Chapter 19

Accounting for income taxes

19.1

Where the carrying amount of an asset or liability (the carrying amount is determined using
accounting rules) is different to the tax base (determined by applying taxation rules) then a
temporary difference can arise. Paragraph 5 of AASB 112 defines a temporary difference
as:
The difference between the carrying amount of an asset or a liability in the balance
sheet and its tax base.
AASB 112 explains that temporary differences may be either:
(a) deductible temporary differences, which are temporary differences that will result
in amounts that are deductible in determining taxable profit (tax loss) of future
periods when the carrying amount of the asset or liability is recovered or settled; or
(b) taxable temporary differences, which are temporary differences that will result in
taxable amounts in determining taxable profit (tax loss) of future periods when the
carrying amount of the asset or liability is recovered or settled.
Something that will lead to an increase in taxable income in future years (a taxable temporary
difference) creates a liabilitya deferred tax liability. Something that will lead to a decrease
in taxable income in future years (a deductible temporary difference) creates an asseta
deferred tax asset.

19.2

The tax base of an asset is determined by calculating what the value of the asset would be
from a taxation perspective: that is, it is the value that would be calculated if we applied
taxation rules. As paragraph 5 of AASB 112 states:
The tax base of an asset or liability is the amount attributed to that asset or liability
for tax purposes.
According to paragraph 7 of AASB 112:
The tax base of an asset is the amount that will be deductible for tax purposes
against any taxable economic benefits that will flow to an entity when it recovers
the carrying amount of the asset. If those economic benefits will not be taxable, the
tax base of the asset is equal to its carrying amount.

19.3 The tax base of a liability is the amount that is attributed to a liability for tax purposes.
According to paragraph 8 of AASB 112:
The tax base of a liability is its carrying amount, less any amount that will be
deductible for tax purposes in respect of that liability in future periods. In the case
of revenue which is received in advance, the tax base of the resulting liability is its
carrying amount, less any amount of the revenue that will not be taxable in future
periods.

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19.4

Income tax expense represents the sum of the tax attributable to the taxable profit (where
taxable profit is calculated by applying tax rules) plus or minus any adjustments relating to
temporary differences. (Temporary differences arise because of differences between
accounting rules and taxation rules.) This is consistent with the definition of income tax
expense provided in AASB 112, which is:
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.
Paragraph 6 of AASB 112 further states:
Tax expense (tax income) comprises current tax expense (current tax income) and
deferred tax expense (deferred tax income).

19.5

The tax assessed by the Tax Office, and reflected in the current liability of income tax payable
(which appears in an entitys balance sheet), will be based on the taxable profit derived by the
entity, and this will be determined by applying the rules stipulated in taxation law, rather than
the rules incorporated within accounting standards.

19.6

The rationale for recognising a deferred tax asset or a deferred tax liability is that failure to
do so will mis-state the assets and liabilities of an entity. The argument is that the entitys
current activities will create some future taxation obligations or taxation benefits which
would otherwise be ignored.

19.7

If an entity has generated taxable income then it will be required to pay tax. For example,
assume that a company has taxable income of $1 million and that the tax rate is 30 per cent.
In this case the entity will have an obligation to the Tax Office of $300 000 (which will be
recorded as Income Tax Payable). However, if the entity has unused tax losses then it can use
these amounts to offset the amount that would otherwise be payable. That is, the unused tax
losses will provide future economic benefits (a requirement of an asset) because they will
reduce the amount that would otherwise have to be paid by the entity. For example, if the
company has unused tax losses of $600 000 then it can use these losses to reduce the amount
of tax payable in the current year to $120 000, which equals ($1 000 000 $600 000) x 30%.
The unused tax losses provided an economic benefit of $180 000 (the absolute amount of the
loss multiplied by the tax rate). However, there are some restrictions on recognising deferred
tax assets that arise as a result of tax losses. For example, paragraphs 34 to 36 of AASB 112
state:
34. A deferred tax asset shall be recognised for the carryforward of unused tax
losses and unused tax credits to the extent that it is probable that future taxable
profit will be available against which the unused tax losses and unused tax
credits can be utilised.
35. The criteria for recognising deferred tax assets arising from the carryforward of
unused tax losses and tax credits are the same as the criteria for recognising
deferred tax assets arising from deductible temporary differences. However, the
existence of unused tax losses is strong evidence that future taxable profit may
not be available. Therefore, when an entity has a history of recent losses, the
entity recognises a deferred tax asset arising from unused tax losses or tax
credits only to the extent that the entity has sufficient taxable temporary

