Week 8 Everything Flashcards
The profit or loss determined according to AASB accounting standards is known as the
“accounting profit before income taxes”.
The profit or loss determined according to AASB accounting standards is known as the “accounting profit before income taxes”.
Is this the profit on which the company has to
pay taxes?
NO
The taxes are to be paid on the income that is determined in accordance with Australian income tax legislation (ATO rules)
The “Taxable income”
Difference between accounting profit and taxable income
“Taxable income” differs from “Accounting profit (before taxes)”, because taxable income is determined in accordance with Australian income tax legislation (ATO rules) and accounting profit is determined according to AASB rules
Being calculated according to different rules means that
Some revenues and expenses recognised for accounting purposes are not recognised for tax purposes or vice versa.
Accounting profit =
Accounting revenues - Accounting expenses
Taxable profit =
Taxable revenues - Deductible expenses
Examples of differences between accounting and tax rules
2/4/19
Calculation of Taxable profit
The most convenient way is derive the taxable income from the accounting income
Calculation of Taxable profit
Step 1
In the case of Jen Ltd, some revenues (not recognised in accounting profit) are to be considered as part of Taxable profit (according to ATO rules).
Calculation of Taxable profit
Step 2
The accounting revenue is subtracted from the accounting profit and replaced by the taxable revenue determined according to tax rules; the accounting expense is added back from the accounting profit and replaced by the deductible expense determined according to tax rules.
Summary for calculation of taxable profit
Accounting profit before taxes (from company’s accounting)
- Accounting revenues (according to AASB standards)
+ Taxable revenues (according to tax rules)
+ Accounting expenses (according to AASB standards)
- Deductible expenses (according to tax rules)
= Taxable income
Once Taxable profit is calculated, the tax due to Australian
Taxation Office can be calculated as:
Taxable profit x Tax rate = Tax payable
Tax PAYABLE
The DEBT for taxes to be paid to ATO and recorded as liability. Tax payable differs from the tax relating to Accounting profit (before tax), which is the accounting expense for taxes (To be recorded as EXPENSE in
STATEMENT OF PROFIT OR LOSS)
To determine Tax EXPENSE for accounting purposes we need to apply the
“balance sheet” method of tax effect accounting (AASB112)
Balance sheet approach to accounting for taxation
To explain the difference between tax payable and tax expense, the “balance sheet” method (AASB112) is applied. This method is based on the differences between accounting and tax values of assets and liabilities. It compares the carrying amount of assets and liabilities (determined by accounting rules) with the tax base for those assets and liabilities (determined by tax rules). Effectively involves comparing the balance sheet derived using accounting rules with the balance sheet that would be derived from taxation rules
Carrying amount
Carrying amount is the amount of asset or liability that is
determined according to AASB accounting rules.
Tax base
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 at which an asset or liability would be recorded, if the balance sheet (statement of financial position) is prepared according to taxation rules
If carrying amount and tax base of an asset or liability are different
a ‘temporary difference’ arises
Temporary differences can be of two types:
- A taxable temporary difference
2. A deductible temporary difference
- 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. They generate a deferred tax liability (tax-related liability)
- 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. They generate a deferred tax asset (tax-related asset)
Deferred tax assets and/or deferred tax liabilities explained the difference between
income tax payable and income tax expense
Temporary differences, deferred tax assets
and liabilities - summary
2/4/19
Temporary differences, deferred tax assets
and liabilities - summary
Tax expense (tax income) is the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax.
Tax Expense =
Income Tax Payable + Increase in DTL – Increase in DTA
Effectively, Tax Expense is the balancing item in the tax journal entry after determining
➢ Income tax payable
➢ increase or decrease in DTL
➢ Increase or decrease in DTA
Tax expense measures the tax effect of all accounting revenues and expenses included in the current year’s accounting profit, regardless of whether of whether the revenue or expense is taxed in the current, or a past or future year. It is consistent with accrual accounting
Deferred tax liability
It is generated by a taxable temporary difference when the carrying amount of the asset exceeds the tax base, or the tax base of a liability exceeds its carrying amount. It represent a deferral of taxation payments to future periods. The tax payments are reduced (or ‘saved’) in early years, but additional tax will need to be paid in future years. Tax payments are delayed to future periods.
Deferred tax asset
It is generated by a deductible temporary difference when he tax base of an asset exceeds it carrying amount or the carrying amount of the liability exceeds the tax base. It represents a prepayment of tax relating to future years. The tax payments are higher in early years, but lower tax will be paid in future years (when the deferred tax asset is reversed). Tax payments are paid in advance.
Tax effect of revaluation of non-current assets
Revaluations of non current assets can also create temporary differences. The temporary difference is due to the different treatment of the revaluation increment according to the AASB accounting rules and tax legislation. The carrying amount of the asset will take into account the revaluation increment, but the tax base of the revalued asset will be based on the original cost of the asset. Therefore the carrying amount of the revalued asset will be higher than its tax base, which generates a DTL. Unlike previous examples where the DTL is adjusted against income tax expense, for asset revaluations the increase in DTL is adjusted against the revaluation surplus.
