Chartered Accountants Program

Financial Accounting & Reporting

WE

Worked example 4.1

Calculating the current tax liability

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 (IAS 12).
This worked example links to learning outcome:
•• 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.
It will take you approximately 30 minutes to complete.

Scenario
Bob Jones is the financial controller of Flip Limited (Flip), a manufacturer and distributor
of children’s shoes.
Bob has summarised Flip’s internal financial information for the year ended 30 June 20X3, ready
to prepare the current tax liability. Flip’s tax rate is 30%. The summary is as follows:

Internal statement of profit or loss for the year ended 30 June 20X3

Item Note $’000 $’000

Sales revenue 420

Other income 1  80

Total revenue and other income 500

Expenses

Depreciation 2 10

Warranty 3 40

Fines 4 5

Other expenses 320

Total expenses (375)

Accounting profit before income tax 125

Extract of internal statement of financial position at 30 June 20X2 and 30 June 20X3

Item Note 30.06.X3 30.06.X2

$’000 $’000

Assets

Plant and equipment – cost 2 140 90

Plant and equipment – accumulated depreciation 2 (50) (40)

Inventory 400 100

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Extract of internal statement of financial position at 30 June 20X2 and 30 June 20X3

Item Note 30.06.X3 30.06.X2

$’000 $’000

Total assets 490 150

Liabilities

Warranty provision 3 50 20

Unearned income 5 15 10

Other liabilities  25  20

Total liabilities  90  50

Net assets 400 100

Notes
1. Other income includes $45,000 that is not assessable for tax purposes until the year ending 30 June 20X4.
2. 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.
3. Warranty costs are deductible for tax purposes when paid.
4. Fines are not deductible for tax purposes.
5. Unearned income relates to income received in advance that is assessable for tax purposes when received.
Cash received in the year ended 30 June 20X3 is $15,000.

Task
The directors of Flip have asked Bob to calculate and account for Flip’s current tax liability for
the year ended 30 June 20X3.

Solution
Bob works through the following steps to complete the task.

Step 1 – Review the Standard and determine the approach

Bob reviews IAS 12 para. 5 for the definition of current tax. He also notes that para. 12 requires
current tax to be recognised as a liability to the extent that it is unpaid at the year end.
Bob knows that the common method of calculating the current tax liability is to calculate the
taxable income by adjusting the accounting profit before tax, then multiplying the taxable
income by the tax rate.

Step 2 – Set up a worksheet to calculate the current tax liability

Bob sets up a worksheet to calculate the current tax liability. He starts with the accounting profit
for the period and notes the categories of adjustments that may be identified from the financial
information for the period. These are:
•• Items where the tax and accounting treatments are never the same (non-temporary
difference adjustments).
•• Items where tax and accounting treatments are the same but in different periods (temporary
difference adjustments).
•• Equity or other comprehensive income (OCI) differences affecting taxable income.

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Worksheet to calculate current tax liability at 30 June 20X3

Item $’000 $’000

Accounting profit before tax

1. Non-temporary difference adjustments

2. Temporary difference adjustments

3. Equity or OCI adjustments affecting taxable income

Taxable income

Current tax liability at 30%

Step 3 – Establish how to identify items that require adjustment in the

calculation of taxable income
Bob notes that the adjustments required to calculate the taxable income can be identified by:
(a) Examining income and expense items included in the internal statement of profit or loss
that impact on the taxable income calculation but are not related to an account in the
internal statement of financial position (SFP).
(b) Identifying income and expense items where there is a related account in the SFP, and
calculating the tax deduction/assessable income by reconciling the amount in profit or loss
with the movement in the accounts in the SFP.
(c) Considering whether there are any other items in the SFP that impact on the taxable income
calculation but are not related to an income or expense item in the statement of profit or loss
and other comprehensive income (SPLOCI).