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differences or there is convincing other evidence that sufficient taxable profit

will be available against which the unused tax losses or unused tax credits can
be utilised by the entity. In such circumstances, paragraph 82 requires disclosure
of the amount of the deferred tax asset and the nature of the evidence
supporting its recognition.
36. An entity considers the following criteria in assessing the probability that taxable
profit will be available against which the unused tax losses or unused tax credits
can be utilised:
(a) whether the entity has sufficient taxable temporary differences relating to
the same taxation authority and the same taxable entity, which will result in
taxable amounts against which the unused tax losses or unused tax credits
can be utilised before they expire;
(b) whether it is probable that the entity will have taxable profits before the
unused tax losses or unused tax credits expire;
(c) whether the unused tax losses result from identifiable causes which are
unlikely to recur; and
(d) whether tax planning opportunities (see paragraph 30) are available to the
entity that will create taxable profit in the period in which the unused tax
losses or unused tax credits can be utilised.
To the extent that it is not probable that taxable profit will be available against
which the unused tax losses or unused tax credits can be utilised, the deferred
tax asset is not recognised.
19.8

When a provision is created in relation to long-service leave, or is increased, there is no

actual cash flow. There is a debit to employee benefits expense and a credit to provision for
long-service leave. Typically, tax deductions are only allowed by the Taxation Office when
there are actual cash flows involved. Hence, no tax deduction would be allowed at the time
the provision is created or increased. The company will, therefore, pay a greater amount of
tax than would be payable if it was assessed purely on the basis of its accounting profit. In a
sense the company is prepaying the tax, which creates a Deferred Tax Asset.
When cash flows associated with the long-service leave obligation occur in a subsequent
period, the Taxation Office will allow a deduction. In a sense the company will be receiving a
tax deduction for an expense that was incurred in a previous period: it will receive the
benefits (in the form of lower required tax payments) in this subsequent period as a result of
the previously recorded deferred tax asset. When the cash flow occurs, the company will
debit the provision for long-service leave and credit cash. No expense is recognised at this
point by the company.
Where a provision for long-service leave is created, a liability will be created for accounting
purposes. However, for taxation purposes the liability is not recognised (a tax base of $0).
Where the carrying amount of a liability is greater than the tax base of a liability, this will
give rise to a deductible temporary difference which will in turn give rise to a deferred tax
asset.

19.9

No, unused tax losses will not always lead to the recognition of a deferred tax asset. Before a
deferred tax asset is recognised it must be probable that the benefits associated with the
unused tax losses will ultimately be received. Specifically, paragraph 34 of AASB 112 states:

