Chapter 17 Accounting for Taxation

1.       Objectives

1.1       Account for income taxes in accordance with HKAS 12.
1.2       Record entries relating to income taxes in the accounting records.
1.3       Explain the effect of taxable temporary differences on accounting and taxable profit.
1.4       Calculate deferred tax amounts.
1.5       Record deferred tax in the financial statements.

2.       Current Tax (本期稅項) under HKAS 12

2.1

Definitions

(a)        Accounting profit – Net profit or loss for a period before deducting tax expense. (b)        Taxable profit (tax loss) – The profit (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable). (c)        Tax expense (tax income) – The aggregate amount included in the determination of net profit or loss for the period in respect of current tax and deferred tax. (d)        Current tax – The amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period.

2.2	Recognition and Measurement
	(a)        Recognition – Current tax is recognized as income and expense and included in the income statement for the period. (b)        Measurement – They are measured at the amount expected to be paid to (recovered from) the tax authorities.

2.3

Example 1 – Over and under provision of current tax

In 2011 ABC Co had taxable profits of $120,000. In previous year (2010) income tax on 2010 profits had been estimated as $30,000. Required: Calculate tax payable and the charge for 2011 if the tax due on 2010 profits was subsequently agreed with the tax authorities as: (a)        $35,000 (b)        $25,000 Tax rate is 30%. Any under or over payments are not settled until the following year’s tax payment is due. Solution: (a) Income tax   $   $ Bank 35,000 Bal. b/d 30,000     I/S – underprovision 5,000 Bal. c/d 40,000 I/S (120,000 x 30%) 40,000   75,000   75,000 (b) Income tax   $   $ Bank 25,000 Bal. b/d 30,000 I/S – overprovision 5,000 I/S (120,000 x 30%) 40,000 Bal. c/d 40,000       70,000   70,000

 

2.4

Example 2 – Tax losses carried back

In 2010 BCC Co paid $50,000 in tax on its profits. In 2011 the company made tax losses of $24,000. The local tax authority rules allow losses to be carried back to offset against current tax of prior years. Required: Show the tax charge and tax liability for 2011. Solution: Tax repayment due on tax losses = 30% x $24,000 = $7,200 The double entry will be:   Dr ($) Cr($) Tax receivable (SFP) 7,200   Tax repayment (I/S)   7,200 The tax receivable will be shown as an asset until the repayment is received from the tax authorities.

2.5

Presentation

(a)        In the statement of financial position, tax assets and liabilities should be shown separately from other assets and liabilities. (b)        Current tax assets and liabilities can be offset, but this should happen only when certain conditions apply. (i)         The enterprise has a legally enforceable right to set off the recognized amounts. (ii)        The enterprise intends to settle the amounts on a net basis, or to realize the asset and settle the liability at the same time. (c)        The tax expense (income) related to the profit and loss from ordinary activities should be shown on the face of the income statement.

3.       Deferred Tax (遞延稅項) – Introduction

3.1       Deferred tax is an application of the matching concept. Under the matching concept, the tax consequences of a transaction or other event should be recognised at the same time as the underlying transaction or other event is recognised. Therefore, if those tax consequences are not recognised through the recognition of current tax in the period, i.e. the tax authorities will not acknowledge the transactions until a future period, they need to be recognised in the financial statements by accounting for deferred tax.
3.2       Deferred tax is a basis of allocating tax expense to particular accounting periods. The key to deferred tax lies in the differences between the two concepts of profit: the accounting profit and the taxable profit.
3.3       The two figures of profit are unlikely to be the same because of permanent differences and temporary differences.

3.4

Definitions

(a)        Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences. (b)        Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of: (i)         Deductible temporary differences (ii)        The carry forward of unused tax losses (iii)       The carry forward of unused tax credits (稅款抵減) (c)        Permanent differences (永久性差異) are items included in the accounting profit that will never be taxed or allowed as reductions, for example, dividends, non-business entertainment (disallowable) and traffic fines (disallowable). Permanent differences will not reverse in future periods and thus give rise to no tax effects in other periods. (d)        Temporary differences (暫時性差異) are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base. Temporary differences may be either: (i)         taxable temporary difference (應稅暫時性差異) will result in an increase in income tax payable in future reporting periods, and give rise to a deferred tax liability. (ii)        deductible temporary difference (可抵扣暫時性差異) will result in a decrease in income tax payable in future reporting periods, and give rise to a deferred tax asset. (e)        Tax base (計稅基礎) – the tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.