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Step 4 – Identify the items that require adjustment in the calculation of taxable
income and calculate the adjustments required
Bob reviews the statement of profit or loss and the statement of financial position to identify
items where the accounting treatment is different from the treatment for tax purposes. He
categorises the items and summarises that adjustments are required for:

Items requiring 3(a) Adjustment 3(b) Adjustment linking 3(c) Adjustment from

adjustment from the SPLOCI the SPLOCI and the SFP impacting
impacting on SFP impacting on on taxable income
taxable income taxable income

1. Items where the •• Fines

tax and accounting
treatments are never
the same (non-
temporary difference
adjustments)

2. Items where tax •• Other income

and accounting •• Depreciation
treatments are •• Warranty costs
the same but in
•• Unearned income
different periods
(temporary difference
adjustments)

3. Entity or OCI •• No adjustments

differences

Bob deals with each item in turn.

Step 4.1 – Calculate the adjustment for fines

The fines are an expense for accounting purposes, but are not allowable as a tax deduction and
is therefore a non-temporary difference. Bob must increase accounting profit by $5,000 (to add
back the fines).
Bob enters the adjustment into the worksheet to increase accounting profit by $5,000.

Worksheet to calculate current tax liability at 30 June 20X3

Item $’000 $’000

Accounting profit before tax 125

1. Non-temporary difference adjustments

Fines 5

2. Temporary difference adjustments

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Worksheet to calculate current tax liability at 30 June 20X3

Item $’000 $’000

3. Equity or OCI adjustments affecting taxable income

Taxable income

Current tax liability at 30%

Step 4.2 – Calculate the adjustment for other income

Bob reviews other income and notes that $45,000 included in accounting profit is not assessable
for tax purposes until the year ending 30 June 20X4 and is therefore a temporary difference.
Bob enters the adjustment into the worksheet to reduce accounting profit by $45,000.

Worksheet to calculate current tax liability at 30 June 20X3

Item $’000 $’000

Accounting profit before tax 125

1. Non-temporary difference adjustments

Fines 5

2. Temporary difference adjustments

Other income (45)

3. Equity or OCI adjustments affecting taxable income

Taxable income

Current tax liability at 30%

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Step 4.3 – Calculate the adjustment for depreciation

Bob calculates the tax depreciation based on the plant and equipment information.

Tax depreciation

Item 30.06.X3 30.06.X2

$’000 $’000

Cost 140 90

Tax accumulated depreciation (cost – tax written-down value) (80) (60)

Tax written-down value  60 30

As there have been no disposals during the period, the movement of $20,000 in the tax
accumulated depreciation must be the tax depreciation allowable for the period.
Bob must add back the accounting depreciation of $10,000 and deduct the tax depreciation of
$20,000 in the worksheet as there is a temporary difference.

Worksheet to calculate current tax liability at 30 June 20X3

Item $’000 $’000

Accounting profit before tax 125

1. Non-temporary difference adjustments

Fines 5

2. Temporary difference adjustments

Other income (45)

Accounting depreciation 10

Tax depreciation (20)

3. Equity or OCI adjustments affecting taxable income

Taxable income

Current tax liability at 30%

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Step 4.4 – Calculate the adjustment for warranty costs

Bob notes that there is an expense of $40,000 in the statement of profit or loss in relation to
warranty costs. Warranty costs are deductible for tax purposes when paid. Bob calculates the
warranty amounts paid during 20X3 as:

Amount paid in
Opening provision + Expense in period – Closing provision =
year

$20,000 + $40,000 – $50,000 = $10,000

Bob identifies that this is a temporary difference as $40,000 will be added and $10,000 will
be deducted.