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A deferred tax asset shall be recognised for the carryforward of unused tax losses
and unused tax credits to the extent that it is probable that future taxable profit will
be available against which the unused tax losses and unused tax credits can be
utilised.
Paragraphs 34 to 36 of AASB 112 provide further guidance in relation to unused tax losses.
They state:
34. A deferred tax asset shall be recognised for the carryforward of unused tax
losses and unused tax credits to the extent that it is probable that future taxable
profit will be available against which the unused tax losses and unused tax
credits can be utilised.
35. The criteria for recognising deferred tax assets arising from the carryforward of
unused tax losses and tax credits are the same as the criteria for recognising
deferred tax assets arising from deductible temporary differences. However, the
existence of unused tax losses is strong evidence that future taxable profit may
not be available. Therefore, when an entity has a history of recent losses, the
entity recognises a deferred tax asset arising from unused tax losses or tax
credits only to the extent that the entity has sufficient taxable temporary
differences or there is convincing other evidence that sufficient taxable profit
will be available against which the unused tax losses or unused tax credits can
be utilised by the entity. In such circumstances, paragraph 82 requires disclosure
of the amount of the deferred tax asset and the nature of the evidence
supporting its recognition.
36. An entity considers the following criteria in assessing the probability that taxable
profit will be available against which the unused tax losses or unused tax credits
can be utilised:
(a) whether the entity has sufficient taxable temporary differences relating to
the same taxation authority and the same taxable entity, which will result in
taxable amounts against which the unused tax losses or unused tax credits
can be utilised before they expire;
(b) whether it is probable that the entity will have taxable profits before the
unused tax losses or unused tax credits expire;
(c) whether the unused tax losses result from identifiable causes which are
unlikely to recur; and
(d) whether tax planning opportunities (see paragraph 30) are available to the
entity that will create taxable profit in the period in which the unused tax
losses or unused tax credits can be utilised.
To the extent that it is not probable that taxable profit will be available against
which the unused tax losses or unused tax credits can be utilised, the deferred
tax asset is not recognised.
19.10 Changed tax rates will have implications for the value attributed to pre-existing deferred tax
assets and deferred tax liabilities. For example, if an organisation has recognised a deferred
tax asset relating to a previous loss for tax purposes and that previous carried-forward tax
loss was $1 million, and the tax rate is increased from 30 per cent to 35 per cent, the amount
of the deferred tax asset will need to be increased from $300,000 to $350,000. This is
because when the organisation subsequently earns a taxable profit of say $1,000,000 it will be
able to offset the loss against the $350,000 in tax that would otherwise be payable under the
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revised tax rate. The $50,000 increase in the value of the deferred tax asset (which is
calculated as $1,000,000 x [0.35 0.30]) would be treated as income, given that the carrying
amount of the asset has been increased. Conversely, if the tax rate had been decreased, the
value of the asset would be decreased and this would be recognised as an expense.
An increase in tax rates will create an expense where an organisation has deferred tax
liabilities, whereas a decrease in tax rates will create income in the presence of deferred tax
liabilities. Where there are both deferred tax assets and deferred tax liabilities at the time of a
change in tax rate, there will be both gains and losses (there will be a gain on the asset and a
loss on the liability, or vice versa) and the net amount would be treated as either income or an
expense.
The impact of changing tax rates is discussed at paragraph 60 of AASB 112:
The carrying amount of deferred tax assets and liabilities may change even though
there is no change in the amount of the related temporary differences. This can
result, for example, from:
(a) a change in tax rates or tax laws;
(b) a re-assessment of the recoverability of deferred tax assets; or
(c) a change in the expected manner of recovery of an asset.
The resulting deferred tax is recognised in the income statement, except to the
extent that it relates to items previously charged or credited to equity (see
paragraph 63).
19.11Yes, deferred tax assets can be offset against deferred tax liabilities. Paragraph 75 of AASB 112
requires, subject to limited exceptions, that the entity must set-off deferred tax liabilities and
deferred tax assets and recognise the net amount in the balance sheet. Paragraph 75 states:
To avoid the need for detailed scheduling of the timing of the reversal of each
temporary difference, this Standard requires an entity to set-off a deferred tax asset
against a deferred tax liability of the same taxable entity if, and only if, they relate
to income taxes levied by the same taxation authority and the entity has a legally
enforceable right to set-off current tax assets against current tax liabilities.
19.12 (a)

For taxation purposes, the depreciation in the first two years would be
$250 000 2 = $125 000 per year.
For accounting purposes, the depreciation across five years would be
$250 000 5 = $50 000 per year.
The company will claim a tax deduction of $125 000 per year for the first two years.
No deduction will be available in years three, four and five. For accounting purposes,
the depreciation expense in each of the first five years will be $50 000 per year.
The carrying amount of the asset will be more than its tax base such that the
difference will lead to a deferred tax liability (there is a taxable temporary difference).

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If we multiply this taxable temporary difference by the tax rate then we arrive at the
balance of the deferred tax liability.
(b) The deferred tax liability at 30 June 2008 can be calculated as follows:
Carrying value

Tax base

$
250 000

Machinerycost
Accumulated
depreciation

Temporary
differenc
e
$

$
250 000

150 000
100 000

250 000
0

100 000

As the carrying amount of the asset exceeds the tax base, a deferred tax liability exists. The
balance of the deferred tax liability is $100 000 x 0.30 = $30 000.
19.13

(a)

Assetcost
Accumulated depreciation
(b)
19.1
4

Tax base

$
300
100
200

Temporary
differenc
e
$

300
180
120

(a)

(b)

80

As the carrying amount of the asset exceeds the tax base, a deferred tax liability
exists. The balance of the deferred tax liability is $80 x 0.30 = $24.

Accrued product warranty costs

19.1
5

Carrying
value

Carrying value
$300

Tax base
$0

Temporary
difference
$300

As the carrying amount of the liability exceeds the tax base, a deferred tax asset
exists. The balance of the deferred tax asset is $300 x 0.30 = $90. Whilst the Tax
Office has not given the company a tax deduction now, it will provide a tax deduction
in future periods when the actual cash flow occurs. The deduction will provide
economic benefits to the company.

