8. Tax

Question 1

How is tax treated in accounting terms?

Where is it recorded in the financial statements?

Answer 1

A company as a separate legal entity is liable to pay tax on its profits to HMRC itself: the liability is not that of its owners’. Tax is therefore treated as a deduction from profit.

Any outstanding liability for unpaid tax is shown as a liability on the statement of financial position (tax payable), either current or non-current depending on the circumstances.

Question 2

What is the method used for accounting for tax?

Answer 2

Different methods can be used, but in this workbook a single tax payable ledger account is used for both the expense in the statement of profit or loss and the liability in the statement of financial position.

Question 3

What is the double entry for when a tax liability arises and is identified?

Answer 3

When a tax liability arises and is identified, the double entry to record it is:

DEBIT - Tax expense (P/L)
CREDIT - Tax payable account

Question 4

What is the double entry for when a tax payment is made?

Answer 4

DEBIT - Tax payable account
CREDIT - Cash at bank

At the end of the reporting period, any balance on the tax payable account is carried down. Usually this is a credit balance and is shown as ‘Tax payable’ under current liabilities on the statement of financial position.

Question 5

What is the accounting treatment for an over or under provision of tax?

Answer 5

Since a company’s statement of profit or loss is usually prepared before the tax due is finally agreed with HMRC, the expense in the statement of profit or loss is an estimate.

It nearly always proves to be too high (over-provision) or too low (under-provision). Instead of going back to the the financial statements for the reporting period and changing them:
- Any under provision from the previous reporting period increases the tax expense for the subsequent reporting period.
- Any over provision from the previous reporting period reduces the tax expense for the subsequent reporting period.

Question 6

How is VAT or PAYE/NIC disclosed?

Answer 6

Any balance owed to HMRC in respect of VAT or PAYE/NIC is disclosed as other payables, not as tax payable.