Worksheet to calculate current tax liability at 30 June 20X3

Item $’000 $’000

Accounting profit before tax 125

1. Non-temporary difference adjustments

Fines 5

2. Temporary difference adjustments

Other income (45)

Accounting depreciation 10

Tax depreciation (20)

Warranty expense 40

Warranty payments made (10)

3. Equity or OCI adjustments affecting taxable income

Taxable income

Current tax liability at 30%

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Step 4.5 – Calculate the adjustment for unearned income

Bob reviews the unearned income. This income has been received in advance and has not been
recognised in profit or loss. The income is assessable for tax purposes in the year it is received,
and therefore needs to be included in the taxable income for the year ended 30 June 20X3.
Bob notes that the unearned income balance at 30 June 20X2 of $10,000 will have been taxed in
the 30 June 20X2 year, but recognised in accounting profit in the year ended 30 June 20X3, as
the $15,000 balance was all received in 20X3. Bob reduces the accounting profit by $10,000 and
increases the accounting profit by $15,000 as there is a temporary difference.

Worksheet to calculate current tax liability at 30 June 20X3

Item $’000 $’000

Accounting profit before tax 125

1. Non-temporary difference adjustments

Fines 5

2. Temporary difference adjustments

Other income (45)

Accounting depreciation 10

Tax depreciation (20)

Warranty expense 40

Warranty payments made (10)

Unearned income from 20X2 recognised in 20X3 profit (10)

Unearned income from 20X3 15

3. Equity or OCI adjustments affecting taxable income

Taxable income

Current tax liability at 30%

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Step 5 – Complete the calculation of taxable income and current tax liability
Bob totals up the worksheet to calculate the taxable income and the current tax liability.

Worksheet to calculate current tax liability at 30 June 20X3

Item $’000 $’000

Accounting profit before tax 125

1. Non-temporary difference adjustments

Fines 5

2. Temporary difference adjustments

Other income (45)

Accounting depreciation 10

Tax depreciation (20)

Warranty expense 40

Warranty payments made (10)

Unearned income from 20X2 recognised in 20X3 profit (10)

Unearned income from 20X3  15

 (20)

3. Equity or OCI adjustments affecting taxable income

Taxable income 110

Current tax liability at 30%  33

Step 6 – Prepare the journal entry to record the current tax liability
Using the figure calculated in the worksheet, Bob can now record the journal entry for the
current tax liability at 30 June 20X3.

Date Account description Dr Cr

$ $

30.06.X3 Income tax expense 33,000

30.06.X3 Current tax liability 33,000

To record the current tax liability

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Worked example 4.2

Calculating the tax base and temporary
differences

Introduction
The tax base of an asset or liability is the amount attributable to that asset or liability for tax
purposes. To calculate the tax base of assets and liabilities requires consideration of a notional
tax-based balance sheet in accordance with IAS 12 Income Taxes (IAS 12). The tax base can then
be compared to the accounting carrying amount of the asset or liability to determine whether
there are any taxable temporary differences or deductible temporary differences that give rise
to deferred tax.
This worked example links to learning outcome:
•• Calculate and account for deferred tax.

It follows on from Worked example 4.1. It is recommended that you attempt Worked
example 4.1 first.
At the end of this worked example you will be able to calculate the tax base of assets and
liabilities in accordance with IAS 12, and establish whether taxable temporary differences
or deductible temporary differences arise in relation to those assets and liabilities.
It will take you approximately 45 minutes to complete.

Scenario
Bob Jones is the financial controller of Flip Limited (Flip), a manufacturer and distributor of
children’s shoes.
Bob is preparing the financial statements for the year ended 30 June 20X3 and is currently
working on the tax calculations. Bob has calculated taxable income of $110,000 by adjusting the
accounting profit before tax and based on this, he has prepared the journal entry for the current
tax liability of $33,000.