(a)
Accounts receivable (net)

Carrying value
$240 000

Tax base
$300 000

Temporary
difference
$60 000

The amount of the tax base can be confirmed as follows:

Carrying amount
$240 000

(b)

+
+

Future deductible amount

$60 000

Future taxable amount

$0

= Tax base
= $300 000

As the carrying amount of the asset is less than the tax base, a deferred tax asset
exists. The balance of the deferred tax asset is $60 000 x 0.30 = $18 000. Whilst the
Tax Office has not currently given the company a tax deduction for the doubtful
debts, it will provide a tax deduction in future periods when the doubtful debts are

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written off against accounts receivable. The deduction will provide economic benefits
to the company.
19.1
6

(a)
Carrying value
$400 000

Interest receivable

Tax base
$0

Temporary
difference
$400 000

The amount of the tax base can be confirmed as follows:

Carrying amount
$400 000

(b)

19.1
7

Future taxable amount

$400 000

= Tax base
= $0

As the carrying amount of the asset is greater than the tax base, a deferred tax liability
exists. The balance of the deferred tax liability is $400 000 x 0.30 = $120 000. The
deferred tax liability exists because whilst the Tax Office has not considered the
interest to be assessable in the current year, it will tax the interest revenue in a
subsequent period when it is actually received by the company.

Prepaid rent

Carrying value
$400 000

Tax base
$0

Temporary
difference
$400 000

As the carrying amount of the asset is greater than the tax base, a deferred tax liability
exists. The balance of the deferred tax liability is $400 000 x 0.30 = $120 000. The
deferred tax liability exists because the Tax Office has given the company a deduction
up front when the rent was paid, even though the rent was prepaid. However, when
the company actually treats the rent as an expense (across time as the benefits are
derived), no deduction will be available to the company. In a sense, the company has
received a deduction in advance.

(a)
Provision
for
LSL
Accrued wages
(b)

19.1
9

Future deductible amount

$0

(a)

(b)

19.1
8

+
+

Carrying value
$500 000
$300 000
$800 000

Temporary difference

$0
$300 000
$300 000

$500 000
$0
$500 000

As the carrying amount of the liabilities is more than the tax base, a deferred tax asset
exists. The balance of the deferred tax asset is $500 000 x 0.30 = $150 000. Whilst
the Tax Office has not given the company a tax deduction now for the long-service
leave, it will provide a tax deduction in future periods when the actual cash flow
occurs. The deduction will provide economic benefits to the company.

(a)
Interest revenue received in
advance
Loan payable
(b)

Tax base

Carrying
value
$250 000
$400 000
$650 000

Tax base
$0
$400 000
$400 000

Temporary
difference
$250 000
$0
$250 000

As the carrying amount of the liabilities is more that the tax base, a deferred tax asset
exists. The balance of the deferred tax asset is $250 000 x 0.30 = $75 000. Whilst the

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company would not consider that it has actually earned the interest (as it was received
in advance), it nevertheless has been taxed on the cash inflow. From an accounting
perspective it will earn the interest in future financial periods.
19.2
0

Carrying
value
$200 000
$200 000

If sold immediately
If used within organisation

Temporary
difference
$80 000
$100 000

Tax base
$120 000
$100 000

If the asset is disposed of immediately, the deferred tax liability would be $24 000 (which is
$80 000 x 30%). If it is retained for use in the organisation then no capital gains indexation
applies and the deferred tax liability would be $30 000 (which is $100 000 x 30%).
19.21
Balance at 30 June 2009
Balance at 1 August 2009
$1,000,000
$1,000,000 x 35/30 = $1,166,667
$800,000
$800,000 x 35/30 = $933,333

Deferred tax asset

Deferred tax liability

The accounting entry at 1 August 2009 would be:

Dr
Deferred tax asset
Cr
Deferred tax liability
Cr
Income tax expense

Change
$166,667
$133,333

166,667
133,333
33,334

19.22

Assets
Cash
Accts re net
Prepaid Ins.
Inventory
Plantnet
Land
Liabilities
Accts pay.
Prov LSL
Prov warty
Loan pay.
Net assets

Extract
from
Accounting
Balance
Sheet

Tax bases

Deductible
temporary
differences

Taxable
temporary
differences

Tax
expense

Asset
reval.
reserve

Income
tax
payable

60 000
50 000
20 000
80 000
450 000
600 000
1 260 000

60 000
60 000

80 000
400 000
400 000
1 000 000

60 000
30 000
40 000
400 000
530 000
730 000

60 000

10 000

20 000
50 000
200 000

30 000
40 000

(10 000)
20 000
50 000
(200 000)

(30 000)
(40 000)

400 000
460 000
540 000

Temporary differences at period end

Less: Prior period amounts

80 000

270 000

(10 000)

(200 000)

Movement for the period

Tax effected at 30%
Tax on taxable income, 30% x $700 000
Income tax adjustments

80 000
24 000

270 000
81 000

(200 000)
(60 000)

24 000

81 000

(10 000)
(3 000)
210 000
207 000

(60 000)

210 000
210 000

The required journal entries at 30 June 2009 would be:

