tax asset ($45,000 × 30%) needs to be recognised when correcting
the error.
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To record the increase in the current tax liability arising under the amended assessment notice
relating to the year ended 30 June 20X2