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Bob has summarised the financial information for internal use for the year ended 30 June 20X3
to assist him with the tax calculations:

Internal statement of profit or loss for year ended 30 June 20X3

Item Note $’000 $’000

Sales revenue 420

Other income 1  80

Total revenue and other income 500

Expenses

Depreciation 2 10

Warranty 3 40

Fines 4   5

Other expenses 320

Total expenses (375)

Accounting profit before income tax 125

Extract of internal statement of financial position at 30 June 20X2 and 30 June 20X3

Item Note 30.06.X3 30.06.X2

$’000 $’000

Assets

Plant and equipment – cost 2 140 90

Plant and equipment – accumulated depreciation 2 (50) (40)

Inventory 400 100

Total assets 490 150

Liabilities

Warranty provision 3 50 20

Unearned income 5 15 10

Other liabilities  25  20

Total liabilities  90  50

Net assets 400 100

Notes
1. Other income includes $45,000 that is not assessable for tax purposes until the year ended 30 June 20X4.
2. The tax written-down value at 30 June 20X3 is $60,000, and the tax written-down value at 30 June 20X2 was $30,000.
There have been no disposals of plant and equipment during the year.
3. Warranty costs are deductible for tax purposes when paid.
4. Fines are not deductible for tax purposes.
5. Unearned income relates to income received in advance that is assessable for tax purposes when received. Cash
received in the year ended 30 June 20X3 is $15,000.

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Bob’s worksheet to calculate the current tax liability:

Worksheet to calculate the current tax liability at 30 June 20X3

Item $’000 $’000

Accounting profit before tax 125

1. Non-temporary difference adjustments

Fines 5

2. Temporary difference adjustments

Other income (45)

Accounting depreciation 10

Tax depreciation (20)

Warranty expense 40

Warranty payments made (10)

Unearned income from 20X2 recognised in 20X3 profit (10)

Unearned income from 20X3 15

 (20)

3. Equity or OCI adjustments affecting taxable income

Taxable income 110

Current tax liability at 30%  33

Flip’s tax rate is 30%.

Task
The directors have asked Bob to calculate the taxable temporary differences and deductible
temporary differences for Flip as at 30 June 20X3.

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Solution
Bob worked through the following steps to complete the task.

Step 1 – Review the Standard

Bob reviewed IAS 12 for information relevant to his task.

IAS 12 paragraphs relevant to the task

Item Definition Guidance

Tax base Para. 5 Paras 7–10

Taxable temporary differences Para. 5 Paras 15 and 16

Deductible temporary differences Para. 5 Paras 24 and 25

Bob identified that:

•• There are different calculation methods for the tax base of assets and liabilities.
•• Where the tax base is not immediately apparent, the fundamental principles of IAS 12
should be considered.
•• Not all assets and liabilities that have a tax base appear in the statement of financial
position.

Step 2 – Determine the approach

To identify those assets and liabilities at 30 June 20X3 where the tax base and the accounting
carrying amount were different, Bob examined:
•• 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.

Bob then considered his approach to calculate the following amounts.

The accounting carrying amount

Bob noted that the accounting carrying amount was obtained from the extract of the internal
statement of financial position at 30 June 20X3, which contained all relevant transactions for the
year. If the asset/liability was not recorded in the extract of the internal statement of financial
position at 30 June 20X3, then its accounting carrying amount would be zero.

The tax base of the assets or liabilities

To calculate the tax base Bob recalled that the tax base of an asset equals future deductible
amounts. The exception to this is where the recovery of the asset has no future tax
consequences, in which case the tax base equals the carrying amount. The tax base of a liability
is the carrying amount less future deductible amounts. The exception to this is where the
liability relates to revenue received in advance, in which case the tax base equals the carrying
amount less revenue not taxable in future periods.
Bob also considered that if the tax base of an asset or liability is not immediately apparent, then
he would have to consider the fundamental principle on which IAS 12 is based and determine
whether the item would give rise to larger or smaller tax payments in the future, in accordance
with IAS 12 para. 10.

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Once the accounting carrying amount and the tax base had been established, Bob compared the
two balances to determine whether there was a taxable temporary difference or a deductible
temporary difference.
A taxable temporary difference or a deductible temporary difference arises when the carrying
amount differs from the tax base.

