a. Knowledge involving Deferred Tax Assets(DTA) & Deferred Tax Liabilities(DTL).
b. Methods to derive computed accounting information outputs required to update the related accounting system -->
Specific for our calculations and adjusting entries -
In our method, WE DO NOT REVERSE prior period DTAs and DTLs in the accounts.
Rather, WE CALCULATE THE MOVEMENT JOURNAL such that the movements in the DTA or DTL between opening and closing values gives rise to adjusting journal entries that instantiate the correct closing balances for DTA and DTL balance sheet balances. I.E.
Closing DTA - Opening DTA = Movement in DTA
Closing DTL - Opening DTL = Movement in DTL
Inputs include -->
Column A: Account Names
Column B: Carrying Amount
Column C: Tax Base
Column D: Tax Rate
Column E: Opening DTA
Column F: Opening DTL
Column G: Temp Diff Taxable(TTD)
Column H: Temp Diff Ded(DTD)
Column I: Closing DTA
Column J: Closing DTL
Then Movement for each named account MUST be translated into a journal-->
Journal Entry Rules for Deferred Tax Liabilities (DTLs)
For each account, determine the movement between the opening and closing DTL balances.
Then record the appropriate journal entry based on the following scenarios:
1. When Closing DTL is Greater Than Opening DTL (Increase in DTL)
Journal Entry:
Debit: Income Tax Expense
Credit: Deferred Tax Liability
Explanation:
Debit Income Tax Expense: Reflects the increase in tax expense due to the higher future tax obligation.
Credit Deferred Tax Liability: Increases the liability on the balance sheet to represent the additional future tax payable.
Narration:
"To record the increase in deferred tax liability due to temporary taxable differences arising from [Ai explaination]."
2. When Closing DTL is Less Than Opening DTL (Decrease in DTL)
Journal Entry:
Debit: Deferred Tax Liability
Credit: Income Tax Expense
Explanation:
Debit Deferred Tax Liability: Decreases the liability on the balance sheet, reflecting a reduction in future tax payable.
Credit Income Tax Expense: Reduces the current period's income tax expense due to the decrease in future tax obligations.
Narration:
"To record the decrease in deferred tax liability due to the movement of temporary taxable differences from [Ai explaination]."
Journal Entry Rules for Deferred Tax Assets (DTAs)
For each account, where relevant, determine the movement between the opening and closing DTA balances.
Then record the appropriate journal entry based on the following scenarios:
1. When Closing DTA is Greater Than Opening DTA (Increase in DTA)
Journal Entry:
Debit: Deferred Tax Asset
Credit: Income Tax Expense
Explanation:
Debit: Deferred Tax Asset: Reflects the increase in the deferred tax asset due to the higher future tax benefit.
Credit Income Tax Expense: Reduces the current period's income tax expense due to the increase in future tax benefit.
Narration:
"To record the increase in deferred tax asset due to deductible temporary differences arising from [Ai explaination]."
2. When Closing DTA is Less Than Opening DTA (Decrease in DTA)
Journal Entry:
Debit: Income Tax Expense
Credit: Deferred Tax Asset
Explanation:
Debit Income Tax Expense: Increases the current period's income tax expense due to the decrease in future tax asset.
Credit Deferred Tax Asset: Decreases the asset on the balance sheet, reflecting a reduction in future tax benefit.
Narration:
"To record the decrease in deferred tax asset due to the movement of temporary taxable differences from [Ai explaination]."
General classes of Assets and liabilities.
Classifications reflect the nature of temporary differences arising from mismatches in accounting and tax treatments.
Here's a breakdown:
General Classes Leading to Deferred Tax Liabilities (DTLs)
- DTLs arise when taxable temporary differences increase future taxable income.
- Deferred tax liabilities arise from taxable temporary differences, where:
- The carrying amount of an asset exceeds its tax base.
- The carrying amount of a liability is less than its tax base.
Examples of Items Leading to DTLs:
- Depreciable Assets: Differences between accounting depreciation and tax depreciation (e.g., accelerated depreciation for tax purposes).
- Revalued Assets: Increases in asset values recognized for accounting but not for tax until realization.
