Chapter 6: Accounting For Income Tax: Review Questions

Tutorial Week 3 Moodle Questions and Solutions
Chapter 6: Accounting for income tax

REVIEW QUESTIONS
4.
Explain the meaning of the tax base for an asset, and distinguish the tax
base from an assets carrying amount.
The tax base of an asset is the amount that is attributed to the asset in accordance with
tax law, and recorded in a tax-based balance sheet. The assets carrying amount is the
amount at which an asset is recorded in the accounting-based statement of financial
position, prepared in accordance with the principles of accrual accounting and
accounting standards.
5.
How does the tax base for an asset differ from the tax base for a liability?
The calculation for the tax base for an asset can be found at paragraph 7 of AASB
112. The tax base for a liability is discussed in para 8. See Section 6.4.2 of the text
for further discussion.
6.
In tax-effect accounting, creation of temporary differences between the

carrying amount and tax base for assets and liabilities leads to the
establishment of deferred tax assets and liabilities in the accounting
records. List examples of temporary differences that create (a) deferred tax
assets and (b) deferred tax liabilities.
(a) Deferred tax assets occur when for assets the Carrying Amount < Tax Base, or
when the future taxable amount < future deductible amount. Examples would be
where a company has accounts receivable with an allowance for doubtful debts, or
where the tax depreciation rates are less than the accounting depreciation rates.
Deferred tax assets also occur when for liabilities the Carrying Amount > Tax
Base. Examples would be provision for employee benefits or provisions for
warranty.
(b) Deferred tax liabilities occur when for assets when the Carrying Amount > Tax
Base, when the future taxable amount > future deductible amount. Examples
would be revenue receivable, prepaid expenses or where the tax depreciation rates
are greater then the accounting depreciation rates in the early years of an assets
life. Deferred tax liabilities also occur when for liabilities the Carrying Amount <
Tax Base. There doesnt appear to be any examples for this situation.
PRACTICE QUESTIONS
QUESTION 6.4
Case 1
Determination of Taxable Income
$
Accounting profit before income tax
Add:
Goodwill impairment
Donation to political party
Depreciation
Long service leave expense
$
40 000
6 000
1 000
4 000
600
Deduct:
Long service leave for tax
Depreciation for tax
Taxable income
Current tax liability @ 30%
8 000
11 600
51 600
(8 000)
43 600
$13 080
The journal entry is:

Income Tax Expense
Current Tax Liability
Dr
Cr
13 080
13 080
Case 2
$
Add:
Entertainment expense
Donation to political party
Depreciation
$
20 000
6 000
3 000
2 000
600
Deduct:
Depreciation of plant for tax
Taxable income
4 000
11 600
31 600
(4 000)
27 600
$8 280

Income Tax Expense
Dr
Cr
8 280
8 280

Case 3
$
Add:
Entertainment expense
Depreciation
$
5 000
7 000
10 000
600
Deduct:
Taxable income
17 600
22 600
20 000
(20 000)
2 600
$ 780

Income Tax Expense
Dr
Cr
780
780
Case 4
$
Accounting loss before income tax
Add:
Goodwill impairment
Depreciation
$
(10 000)
8 000
2 000
1 200
Deduct:
Tax loss
2 400
4 000
11 200
1 200
(6 400)
(5 200)
$0
Assuming that recognition criteria are satisfied, the journal entry is:
Deferred Tax Asset (tax loss)
Income Tax Income
Dr
Cr
1 560
1 560
QUESTION 6.9
CRADLE LTD
Calculation of deferred tax as at 30 June 2013
Carrying
Taxable
Deductible Tax Base Taxable
Amount
Amount
Amount
Temporary
Differences
$
$
$
$
$
Assets
Cash
Receivables
Inventory
Prepaid
insurance
Dividends
Receivable
Plant
Goodwill
Shares in
coys
Liabilities
Bank Odraft
A/cs payable
Current tax
liability
Div payable
Convertible
notes
LSL payable
Temporary
differences
Excluded
differences
Net temp
differences
Def tax liab
Def tax ass
Begin bals
Movement
during year
Adjustment
65 000
805 000
640 000
4 000
(0)
(640 000)
(4 000)
80 000
640 000
0
65 000
885 000
640 000
0
4 000
36 000
(36 000)
36 000
860 000
78 000
140 000
(860 000)
(78 000)
(140 000)
955 000
0
140 000
955 000
0
140 000
209 300
191 100
50 985
209 300
191 100
50 985
65 000
-
65 000
-
137 800
(137 800)
Deductible
Temporary
Differences
$
80 000
95 000
78 000
137 800
118 000
312 800
-
78 000
40 000
12 000
312 800
(7 200)
-
93 840
(87 125)
*(2 800)
4 800 Cr
9 515 Dr
* (adjustment for error in prior year)