Assets

Carrying amount > Tax base = Taxable temporary difference

Carrying amount < Tax base = Deductible temporary difference

Liabilities

Carrying amount > Tax base = Deductible temporary difference

Carrying amount < Tax base = Taxable temporary difference

When the carrying amount of an asset exceeds the tax base, the amount of taxable economic
benefits will exceed the amount that will be deductible for tax purposes. This results in an
obligation to pay the resulting income tax in future periods and is therefore a taxable temporary
difference (IAS 12 para. 16).
When the carrying amount of an asset is less than its tax base, this results in income taxes that
will be recoverable in future periods and is therefore a deductible temporary difference (IAS 12
para. 25).
When liabilities are settled, part or all of the amounts may be deductible in determining
taxable income. Where the carrying amount of a liability exceeds its tax base, this gives rise to
a deductible temporary difference (IAS 12 para. 25). When the carrying amount of a liability is
less than its tax base, this will result in fewer deductions in the future and is therefore a taxable
temporary difference.

Step 3 – Establish which items will result in temporary differences

Bob recalled that temporary differences only arise on items where the accounting carrying
amount does not equal the tax base. He reviewed the balances in the extract of internal
statement of financial position at 30 June 20X3 and the worksheet to calculate current tax
liability at 30 June 20X3 to establish the items where there would be a temporary difference.
He identified that the treatment of the items included as inventory and other liabilities is the
same for tax and accounting purposes for Flip, and therefore these items did not give rise to a
temporary difference.
This meant that the following items from Flip’s internal statement of financial position and the
worksheet gave rise to a temporary difference:
•• Plant and equipment.
•• Warranty provision.
•• Unearned income.
•• Other income.

Step 4 – Create a table to record the carrying amount, the tax base and the
temporary differences
Bob created a table to input the relevant information.
He input the items identified in the previous step in the first column of his table, as these were
the items on which temporary differences would arise.

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Calculation of temporary differences as at 30 June 20X3

Item Carrying Tax base Taxable Deductible

amount temporary temporary
difference difference
$’000 $’000 $’000 $’000

Plant and equipment

Warranty provision

Unearned income

Other income

Step 5 – Enter the carrying amount

Bob started to complete the table by entering the carrying amount.

Calculation of temporary differences as at 30 June 20X3

Item Carrying Tax base Taxable Deductible

amount temporary temporary
difference difference
$’000 $’000 $’000 $’000

Plant and equipment 1

90

Warranty provision (50)

Unearned income (15)

Other income2 0

Notes
1. The carrying amount of plant and equipment is the cost less accumulated depreciation.
2. There is no balance in the extract of the internal statement of financial position for other income, and therefore the
accounting carrying amount is zero.

Step 6 – Calculate the tax base of the assets

Bob recalled the method for calculating the tax base of an asset from IAS 12 para. 7:

Tax base = Future deductible amounts

The exception to this is where the tax base has no future tax consequences. In this instance:

Tax base = Carrying amount

Bob considered the plant and equipment.

The tax written-down value at 30 June 20X3 was $60,000, which meant that future tax
depreciation (i.e. future deductible amounts) on plant and equipment would be $60,000, and
this was therefore the tax base.

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Step 7 – Calculate the tax base of the liabilities

Bob knew that for a liability:

Tax base = Carrying amount – Future deductible amount

The exception to this is where the liability relates to revenue received in advance:

Tax base = Carrying amount – Revenue not taxable in future periods

Bob considered the warranty provision.

The warranty costs are deductible for tax purposes when paid, and therefore the full amount of
the warranty provision was a future deductible amount.

Tax base = Carrying amount – Future deductible amounts

$0 = $50,000 – $50,000

Bob considered the unearned income.

The exception would apply to the unearned income as it relates to revenue received in advance.
The full amount of the unearned income was taxed on a receipts basis, and therefore none of
this revenue would be taxed in future periods.

Tax base = Carrying amount – Revenue not taxable in future periods

$0 = $15,000 – $15,000

Step 8 – Calculate the tax base of other items

Bob calculated the tax base of the other income. As there was not an asset or liability in the
extract of the internal statement of financial position for the other income, Bob considered
whether the other income would give rise to larger or smaller tax payments in the future.
The tax base of other income was ($45,000).
The other income was included in accounting profit in the year ended 30 June 20X3, but would
not be included in taxable income until 30 June 20X4; therefore this would be reflected as a
liability in a notional tax balance sheet.