- Prepaid Expenses: Recognized as assets in accounting but deducted immediately for tax purposes (e.g., prepaid insurance or rent).
General Classes Leading to Deferred Tax Assets (DTAs)
DTAs arise when deductible temporary differences reduce future taxable income.
DTAs arise from:
- Temporary differences where carrying amounts of liabilities exceed their tax bases.
- Temporary differences where carrying amounts of assets are less than their tax bases.
- Tax losses or unused tax credits carried forward.
Examples of Items Leading to DTAs:
- Provisions and Accruals: Liabilities recognized in accounting but deductible only when paid (e.g., warranties, employee benefits).
- Impairment of Assets: Losses or impairments recognized for accounting but not deductible until realized for tax.
- Unearned Revenue: Taxed on receipt but recognized later in accounting, leading to future tax deductions.
Carrying Amount and Deferred Tax Relationships
The carrying amount of an asset or liability is its value as reported in the financial statements under applicable accounting standards (e.g., IFRS or AASB).
It represents the net book value after accounting for adjustments such as depreciation, amortization, impairment, or allowances.
Relationships Between Carrying Amount, Tax Base, and Deferred Tax
Temporary differences arise when the carrying amount of an asset or liability differs from its tax base (the amount attributed to the asset or liability for tax purposes). These differences lead to deferred tax assets (DTAs) or deferred tax liabilities (DTLs) depending on the nature of the difference.
For Assets
Carrying Amount > Tax Base
Results In: Taxable Temporary Difference
Leads To: Deferred Tax Liability (DTL)
Carrying Amount < Tax Base
Results In: Deductible Temporary Difference
Leads To: Deferred Tax Asset (DTA)
Examples:
- Depreciable Assets: When accounting depreciation is slower than tax depreciation (e.g., accelerated depreciation for tax purposes), the carrying amount exceeds the tax base, resulting in a taxable temporary difference and a DTL.
- Impairment of Assets: Impairment losses recognized in accounting may not be deductible for tax purposes until realized. This causes the carrying amount to be less than the tax base, resulting in a deductible temporary difference and a DTA.
- Trade Receivables (Net of Allowances): Accounting may recognize impairment losses that are not immediately deductible for tax purposes, leading to a carrying amount less than the tax base and a DTA.
Summary of Key Relationships
- Carrying Amount > Tax Base ⇒ Taxable Temporary Difference ⇒ Deferred Tax Liability (DTL)
- Carrying Amount < Tax Base ⇒ Deductible Temporary Difference ⇒ Deferred Tax Asset (DTA)
For Liabilities
Carrying Amount > Tax Base
Results In: Deductible Temporary Difference
Leads To: Deferred Tax Asset (DTA)
Carrying Amount < Tax Base
Results In: Taxable Temporary Difference
Leads To: Deferred Tax Liability (DTL)
Examples:
- Provisions and Accruals: Liabilities like warranties or employee benefits are recognized in accounting but may not be deductible for tax until paid. The carrying amount exceeds the tax base (which may be zero), creating a deductible temporary difference and a DTA.
- Lease Liabilities: Differences between accounting treatment under IFRS 16 and tax treatment can lead to carrying amounts that exceed the tax base, resulting in a deductible temporary difference and a DTA.
- Unearned Revenue: If revenue is taxed upon receipt but recognized in accounting later, the carrying amount of the liability (unearned revenue) is higher than the tax base (which may be zero), leading to a deductible temporary difference and a DTA.
- Carrying Amount > Tax Base ⇒ Deductible Temporary Difference ⇒ Deferred Tax Asset (DTA)
- Carrying Amount < Tax Base ⇒ Taxable Temporary Difference ⇒ Deferred Tax Liability (DTL)
Tax Base Definition
Tax Base of an Asset:
Definition:
The tax base of an asset is the amount that will be deductible for tax purposes against the taxable economic benefits when the asset is recovered.
Formula:
Tax Base (Asset) = Carrying Amount – Amounts that are not deductible for tax purposes in future periods + Amounts that will be deductible in future periods
Tax Base of a Liability:
Definition:
- The tax base of a liability is its carrying amount minus any amounts that will be deductible for tax purposes in future periods.