3.5       Examples of taxable temporary differences
(a)        Transactions affecting the income statement:
(i)         Interest revenue received in arrears, included in the accounting profit on a time apportionment basis but taxable on a cash basis.
(ii)        Depreciation of an asset is accelerated for tax purposes.
(iii)       Development costs have been capitalized and will be amortised to the income statement but were deducted for tax purposes as incurred.
(iv)       Prepaid expenses have already been deducted on a cash basis for tax purposes but are to be charged in the income statement in a later period.
(b)        Transactions affecting the statement of financial position
(i)         Current investments are carried at fair value which exceeds cost but remain at cost for tax purposes.
(ii)        Non-current assets are revalued upwards for accounting purposes with no adjustment for tax purposes.
3.6       Examples of deductible temporary differences
(a)        Accumulated depreciation of an asset in the financial statements is greater than the cumulative depreciation allowed up to the balance sheet date for tax purposes.
(b)        The net realizable value of an item of inventory, or the recoverable amount of an item of property, plant or equipment, is less than the previous carrying amount and an enterprise therefore reduces the carrying amount of the asset, but that reduction is ignored for tax purposes until the asset is sold.
(c)        Research costs (or organization or other start up cost) are recognised as an expense in determining accounting profit but are not permitted as a deduction in determining taxable profit until a later period.
(d)        Income is deferred in the statement of financial position but has already been included in taxable profit in current or prior periods.

4.       Deferred Tax – Recognition and Measurement

4.1	Recognition
	HKAS 12 provides that: (a)        a deferred tax liability shall be recognized for all taxable temporary differences; (b)        a deferred tax asset shall be recognized for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilized.

(A)       Temporary differences arising from statement of financial position items

4.2       Most of the taxable temporary differences and deductible temporary differences arise because of the difference between the carrying amount and the tax base of assets and liabilities in the statement of financial position.

(a)       Tax base of assets

4.3       HKAS 12 provides that the tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefit that will flow to an entity when it recovers the carrying amount of the asset.

4.4

Example 3 – Accounting depreciation and tax depreciation

ABC Ltd (with 31 December accounting year-end) bought a machinery at a cost of $300,000 on 1 January 2011. For accounting purposes, the cost of the machinery is to be depreciated using the straight-line method over five years. Assume that tax rules allow the cost of machinery to be claimed over three years commencing 2011 on straight-line method. Comparing the carrying amount and the tax base of the machinery will yield the following taxable temporary differences (assume a tax rate of 25%): Year Carrying amount ($) Tax base ($) Taxable temporary differences ($) Deferred tax liability ($) 2011 240,000 200,000 40,000 10,000 2012 180,000 100,000 80,000 20,000 2013 120,000 0 120,000 30,000 2014 60,000 0 60,000 15,000 2015 0 0 0 0

 

4.5

Example 4 – Interest income

B Ltd (with 31 December accounting year-end) recognizes interest income on accrual basis. On 31 December 2011, B Ltd accrues for an interest income receivable of $100,000. For tax purposes, the interest is taxable on a cash basis. Comparing the carrying amount and the tax base of the interest receivable account will yield a taxable temporary difference (assume a tax rate of 25%): Year Carrying amount ($) Tax base ($) Taxable temporary differences ($) Deferred tax liability ($) 2011 100,000 0 100,000 25,000

 

4.6

Example 5 – Trade receivable

C Ltd has recorded a trade receivable account of $200,000 in its statement of financial position as at 31 December 2011 arising from sales for the year. For tax purposes, the tax base of the trade receivable account is $200,000. Since the carrying amount of the trade receivable account equals its tax base, there is nil temporary differences. Accordingly, there will be no deferred tax liability as at 31 December 2011. Year Carrying amount ($) Tax base ($) Taxable temporary differences ($) Deferred tax liability ($) 2011 200,000 200,000 0 0

 

4.7

Example 6 – Loan receivable

D Ltd as a loan receivable account of $500,000 in its balance sheet as at 31 December 2011. Under the tax rules, the granting and subsequent repayment of the loan has no tax consequences. In this case, since the loan is not taxable, the tax base of the loan receivable amount is deemed to be equal to its carrying amount of $500,000. There is thus no temporary difference, and consequently, no deferred tax liability/asset.