Step 9 – Enter the tax base

Bob entered the tax base of the assets and liabilities into the table.

Calculation of temporary differences as at 30 June 20X3

Item Carrying Tax base Taxable Deductible

amount temporary temporary
difference difference
$’000 $’000 $’000 $’000

Plant and equipment 90 60

Warranty provision (50) 0

Unearned income (15) 0

Other income 0 (45)

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Step 10 – Calculate the temporary differences and allocate them

Finally, Bob completed the table by calculating the difference between the carrying amount and
the tax base, and allocating it into the correct column as either a taxable temporary difference or
a deductible temporary difference.

Calculation of temporary differences as at 30 June 20X3

Item Carrying Tax base Taxable Deductible

amount temporary temporary
difference difference
$’000 $’000 $’000 $’000

Plant and equipment 90 60 30 0

Warranty provision (50) 0 0 50

Unearned income (15) 0 0 15

Other income 0 (45) 45 0

The asset carrying amount for the plant and equipment of $90,000 exceeds the tax base of
$60,000, resulting in a taxable temporary difference of $30,000.
The liability carrying amount for the warranty provision of ($50,000) exceeds the tax base of $0,
resulting in a deductible temporary difference of $50,000.
The liability carrying amount for the unearned income of ($15,000) exceeds the tax base of $0,
resulting in a deductible temporary difference of $15,000.
The other income carrying amount of $0 is less than the tax base of ($45,000), resulting
in a taxable temporary difference of $45,000.

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Worked example 4.3

Calculating deferred tax assets and liabilities

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 (IAS 12). As a Chartered Accountant you may be required
to account for deferred tax in accordance with IAS 12.
This worked example links to learning outcome:
•• Calculate and account for deferred tax.

It follows on from Worked examples 4.1 and 4.2. It is recommended that you attempt these
worked examples first.
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 30 minutes to complete.

Scenario
Bob Jones is the financial controller of Flip Limited (Flip), a manufacturer and distributor of
children’s shoes. Flip is an Australian resident company, taxed in Australia on its worldwide
income.
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 $110,000 by adjusting
the accounting profit before tax and, based on this, he has prepared the journal entry for the
current tax liability of $33,000.
Bob has also calculated the taxable temporary differences and deductible temporary differences
as at 30 June 20X3.

Calculation of temporary differences as at 30 June 20X3

Item Carrying Tax base Taxable Deductible

amount temporary temporary
difference difference
$’000 $’000 $’000 $’000

Plant and equipment 90 60 30 0

Warranty provision (50) 0 0 50

Unearned income (15) 0 0 15

Other income 0 (45) 45 0

At 30 June 20X2 the DTL and DTA were $6,000 and $9,000 respectively.
Flip’s tax rate is 30%.

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Task
The directors have asked Bob to prepare the deferred tax journal entry for Flip for the year
ended 30 June 20X3.

Solution
Bob worked through the following steps to complete the task.

Step 1 – Review the Standard

Bob reviewed IAS 12 for information relevant to his task. He noted the following applicable
paragraphs:

IAS 12 paragraphs that offer relevant guidance

Item Definition Recognition Measurement

DTLs Para. 5 Para. 15 Paras 47, 51, 53

DTAs Para. 5 Para. 24 Paras 47, 51, 53, 56

In addition, Bob noted that paras 74 and 75 provide guidance on when deferred tax assets and
deferred tax liabilities shall be offset.

Step 2 – Prepare to apply the Standard

Bob noted that taxable temporary differences give rise to DTLs, and deductible temporary
differences result in DTAs.
As Bob had already calculated the taxable temporary differences and deductible temporary
differences, he extended the table to calculate the DTLs and DTAs, and the movement in the
year.