The journal entry required to record movements in the deferred tax accounts for the
year ended 30 June 2013 are:
Deferred Tax Asset
Deferred Tax Liability
Income Tax Income
Dr
Cr
Cr
9 515
4 800
4 715
4
QUESTION 6.15
MEHARRY LTD
MEHARRY LTD
A.
(for year ended 30 June 2014)
Add:
Entertainment expense (non-deductible)
Amortisation of development costs
Insurance expense
Depreciation expense
Carrying amount of equipment sold
Doubtful debts expense
Annual leave expense
Rent received
Deduct:
Royalty revenue (exempt)
Rent revenue
Carrying amount of equip sold tax
Depreciation of equipment tax
Bad debts written off
Insurance paid
Development costs paid
Additional deduction devpt costs
Annual leave paid
Taxable income
Total tax liability @ 30%
Less tax paid during the year
Current tax liability
B.
Journal entry:
Income tax expense
Current tax liability
(Recognition of current
tax liability at 30 June 2014)
$252 450
$12 450
30 000
24 000
40 000
36 667
14 000
54 000
27 000
2 000
25 000
26 667
53 333
16 000
29 000
120 000
30 000
58 000
Dr
Cr
238 117
490 567
(360 000)
130 567
39 170
(27 550)
$11 620
11 620
11 620

Workings:
Gain/loss on sale of equipment at end of year:
Accounting
Cost
$66 667
Accum depn
30 000
Carrying amt/tax base
36 667
Proceeds
30 000
Gain (loss)
(6 667)
Tax
$66 667
40 000
26 667
30 000
3 333
Tax depreciation charge = $266 667 x 20% = $53 333

Accumulated depreciation for tax 30 June 2013 = $266 667 x 20% x 2.1375 (85
500/40 000) years = $114 000
Accumulated depreciation for tax 30 June 2014 = $200 000 x 20% x 3.183 (95 500/30
000) years = $127 320
Allowance for Doubtful Debts
Ending balance
16 000
Beginning
balance
Debts written off
16 000
Expense
32 000
18 000
14 000
32 000
Beginning balance
Revenue
Rent Receivable
5 500
25 000
30 500
Ending balance
Cash
3 500
27 000
30 500
Beginning balance
Cash paid
Prepaid Insurance
25 000
29 000
54 000
Ending balance
Expense
30 000
24 000
54 000
Beginning
balance
Expense
65 000
Leave paid
Ending balance
Annual Leave Payable

58 000
61 000
119 000
54 000
119 000

C.
Rationale for treatment
Insurance expenditure
Both the ATO and the accountant regard insurance as an expense, but in different
periods. As $29 000 was spent in cash in the current year, the ATO allows this as a
tax deduction; however, for accounting purposes, under the accrual system, the
company capitalises this cost as an asset until the insurance is used up, $24 000 being
regarded as insurance services used up in the current year. As the allowable deduction
is $5 000 greater than the accounting expense, the companys taxable income will be
less than its accounting profit for the year. Accordingly, the company will pay less
tax this year. Next year, when the $5 000 is recorded as an accounting expense, no
deduction will be allowed for tax purposes and the company will pay more tax. Thus,
at the end of the current year, the company will also record a deferred tax liability to
cater for the taxable temporary difference arising from the prepaid insurance asset
recorded by the company.
Rent revenue
Rent is commonly recorded as revenue for accounting purposes as it is earned in
accordance with AASB 118, but it is taxable by the ATO when it is received in cash.
In this question, $3 500 of revenue has not yet been received and has been recorded in
the companys statement of financial position as a receivable. Rent receivable at 30
June 2013 of $5 500 together with the rent received for the current year of $21 500
($25 000 - $3 500) equals rent income of $27 000 for tax purposes. As the company
has recorded rent revenue of $25 000, an adjustment is made in the worksheet to
deduct the accounting figure and replace with the tax figure. Accordingly, the current
tax liability includes $1 650 deferred from last year but excludes $1 050 payable next
year when the rent is received in cash.
Entertainment expenses
This accounting expense is not allowed as a tax deduction and therefore has been
added back to accounting profit to remove it from the profit. As no deduction is
allowed for entertainment costs, there are no future tax consequences.