Formula:
Tax Base (Liability) = Carrying Amount - Future Tax Deductions
Key Relationship to Accounting
- Tax Base is determined solely by tax law.
- It differs from the carrying amount, which is calculated under accounting standards like IFRS or AASB.
Tax Rate Definition
- The tax rate is the percentage at which a person or entity's taxable income is taxed by the government.
- It is used to calculate the amount of tax payable on taxable income or the deferred tax impact of temporary differences.
Definition of Opening Deferred Tax Asset (DTA)
- The Opening Deferred Tax Asset (DTA) refers to the balance of deferred tax assets at the beginning of an accounting period.
- The opening DTA balance is the closing balance of the deferred tax asset from the previous accounting period.
Definition of Closing Deferred Tax Asset (DTA)
- The Closing Deferred Tax Asset (DTA) is the balance of deferred tax assets at the end of an accounting period.
- It represents the cumulative tax benefits expected to be realized in future periods due to deductible temporary differences, unused tax losses, or unused tax credits that reduce taxable income or tax payable.
Key Characteristics
Represents Future Tax Benefits:
- The closing DTA reflects the portion of temporary differences, tax losses, or tax credits that have not yet been utilized to reduce taxable income or tax payable but are expected to be recoverable in the future.
Definition of Opening Deferred Tax Liability (DTL)
- The Opening Deferred Tax Liability (DTL) refers to the balance of deferred tax liabilities at the beginning of an accounting period.
- The opening DTL balance is the closing balance of the deferred tax liability from the previous accounting period.
Definition of Closing Deferred Tax Liability (DTL)
The Closing Deferred Tax Liability (DTL) refers to the balance of deferred tax liabilities at the end of an accounting period.
It represents the cumulative tax obligations that will arise in future periods due to taxable temporary differences between the carrying amounts of assets or liabilities in the financial statements and their tax bases.
Temporary Differences
- The difference between the carrying amount (from accounting standards) and the tax base (from tax laws) results in temporary differences that lead to:
- Deferred Tax Liabilities (DTLs) for taxable temporary differences.
- Deferred Tax Assets (DTAs) for deductible temporary differences.
A Taxable Temporary Difference (TTD) is a difference between the carrying amount of an asset or liability in the accounting records and its tax base.
- TTDs create Deferred Tax Liabilities (DTLs) because they increase taxable income in future periods.
Key Characteristics
Future Taxable Income:
- TTDs arise when an entity will have to pay more tax in the future due to timing differences between the recognition of revenue or expenses for accounting and tax purposes.
Examples:
Depreciable Assets:
- Accounting depreciation is slower than tax depreciation (e.g., straight-line vs. accelerated), leading to higher carrying amounts than tax bases.
Revaluation of Assets:
- Asset revaluations (e.g., land or investment property) are recognized in accounting but not for tax until disposal.
Prepaid Expenses:
- Prepaid expenses (e.g., rent or insurance) are recognized as assets in accounting but deducted immediately for tax purposes.
Definition: A Taxable Temporary Difference arises when the recovery or settlement of the carrying amount of an asset or liability will result in taxable amounts in future periods.
Identification:
A Deductible Temporary Difference (DTD) is a difference between the carrying amount of an asset or liability in the accounting records and its tax base.
DTDs create Deferred Tax Assets (DTAs) because they represent future tax benefits.
Key Characteristics
Future Tax Benefits:
- DTDs arise when an entity will have lower taxable income (or tax payable) in future periods due to timing differences between the recognition of revenue or expenses for accounting and tax purposes.
Examples:
- Provisions and Accruals: Accounting recognizes liabilities like employee benefits or warranties that are deductible for tax purposes only when paid.
- Impairment Losses: Impairments (e.g., on receivables or inventory) are recognized in accounting but deductible for tax purposes only when realized.
- Tax Losses: Unused tax losses carried forward create future deductions when offset against future taxable income.
- Unearned Revenue/Deferred Revenue: Revenue deferred in accounting but taxed on receipt creates a deductible temporary difference as it reduces taxable income in future periods when recognized.
- Deductible Temporary Difference (DTD): Definition: A Deductible Temporary Difference arises when the recovery or settlement of the carrying amount of an asset or liability will result in amounts that are deductible in future periods.