Chapter 14 - Taxation In Company Financial Statements

Question 1

What is output VAT?

Answer 1

• VAT registered business charge VAT to their customers by adding VAT onto selling price - output VAT
• must be paid over to HMRC (trader acting as collector)
• VAT does not belong to the trader and should not be shown on the value of sales or turnover

Question 2

What is the accounting entry for output VAT? (Sales or turnover)

Answer 2

Bank/debtor debited (VAT-inclusive amount) - increase in assets

Sales/Turnover credited (with VAT-exclusive amount) -increase in income

VAT control a/c credited (output VAT) as this is owed to HMRC

Question 3

What is input VAT?

Answer 3

• businesses may incur VAT as part of the cost of its purchases and expenses - input VAT
• can be reclaimed from HMRC by a VAT registered person
• should not be shown in the value of costs or expenses

Question 4

What are the accounting entries for input VaT? ( purchased or expenses)

Answer 4

Expense/purchased debited (with VAT exclusive amount) - increase in expenses

VAT control a/c debited (input VAT) this is owed to the business

Bank/creditors credited (with VAT inclusive amount) - decrease in assets/increase in liabilities

Question 5

What does it mean if the closing balance on the VAT control a/c is a VAT creditor?

Answer 5

• business owes money to HMRC
  -output VAT > Input VAT

Question 6

What does it mean if the closing balance on the VAT control a/c is a VAT debtor?

Answer 6

• HMRC owes money back to the business
• Input VAT > Output VAT

Question 7

What is the formula for the VAT element where amount given is inclusive of VAT

Answer 7

(VAT rate / 100+VAT rate) * VAT-inclusive amount

Question 8

What is irrecoverable VAT?

Answer 8

• VAT on purchases and expenses that cannot be reinvested from HMRC

Examples include business entertaining and blocked VAT on cars

• in this case VAT is a cost of the business and the full purchase price including VAT will be debited to the expense or asset account

Question 9

What was the aim of the VAT and flat rate scheme?

Answer 9

• to simplify the way small businesses account for VAT so that less time and money is spent keeping VAT records

Question 10

Using the flat rate scheme what is VAT calculated on?

Answer 10

Turnover gross of VAT

Question 11

How is the flat rate determined?

Answer 11

• laid down by HMRC depends upon the trade sector on which the business operates

Question 12

In terms of payments made by the company what is the double entry for interest or patent royalties?

Answer 12

Interest/patent royalty expense a/c debited (gross amount - inclusive of income tax)

Bank credited (net amount)

Income tax control a/c credited (income tax)

Question 13

In terms of income what is the double entry for interest/patent royalties?

Answer 13

Bank debited (net amount - income tax exclusive amount)

Patent royalties a/c credited (net amount)
When cash is received and

Income tax control a/c debited with income tax amount - reflecting that this can be reclaimed

Patent royalties received credited (income tax amount)
With the tax suffered at source

Question 14

Where a company pays both interest and patent royalties the balance on the income tax a/c may be overall a credit or a debit. Describe what these both mean.

Answer 14

Credit - excess payments over receipts
- income tax payable to HMRX

Debit - excess receipts over payments
- repayable to the company
- can be offset against the corporation tax liability

Question 15

What is the double entry for a corporation tax charge?

Answer 15

• corporation tax charge debited (increase in expenses)
• corporation tax creditor credited (increase in liabilities)

Question 16

When is corporation tax paid?

Answer 16

• usually payable 9m and 1 day after the balance sheet date
• large companies will pay their current corporation tax liability in four quarterly instalments

Question 17

How is an under provision of corporation tax accounted for?

Answer 17

Corporation tax charge debited (increase in expenses)

Corporation tax creditor credited (increase in liabilities)

Too little tax was paid hence tax liability I the following period will be greater

Question 18

How is an over provision of corporation tax accounted for?

Answer 18

Corporation tax creditor debited (decrease in liabilities)

Corporation tax charge credited (decrease in expenses)

Over provision means too much tax was paid and hence tax in the following period will be reduced

Question 19

What two areas can the differences between the expected tax charge and actual charge be broken down into?

Answer 19

Permanent difference

Timing differences

Question 20

What are permanent differences?

Answer 20

• arise when certain types of income and expenditure are recognised in the accounts but will never appears on the tax comp I.e business entertaining

Question 21

What are timing differences?

Answer 21

Arise when certain types of income and expenditure are recognised in difference periods for the purpose of financial statements on the one hand and taxation on the other

E.g depreciation charged appear in the financial statements but are not allowed as an expense for tax purposes instead capital allowances reduce taxable profits

Question 22

How do we account for permanent differences?

Answer 22

• do not give rise to deferred tax adjustments
• difference will lead to distortion of tax charge and so will be included in reconciliation

Question 23

What is deferred taxation?

Answer 23

System of dealing with the distortions caused by timing differences

• objective is to ensure tax charge shown in the p&l is not out of line with the profit earned
• not a real tax just an accounting adjustment

Question 24

What would happen in a year where capital allowances are high compared to depreciation?

Answer 24

• tax liability will be lower than the reported profits would suggest

Question 25

What would happen in a year where capital allowances fall short of the depreciation charge?

Answer 25

• would result in a higher tax liability than our reported profits would suggest

Question 26

How is the timing difference calculated?

Answer 26

Difference between capital allowances and depreciation

• the taxed at 20%

Question 27

What is the deferred tax entry when capital allowances > depreciation
I.e where corporation tax charge is lower than expected ?

Answer 27

Deferred taxation charged debited (p&l) (increase in expenses)

Deferred taxation provision credited
(b/s)

Question 28

What is the deferred tax entry when depreciation > capital allowances?
I.e corporation tax charge is higher than expected?

Answer 28

Deferred taxation provision debited (b/s)

Deferred taxation charge credited (p&l)

Question 29

What is meant by profit reconciliations?

Answer 29

FRA 102 requires companies to produce a reconciliation between the expected tax charge based on the accounting profit and the actual corporation tax charge

• need to identify the differences between the accounting profit and taxable profit and split them into timing and permanent differences

Question 30

Give some examples of what gets added back when calculating taxable profit?

Answer 30

• depreciation (timing difference)
• business entertaining (permanent difference)

Question 31

Give some examples of what gets deducted when calculating taxable profits?

Answer 31

• capital allowances (timing difference)