D.
Carrying
Amount
Assets
Cash
Receivables
Inventories
Rent
receivable
Prepaid
insurance
Equipment
Developt
costs
Liabilities
A/cs payble
Mortgage
Annual leave
payable
Temporary
differences
Excluded
differences
Net temp
differences
Deferred tax
liability 30%
Deferred tax
asset 30%
Beginning
balances
Movement
during year
Adjustment
MEHARRY LTD
Calculation of deferred tax
as at 30 June 2014
Taxable
Deductible Tax Base
Amount
Amount
55 000
279 000
162 000
3 500
(0)
(162 000)
(3 500)
30 000
104 500
90 000
Taxable
Temporary
Diffs
16 000
162 000
0
55 000
295 000
162 000
0
3 500
(30 000)
30 000
(104 500)
(90 000)
72 680
0
72 680
0
31 820
90 000
0
0
(61 000)
310 510
100 000
0
310 510
100 000
61 000
Deductible
Temporary
Diffs
16 000
61 000
155 320
77 000
-
0
155 320
46 596
77 000
23 100
(20 060)
(28 220)
*2 360
*3 320
28 896 Cr
1 800 Cr
E. *The change of tax rate requires the following entry to be made:

Income Tax Expense
Deferred Tax Asset
Dr
Dr
Cr
2 360
960
3 320

The journal entry required to record movements in the deferred tax accounts for the
year ended 30 June 2014 is:
Income Tax Expense
Deferred Tax Asset
Dr
Cr
Cr
30 696
1 800
28 896
F.
Notes to the financial statements for the year ended 30 June 2014:
Note X
Income tax
(a) Major components of income tax expense
Current tax expense
Deferred tax revenue from origination
And reversal of temporary differences
Deferred tax expense resulting from
Change in the tax rate
Tax expense
$39 170
30 696
960
70 826
(b) Reconciliation of income tax expense with pre-tax accounting profit,

multiplied by the tax rate
Income tax expense on the accounting profit for the company is
reconciled to the tax as follows:
Pre-tax accounting profit
Tax at the Australian tax rate of 30%
Tax effect of expenses not deductible in
calculating taxable income (entertainment)
Tax effect of non-taxable revenue (royalty)
Tax- effect of additional tax deductions (development)
Tax effect of net movements in
items giving rise to:
Deferred tax assets
Deferred tax liabilities
Current tax expense
$252 450
75 735
3 735
(600)
(9 000)
(1 800)
(28 900)
39 170
The tax rate is the national income tax rate.

(c) Change in tax rate
As from 1 July the company tax rate changed from 34% to 30%.
(d) Deferred tax assets and liabilities for each type of temporary
difference
The following items have given rise to deferred tax assets:
Allowance for doubtful debts
$4 800
Employee benefits
18 300
Total deferred tax assets
$23 100
The following items have given rise to deferred tax liabilities:
Prepayments
Development costs
Rent receivable
Plant and equipment
Total deferred tax liability
Offset of deferred tax asset against liability
Net deferred tax liability (asset)
9 000
27 000
1 050
9 546
46 596
23 100
23 496
(e) Deferred tax expenses and revenues recognised in profit for each type
of temporary difference:)*
Deferred tax expense in relation to:
Prepayments
Development costs
Plant and equipment
Rent receivable
Total deferred tax expense
Deferred tax income in relation to:
Accounts receivable
Employee benefits
Total deferred tax income
$1 500
27 000
996
(600)
28 896
(600)
(1 200)
(1 800)
* This disclosure item is only required if the movements in deferred items cannot be
readily ascertained from other disclosures made with respect to deferred assets and
liabilities. This is the case in this question where the change in the tax rate
adjustments have obscured the movements in deferred items.
10

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Tutorial Week 3 Moodle Questions and Solutions