Principles Of Tax-Effect Accounting: Memorandum Explanation

Memorandum

Dunedin Ltd.

New South Wales, Australia

To: Senior Management

From: Linda May

Date: August 18, 2018

Subject: Impact of Depreciation on future income tax of company

The memorandum will discuss regarding the principles of the tax effect as per requirement of AASB 112 on Income Taxes.

• Accounting profit is stated as the profit earned by the company after subtracting all the expenses from total revenue (Paramita, 2017). On the other hand, taxable profit is the business profit that is taxable in accordance with the rules for income tax.
• As per the ruling of ATO (Australian taxation office) to calculate the taxable profit of the company the revenues and expenses shall be classified. In the next step, the apportionable items shall be separated and taxable profit shall be calculated from that (Ato.gov.au, 2018).
• Current tax expense is the liability that is owed to state, provincial or federal government with the given period. It is calculated through multiplying the applicable tax rate for the business with the income generated by the company before taxes and after factoring non-deductible items, tax liabilities and tax assets (Safonova et al., 2016).
• Deferred income tax is the liability that is recorded under the balance sheet. It is resulted from the difference in accounting profit and taxable profit. Owing to this there is difference in income tax payable by the company and reported tax expenses. Reason of difference between accounting profit and the taxable profit arises due to timing difference. Further, the timing difference takes place owing to the depreciation rate, depreciation method and difference in deductible expenses while calculating taxable profit and accounting profit. Where the expense as per income tax is lower as compared to accounting expenses the deferred tax asset is created (Hanlon, Navissi & Soepriyanto, 2014). On the contrary, where the expense as per income tax is higher as compared to accounting expenses the deferred tax liability is created.
• Deferred tax asset (DTA) is the asset recorded under the balance sheet of the company and can be used for reducing the taxable income. It takes place in the situation where the business overpaid the taxes or the taxes have been paid in advance. Eventually these taxes are returned to business in form of the tax relief and therefore, the over payment is considered as asset for the company. DTA is generally created owing to taxes carries forward or paid but not yet recorded under income statement. For instance, the DTA can be created as the tax authorities recorded the expenses or revenues at various times that is not as per the accounting standards (Wang, Butterfield & Campbell, 2016). A simple example for DTA is carry-over of the losses. If the business incurs loss in the financial year the company is allowed to use the loss for lowering the taxable income in next year. Hence, the loss here is an asset.
• On the other hand, the deferred tax liability takes place when the taxable income is lower as compared to the income reported on income statements. This happens owing to the accounting differences of certain expenses and income account. The difference is only temporary difference (Safonova et al., 2016). The main reason behind this is that the deferred tax liability is use of various method of depreciation for the purpose of financial reporting.
• Through deferred tax asset (DTA) the firm represent that it has paid extra taxes or has paid advance taxes which will be claimed as tax relief.  DTA is the income tax that is created by the carrying amount of tax credit or net loss that will eventually be returned to company and will be reported on the balance sheet of the company as asset. Tax deferrals are used by the company to lower the expenses of income tax for the future accounting period provided that the future tax period will generate positive income (Ifada & Wulandari, 2015). On the other hand, deferred tax liability (DTL) represents that the income tax created from temporary difference among the tax deductions and book expenses that is recorded on balance sheet and which will be pain in next accounting period. DTL is recorded on the balance sheet of the entity and it represents the difference among the paid tax in current accounting period and tax payable in next accounting period. Liability generated while accounting income is more as compared to taxable income (Mullinova & Simonyants, 2016). In case of DTL the firm is allowed to defer the taxes on specific percentage of the income and the amount is reported under balance sheet as DTL.
• Income tax expense is the expense amount that is recognized by the business under the accounting period for ATO associated with the taxable profit. Income tax expense amount that is recorded in the income statement of the company is unlikely to match with the standard percentage of income tax applicable to the business profit. The reason behind this is that there is difference between the income chargeable to tax and allowable deductions (Laux, 2013). On the other hand, income tax paid is the amount paid by the company as tax on income. Paid amount is calculated after allowing various deductible expenses as per ATO. Income tax paid is recorded in the cash flow statement of the company.