4.8

Example 7 – Dividend receivable

E Ltd has a dividend receivable account of $100,000 in its balance sheet as at 31 December 2011. Assuming the dividend is paid out of the exempt profit of the investee, the dividend will not be taxable at the hand of E Ltd under the relevant tax rules. In this case, since the dividend income is not taxable, the tax base of the dividend receivable account is deemed to be equal to its carrying amount of $100,000. There is thus no temporary difference, and consequently, no deferred tax liability.

(b)       Tax base of liabilities

4.9       HKAS 12 provides that the tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods.

 

4.10

Example 8 – Accrued expense payable

ABC Ltd has an accrued expense payable account of $10,000 in its statement of financial position as at 31 December 2011. For tax purpose, the related expense will be deductible on cash basis. Comparing the carrying amount and the tax base of the accrued expense payable account will yield a deductible temporary difference of $10,000 as at 31 December 2011. (Assume a rate of 25%) Year Carrying amount ($) Tax base ($) Deductible temporary differences ($) Deferred tax asset ($) 2011 10,000 0 10,000 25,000

 

4.11

Example 9 – Accrued expense payable

ABC Ltd has an accrued expense payable account of $10,000 in its statement of financial position as at 31 December 2011. For tax purpose, the related expense has already been deducted. Comparing the carrying amount of the accrued expense payable account equals its tax base, there is nil temporary difference. Accordingly, there will be no deferred tax asset as at 31 December 2011. Year Carrying amount ($) Tax base ($) Deductible temporary differences ($) Deferred tax asset ($) 2011 10,000 10,000 0 0

 

4.12

Example 10 – Rent received in advance

ABC Ltd has a rent received in advance account of $10,000 in its statement of financial position as at 31 December 2011. For tax purpose, the rental income was taxed on cash basis. Comparing the carrying amount and the tax base of the rent received in advance account will yield a deductible temporary difference of $10,000 as at 31 December 2011 (assume a tax rate of 25%). Year Carrying amount ($) Tax base ($) Deductible temporary differences ($) Deferred tax asset ($) 2011 10,000 0 10,000 2,500

 

4.13     For a liability which embodies revenue/expense which are not taxable/deductible, the tax base of the liability shall be deemed to be equal to its carrying amount.

4.14

Example 11 – Penalty

MNO Ltd has accrued for a penalty imposed by the government of $10,000 in its statement of financial position as at 31 December 2011. For tax purpose, the penalty is not deductible (permanent difference). In this case, since the penalty is not deductible, the tax base of the penalty payable account is deemed to be equal to its carrying amount of $10,000. Comparing the carrying amount and the tax base of the penalty will yield no temporary difference as at 31 December 2011. Year Carrying amount ($) Tax base ($) Deductible temporary differences ($) Deferred tax asset ($) 2011 10,000 10,000 0 0

 

4.15	Summary
	It may be useful to remember the fundamental principle upon which HKAS 12 is based: that an entity shall, with certain limited exceptions, recognize a deferred tax liability/asset whenever recovery or settlement of the carrying amount of an asset or a liability would make the future tax payments larger/smaller than they would be if such recovery or settlement were to have no tax consequences.

4.16

Exercise 1

Assume that XYZ Ltd commenced operation in January 2011. Its statement of financial position as at 31 December 2011 showed the following relevant items: (a)       carrying amount of machinery of $40,000,000; (b)       provision for doubtful debt of $2,000,000; and (c)       provision for warranty of $1,000,000. For tax purposes: (a)       the tax written down value of the machinery is $35,000,000; (b)       the provision for doubtful debt is deemed to be a general provision and is not allowed deduction until it becomes a specific provision; and (c)       the warranty is deductible only when incurred. Required: Calculate the deferred tax liability/asset and prepare the journal entries for the above items.