Calculation of deferred tax as at 30 June 20X3

Item Carrying Tax base Taxable Deductible

amount temporary temporary
difference difference
$’000 $’000 $’000 $’000

Plant and equipment 90 60 30 0

Warranty provision (50) 0 0 50

Unearned income (15) 0 0 15

Other income  0 (45) 45  0

Total temporary differences

DTL/DTA at 30%

Less: opening balances

Movement

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Step 3 – Calculate the deferred tax balances

Bob calculated the DTL and DTA balances at 30 June 20X3.

Calculation of deferred tax as at 30 June 20X3

Item Carrying Tax base Taxable Deductible

amount temporary temporary
difference difference
$’000 $’000 $’000 $’000

Plant and equipment 90 60 30 0

Warranty provision (50) 0 0 50

Unearned income (15) 0 0 15

Other income  0 (45)   45    0

Total temporary differences   75   65

DTL/DTA at 30% 22.5 19.5

Step 4 – Calculate the movement on the deferred tax balances

Bob calculated the movement in the DTL and DTA for the year ended 30 June 20X3.

Calculation of deferred tax as at 30 June 20X3

Item Carrying Tax base Taxable Deductible

amount temporary temporary
difference difference
$’000 $’000 $’000 $’000

Plant and equipment 90 60 30 0

Warranty provision (50) 0 0 50

Unearned income (15) 0 0 15

Other income  0 (45)   45    0

Total temporary differences   75    65

DTL/DTA at 30% 22.5 19.5

Less: opening balances (6) (9)

Movement 16.5 10.5

Step 5 – Record the journal entry

Bob recorded the journal entry for the DTL and DTA at 30 June 20X3 based on the amounts
calculated in Step 4.

Date Account description Dr Cr

$ $

30.06.X3 DTA 10,500

30.06.X3 DTL 16,500

30.06.X3 Income tax expense 6,000

To record the movement in the deferred tax balances at 30 June 20X3

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Step 6 – Consider if the DTAs and DTLs can be offset

Finally, Bob considered whether the DTA and DTL could be offset for disclosure purposes, in
accordance with IAS 12 para. 74.
He noted that Flip should offset the DTA and DTL to the extent that the following two
conditions were satisfied:
•• There is a legally enforceable right to offset current tax assets and current tax liabilities.
•• The DTAs and DTLs relate to income taxes levied by the same taxation authority.

As Flip is an Australian resident company, all tax would be settled with the same tax authority,
and therefore these conditions were met.
A net DTL of $3,000 ($22,500 – $19,500) would be disclosed.

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Worked example 4.4

Accounting for carryforward tax losses

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 learning outcome:
•• 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 (IAS 12).
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%.

Task
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.

Solution
Trish goes through the following steps to complete the task.

Part A

Step 1 – Review the Standard

Trish reviews IAS 12 and notes that paras 34–36 are relevant to the task.

Step 2 – Determine the deferred tax balance arising from the tax loss incurred
Trish determines 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. It is anticipated that sufficient taxable profits will

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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%).

Step 3 – Prepare the journal entry

Trish records the journal entry for the DTA relating to the tax loss.

Date Account description Dr Cr

$ $

30.06.X2 Deferred tax asset (DTA) 6,000

30.06.X2 Income tax expense 6,000

To record the DTA for the tax loss

Part B

Step 1 – Determine the appropriate accounting treatment

Trish notes 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 prepares the journal entry to record the recoupment of the tax loss in the year ended
30 June 20X3.

Date Account description Dr Cr

$ $

30.06.X3 Current tax liability 6,000

30.06.X3 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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Worked example 4.5

Accounting for an underprovision of
income tax

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 learning outcome:
•• 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 rate of 12.5% straight line 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
He works through the following steps to complete the task.