Schedule 1

Calculating the carrying amount of the machine at the end of 30th June
Year	Depreciation	Carrying amount
2017	$                              –	$                             300,000.00
2018	$                 60,000.00	$                             240,000.00
2019	$                 60,000.00	$                             180,000.00
2020	$                 60,000.00	$                             120,000.00
2021	$                 60,000.00	$                               60,000.00
2022	$                 60,000.00	$                                       –

Calculation of depreciation
Year	Accounting policy	Tax policy	Temporary difference	Tax Amount	DTA/DTL
2018	$            60,000.00	$    100,000.00	$  40,000.00	$  12,000.00	DTL
2019	$            60,000.00	$    100,000.00	$  40,000.00	$  12,000.00	DTL
2020	$            60,000.00	$    100,000.00	$  40,000.00	$  12,000.00	DTL
2021	$            60,000.00	$                  –	$ (60,000.00)	$ (18,000.00)	DTA
2022	$            60,000.00	$                  –	$ (60,000.00)	$ (18,000.00)	DTA

Schedule 2

Year	Accounting profit	Depreciation	Adjusted accounting profit	Tax on profit	Adjustment for DTA/DTL	Payable tax to ATO
2018	$          150,000.00	$      60,000.00	$  90,000.00	$  27,000.00	$  12,000.00	$ 27,000.00
2019	$          150,000.00	$      60,000.00	$  90,000.00	$  27,000.00	$  12,000.00	$ 39,000.00
2029	$          150,000.00	$      60,000.00	$  90,000.00	$  27,000.00	$  12,000.00	$ 39,000.00
2021	$          150,000.00	$      60,000.00	$  90,000.00	$  27,000.00	$(18,000.00)	$ 39,000.00
2022	$          150,000.00	$      60,000.00	$  90,000.00	$  27,000.00	$(18,000.00)	$   9,000.00

Therefore, it can be concluded that due to timing difference in depreciation charged under account and charged as per tax rules, significant difference is there among income tax expenses reported in income statement and tax paid to ATO.

Copy to:

Mr. Hogward Stephen

Ms. Mary Edward

• I expect to score 75% marks in this assignment as I have tried to answer all question included in the assignment with best knowledge of mine.
• In the given assignment as per my assessment I have answered the part 6 and 7 of question 1. I have tried to answer the concept of deferred tax asset (DTA) and deferred tax liability (DTL) in broader view. Further, I have given an idea regarding what is represented by DTA and DTL.
• Part 4 of question 1 that is the calculation of deferred income tax expenses I think I did least well in the given assignment. The hardest part in this I found that I was a bit confused among taxable profit and accounting profit from which the deferred tax is to be computed.
• Hardest part of the assignment was computation. Deferred tax asset and deferred tax liability and its adjustment with current tax were toughest. Without clear knowledge of DTA and DTL it is not possible to segregate the timing difference as DTA and DTL and its adjustment with current tax expenses and finally computing the amount of payable tax.
• Most important part I learned in this assignment is that the deferred tax is nothing but temporary difference. If the difference is permanent deferred tax is not created.

Reference

Ato.gov.au.  (2018). Ato.gov.au. Retrieved 18 August 2018, from https://www.ato.gov.au/

Hanlon, D., Navissi, F., & Soepriyanto, G. (2014). The value relevance of deferred tax attributed to asset revaluations. Journal of Contemporary Accounting & Economics, 10(2), 87-99.

Ifada, L. M., & Wulandari, N. (2015). The Effect Of Deferred Tax And Tax Planning Toward Earnings Management Practice: An Empirical Study On Non Manufacturing Companies Listed In Indonesia Stock Exchange In The Period Of 2008-2012. International Journal of Organizational Innovation, 8(1).

Laux, R. C. (2013). The association between deferred tax assets and liabilities and future tax payments. The Accounting Review, 88(4), 1357-1383.

Mullinova, S., & Simonyants, N. (2016). Reflection of a deferred tax liability in the credit union reporting according to IFRS (IAS) 12″ Income taxes”. Modern European Researches, (1), 83-88.

Paramita, R. W. D. (2017). The Window Information For Investor On Accounting Profit Forecasting. Jurnal Terapan Manajemen Dan Bisnis, 3(2), 193-204.

Safonova, M. F., Kalinina, I. N., Vasilieva, N. K., Bershitskiy, Y. I., & Kiselevich, T. I. (2016). Methodology of planning tax expenses. International Journal of Economics and Financial Issues, 6(4), 1550-1559.

Wang, Y., Butterfield, S., & Campbell, M. (2016). Deferred tax items as earnings management indicators. International Management Review, 12(2), 37-42.