ACCT20002 Lecture Notes - Lecture 4: Deferred Tax, Tax, Tax Avoidance
5 Jun 2018
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SOLUTION FOR INCLASS TUTORIAL QUESTION: ACCOUNTING FOR INCOME TAX
Q. 1
Consider the following 2 scenarios:
Scenario 1 (adapted from Loftus et al)
BhL Ltd has always adhered to good Human Resource policies. Its policies include awarding its employees
long service leave payments as well as redundancy payments in the event that there is a retrenchment. This
has resulted in the creation of Deferred Tax Assets.
Recently BhL Ltd has had tough trading conditions and has had to stream line its operations. Due to this it
has retrenched some of its work force and has had to pay out the long service leave and retrenchment
benefits. The long service leave and retrenchment payments has been claimed as a deduction from its
current tax liability. Due to these large payouts, BhL Ltd reported a tax loss in the current period.
You are asked to consider whether BhL Ltd can continue to raise a deferred tax asset in the current period
in relation to the long service leave and redundancy payments.
Solution (adapted from Loftus et al)
For tax purposes, long service leave liabilities and retrenchment liabilities can only be claimed as tax
deductions when a cash payment is made. For accounting purposes, these expenses are recognised on an
accrual basis. This therefore creates a timing difference between the carrying amount of the liability for
accounting purposes and the tax base of zero, as the deduction is only available for the long service and
retrenchment liabilities when it is paid in the future. The timing difference thus creates a deferred tax asset.
The question then arises as to whether the entity can recognize this deferred tax asset.
Paragraph 24 of AASB 112/IAS 12 specifies that a deferred tax asset can be recognised ‘to the extent
that it is probable that taxable profit will be available against which the deductible temporary
difference can be utilised’.
Further Para. 28 states:
It is probable that taxable profit will be available against which a deductible temporary difference can be
utilised when there are sufficient taxable temporary differences relating to the same taxation authority and
the same taxable entity which are expected to reverse:
(a) in the same period as the expected reversal of the deductible temporary difference; or
(b) in periods into which a tax loss arising from the deferred tax asset can be carried back or forward.
When there are insufficient taxable temporary differences for the entity to use against the deductible
temporary differences, a deferred tax asset can be recognised only to the extent that it is probable that
the entity will have enough taxable income in the same period as the reversal of the deductible
temporary difference or recovery of a tax loss, or tax planning opportunities are available to the entity
that will create taxable income in appropriate periods (para. 29). All available evidence, both positive and
negative, must be evaluated before determining whether to recognise a deferred tax asset. In evaluating
whether the entity will have sufficient taxable income in future periods, paragraph 29 states that the entity
must ignore the taxable amounts arising from deductible temporary differences expected to originate in
future periods, because the deferred tax asset from future deductible temporary differences will itself require
future taxable income in order to be used.
In relation to tax losses, the recognition criteria are discussed in paragraph 34. A deferred tax asset arising
from the carry forward of an unused tax loss must be recognised to the extent that it is probable that future
taxable profits will be available against which the unused tax loss can be used. It appears, therefore, that
the recognition criteria for deferred tax assets from tax losses are the same as the recognition criteria for
other deferred tax assets, described above. AASB 112/IAS 12 also points out, however, that the mere
existence of a tax loss provides strong evidence that future taxable income may not be available to ensure
that the deferred tax asset from the tax loss is recognisable. Para. 35 states that when an entity has a history
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of recent losses, it can recognise a deferred tax asset from tax losses only to the extent that it has sufficient
taxable temporary differences, or there is other convincing evidence that sufficient taxable profits will be
available in the future against which the unused tax losses can be used. Para. 36 specifies a number of
factors which the entity must consider in assessing the probability that a deferred tax asset from a tax loss
can be recognised:
• whether the entity has sufficient taxable temporary differences which will result in taxable amounts
in future so that the tax losses can be used
• whether it is probable that the entity will have future taxable profits before the tax losses expire (this
is not an issue in Australia as tax losses can be carried forward indefinitely)
• whether the unused tax losses result from identifiable causes which are unlikely to recur
• whether tax planning opportunities are available to the entity that will create sufficient future taxable
profits to recover the tax losses.
If, based on an assessment of the evidence, it is not probable that sufficient future taxable income will exist,
then a deferred tax asset can be recognised only to the extent that it can be recovered against the future
taxable income available.
Based on these requirements, there are doubts about the legitimacy of the deferred tax assets recognised by
BhL Ltd as BhL Ltd might not be able to show evidence that it will be able to generate future taxable
income.
Scenario 2 (adapted from Loftus et al)
Many accounting standards (e.g. AASB16 Leases, AASB13 Fair value measurement) require entities to
discount the value of assets and liabilities due/payable in the future. However Paragraph 53 of AASB 112
states that deferred tax assets and liabilities shall not be discounted. Do you agree with this requirement?
Justify your answer.
Solution (adapted from Loftus et al)
There is a good argument that the disclosure of the gross amount for deferred tax assets and liabilities may
be misleading.
AASB112, requires that the expected increase (decrease) in tax to be paid in future periods is recognised
on a gross basis.
Take the following example: Land revalued from its cost of $100 000 to its fair value of $1 100 000 gives
rise to a taxable temporary difference of $1 000 000 and a deferred tax liability of $300 000. The tax will
not be paid until the land is actually sold for $1 100 000 and such a sale may not happen for 5 or 10 years.
The statement of financial position may show a deferred tax liability of $300 000 for tax that is not due for
10 years. Based on a discount rate of 5%, the present value of the liability would be $300 000/(1.05)^10
equal to $184 174. It is clear that there is a material difference between the gross amount of the liability
and its present value.
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Q. 2 Income Tax Solution Guide
Newcastle Ltd determined an accounting profit before tax of $256,000 for the year ended 30 June 2014.
Included in this profit are the following items:
Royalty revenue (non-assessable)
6 000
Annual leave expense
(45 000)
Depreciation expense – buildings
(8 000)
Depreciation expense – plant
(22 500)
Doubtful debts expense
(3 500)
Entertainment expense
(2 000)
Insurance expense
(7 000)
An extract of the company’s draft balance sheet at 30 June 2014 showed the following:
Assets
Cash
Accounts receivable
$ 21 500
$ 2 500
less allowance for doubtful debts
(4 000)
17 500
Inventory
32 000
Prepaid insurance
Plant
150 000
4 500
less Accumulated depreciation
(67 500)
82 500
Buildings
170 000
less Accumulated depreciation
(60 000)
110 000
Land
75 000
Deferred tax assets (net) as at 1 July 2013
4 500
328 500
Liabilities
Accounts payable
25 000
Provision for annual leave
10 000
Loan
140 000
$175 000
Document Summary
Solution for inclass tutorial question: accounting for income tax: 1. Bhl ltd has always adhered to good human resource policies. Its policies include awarding its employees long service leave payments as well as redundancy payments in the event that there is a retrenchment. This has resulted in the creation of deferred tax assets. Recently bhl ltd has had tough trading conditions and has had to stream line its operations. Due to this it has retrenched some of its work force and has had to pay out the long service leave and retrenchment benefits. The long service leave and retrenchment payments has been claimed as a deduction from its current tax liability. Due to these large payouts, bhl ltd reported a tax loss in the current period. You are asked to consider whether bhl ltd can continue to raise a deferred tax asset in the current period in relation to the long service leave and redundancy payments.