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Dr
Dr
Dr
Cr
Cr

Income tax expense

Deferred tax asset
Asset revaluation reserve
Deferred tax liability
Income tax payable

207 000
24 000
60 000
81 000
210 000

Because in most cases the tax is payable to the same authority, AASB 112 requires that the
deferred tax liabilities and deferred tax assets be set-off against one another and only the net
amount be disclosed in the balance sheet. Hence, we will also make the following entry:
Dr
Cr

19.23

Deferred tax liability

Income tax payable

24 000
24 000

Our first step will be to determine taxable income. We will need to know this to determine
income tax payable.
Profit before tax
Adjust for differences between tax and accounting rules
Long-service leave not yet deductible
Warranty expenses
30 000
Warranty expenses paid
(10 000)
Accounting depreciation
80 000
Tax depreciation
(100 000)
Insurance expense
20 000
Insurance actually paid
(30 000)
Taxable income

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$300 000
20 000
20 000
(20 000)
(10 000)

10 000
$310 000

199

Extract
from
Accounting
Balance
Sheet
$
Assets
Cash
Accts rec.
Inventory
Prepaid Ins.
Plantnet
Liabilities
Act payable
Prov. warty
Prov. LSL
Loan
Net assets

Tax
bases
$

20 000
100 000
100 000
10 000
320 000
550 000

20 000
100 000
100 000

300 000
520 000

80 000
20 000
20 000
200 000
320 000
230 000

80 000

200 000
280 000
240 000

Temporary differences at period end

Less: Prior period amounts
Movement for the period
Tax effected at 30%
Tax on taxable income,
30% x $310 000
Income tax adjustments

Deductible
temporary
differences
$

Taxable
temporary
differences
$

Tax
expense
$

10 000
20 000

20 000
20 000

Current
tax
payable
$

10 000
20 000

(20 000)
(20 000)

40 000

40 000
12 000

30 000

30 000
9 000

(10 000)

(10 000)
(3 000)

12 000

9 000

93 000
90 000

93 000
93 000

The journal entries at year end are:

Dr
Income tax expense
93 000
Cr
Income tax payable
(To recognise the tax expense pertaining to taxable income)

93 000

Dr
Deferred tax asset
12 000
Cr
Tax expense
3 000
Cr
Deferred tax liability
9 000
(To recognise the reduction in tax expense pertaining to the temporary differences)
Dr
Cr

Deferred tax liability

Deferred tax asset

9 000

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1910

19.24 E-Surfboards Ltd

(a)

Asset/Liability
Assets
Computers (net)

Accounting
base
($000)

Tax
base
($000)

240

200

Accounts
receivable

90

100

Liabilities
Provn for
Warranty

30

Provn for LSL

20

Temporary difference
30 June 2008
($000)
40
taxable temporary difference
10
deductible temporary
difference
30
deductible temporary
difference
20
deductible temporary
difference

(b) Deferred tax asset: ($10 000 + $30 000 + $20 000) x 30% = $18 000 dr
Deferred tax liability: $40 000 x 30% = $12 000 cr
(c)
Profit before tax
Add accounting depreciation
Less tax depreciation
Add warranty expense
Warranty costs paid
Add LSL expense (nil paid)
Add doubtful debts expense
Less bad debts written off
Taxable income

($000)
650
60
(100)
90
(70)
10
25
(15)
650

(d)
30/6/200
9
Dr
Tax expense
195 000
Cr
Income tax payable
195 000
To recognise tax expense pertaining to taxable income, 30% x $650 000
Deferred tax assets and liabilities must be calculated as at 30 June 2009 and the adjustments
necessary are determined by deducting the opening balances of deferred tax assets and liabilities
calculated in part (b) for the previous year.

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Asset/Liability
Assets
Computers (net)

Accounting
base
($000)

Tax
base
($000)

180

100

Accounts
receivable

100

120

Liabilities
Provn for
Warranty

50

Provn for LSL

30

Temporary difference
30 June 2006
($000)
80
taxable temporary difference
20
deductible temporary
difference
50
deductible temporary
difference
30
deductible temporary
difference

Deferred tax asset: ($20 000 + $50 000 + $30 000) x 30% =
Less amount already recognised as at 30 June 2008
Adjustment required

$30 000 dr
$18 000 dr
$12 000 dr

Deferred tax liability: $80 000 x 30% =

Less amount already recognised 2008
Adjustment required

$24 000 cr
$12 000 cr
$12 000 cr

30/6/200
9
Dr
Deferred tax asset
Cr
Deferred tax liability
To recognise deferred tax as at 30 June 2009

12 000
12 000

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