Step 1 – Review the relevant Standards

Javier reviews:
•• IAS 12 para. 5 for the definitions of current tax, temporary differences, deferred tax assets
and tax expense. He notes the definition of current tax is ‘the amount of income taxes
payable (recoverable) in respect of the taxable profit (tax loss) for a period’. He also reads
IAS 12 para. 12 which states that ‘current tax for current and prior periods shall, to the
extent unpaid, be recognised as a liability’.
•• IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors (IAS 8) paras 5 and 42.

He notes the definition of prior period error from para. 5 is:

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.

Javier also reads para. 42 which states:

Subject to paragraph 43, an entity shall correct material prior period errors retrospectively in the
first set of financial statements authorised for issue after their discovery by:

(a) restating the comparative amounts for the prior period(s) presented in which the error
occurred; or

(b) if the error occurred before the earliest prior period presented, restating the opening balances
of assets, liabilities and equity for the earliest prior period presented.

Step 2 – Decide whether retrospective adjustment needs to be made for the

errors
Javier concludes that the adjustments the taxation authority made arose because of errors made
in preparing the income tax return that had been reflected in the current tax liability calculation.
Had closer examination and/or review of the current tax liability calculation been made, the
donation would have been added back as being non-deductible, and the correct tax depreciation
rate would have been applied in relation to the building.
He concludes that the error in the calculation of the current tax liability is not material, so he
will not have to restate the comparatives by adjusting opening retained earnings at 1 July 20X2.
Instead, any impact of correcting the error can be recorded through profit or loss in the current
year.
Javier concludes that IAS 8 para. 43, which provides an exception to retrospective adjustments
in limited situations, does not apply as he is able to determine the period-specific effects of the
errors, which he has decided are immaterial.

Step 3 – Identify the nature of the errors in the current tax liability calculation
Javier knows that, following the requirements of IAS 12 para. 12, he will need to adjust the
current tax liability that was recorded in the statement of financial position at 30 June 20X2.
It has been understated and he needs to recognise as a liability the full amount of current tax for
the prior period to the extent that it is still unpaid.

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He reads the details on the amended assessment notice from the taxation authority and
categorises the impact of the adjustments as follows:

Adjustments to current tax liability are recognised by adjusting tax expense when:

Change relates to a Change relates to a

one-off adjustment that temporary difference,
has no future taxation unless the underlying
consequences, unless the transaction was accounted
underlying transaction was for outside of profit or loss
accounted for outside of
profit or loss

Error – deduction for donation X

denied

Error – incorrect tax depreciation rate X

applied to the cost of the building

As neither of the underlying transactions was accounted for outside of profit or loss, the
adjustment to the current tax liability will be recognised by adjusting income tax expense.
The lower tax depreciation rate will increase the tax base of the building, giving rise to a
deductible temporary difference. The carrying amount of the building will remain unchanged
for financial reporting purposes.

Step 4 – Calculate the amount of the underprovision of the current tax liability
Javier creates a table to quantify the errors made regarding the donation and the depreciation.

Quantification of errors in current tax liability calculation

Error Impact on Impact on Nature of Account

taxable income current tax change impacted
liability (reduced
deduction × 30%
tax rate)

Donation not allowed Increases $2,250 increase Non-temporary Income tax

as a deduction taxable income difference expense
by $7,500 adjustment

Reduction of tax Increases $13,500 increase Temporary Deferred tax

deduction due to taxable income difference asset
lower tax depreciation by $45,000*
rate for building

* Calculated as follows:

Deduction claimed ($1.2 million × 12.5% × ½ year) 75,000

Deduction allowed by the tax authority ($1.2 million × 5% × ½ year) (30,000)

Excess deduction denied 45,000

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Step 5 – Prepare the journal entry

Using the figures calculated in the table, Javier records the journal entry to correct the current
tax liability.

Date Account description Dr Cr

$ $

1.02.X3 Income tax expense 2,250

1.02.X3 Deferred tax asset 13,500

1.02.X3 Current tax liability 15,750

To record the increase in the current tax liability arising under the amended assessment notice relating
to the year ended 30 June 20X2

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