Solution:

 

(B)       Temporary difference arising from revaluation of assets

4.17     Under the Hong Kong tax rules, revaluation of an item of property, plant and equipment under HKAS 16 does not affect the tax base of the asset and the revaluation surplus is not taxable in the period of revaluation. However, assuming the future recovery of the carrying amount with result in an inflow of taxable economic benefits to the entity and the amount that will be deductible for tax purpose will differ from the amount of those economic benefits, the difference between the carrying amount of a revalued asset and in tax base is a temporary difference.
4.18     HKAS 12 requires such temporary differences to be recognized as deferred tax liability or asset. Assuming the gain/(loss) on sale of asset is taxable/(deductible), when an asset is revalued upwards and subsequently sold at this revalued amount, there will be a taxable profit and additional tax to be paid.
4.19     On the other hand, when an asset is revalued downwards and subsequently recovered at this revalued amount, there will be tax deductions and less tax to be paid.
4.20     Thus, when an asset is revalued (upwards and downwards), it affects the entity’s tax bills in the future, a deferred tax liability/ asset has to be accounted for.
4.21     Since revaluation reserve is accounted for directly in equity, the deferred tax effect thereof shall also be accounted for directly in equity.

4.22

Example 12 – Revaluation of non-current assets

AB Ltd acquires a piece of land as an investment property in 20X5 at a cost of $10,000,000. On 31 December 2011, the land is revalued to $12,000,000. Assume that when the investment property is sold, the profit thereof will attract tax at a rate of 25%. In this case, when the land is revalued, it gives rise to a temporary difference of $2,000,000, being the difference between the carrying amount of $12,000,000 and the tax base of $10,000,000. (Alternatively, when the land is revalued and subsequently recovered at $12,000,000, it will give rise to a taxable profit of $2,000,000 and an additional tax to be paid, and therefore a deferred tax liability should be recognized at the date of revaluation.) Thus, a deferred tax liability of $500,000 ($2,000,000 x 25%) should be recognized. Since the revaluation surplus is recorded directly in revaluation reserve, the deferred tax liability should similarly be taken directly to revaluation surplus. Consequently, the revaluation in 20X6 will be recorded as follows:   Dr. ($) Cr. ($) Land 2,000,000   Revaluation surplus   2,000,000 Revaluation surplus 500,000   Deferred tax liability   500,000 Subsequently, how the deferred tax liability is accounted for depends on whether or not the gain on sale of land is taxable. Scenario I Assume that the land is sold in 2012 for $13,000,000, and the profit thereof attracts tax at the rate of 25%. In this case, the taxable profit will be $3,000,000 ($13,000,000 – $10,000,000), and the tax payable will be $750,000 ($3,000,000 x 25%). However, the accounting profit will only be $1,000,000 ($13,000,000 – $12,000,000), and the tax expense thereof shall be $250,000 ($1,000,000 x 25%). The journal entries to record the sale of land and the tax effect thereof will be as follows:   Dr. ($) Cr. ($) Cash 13,000,000   Land   12,000,000 I/S – Gain on sale of land   1,000,000 (To record gain on sale of land)       Dr. ($) Cr. ($) Revaluation reserve 1,500,000   Retained profit   1,500,000 (To record realization of revaluation surplus)       Dr. ($) Cr. ($) Tax expense 250,000   Deferred tax liability 500,000   Tax payable   750,000 (To record tax effect on gain on sale of land)     Scenario II Assume that the land is sold in 2012 for $13,000,000, and the profit thereof is not taxable. The deferred tax liability previously provided for should be reversed. In this case, the journal entries related to the sale of land and the tax effect thereof will be as follows:   Dr. ($) Cr. ($) Cash 13,000,000   Land   12,000,000 I/S – Gain on sale of land   1,000,000 (To record gain on sale of land)       Dr. ($) Cr. ($) Deferred tax liability 500,000   Revaluation reserve   500,000 (To record the reversal of the deferred tax liability previously provided for.)   Dr. ($) Cr. ($) Revaluation reserve 1,500,000   Retained profit   1,500,000 (To record realization of revaluation surplus.)

 

(C)       Other issues

(a)       Changes in tax rates

4.23     Where the corporate rate of income tax fluctuates from one year to another, a problem arises in respect of the amount of deferred tax to be credited (debited) to the statement of comprehensive income in later years.
4.24     HKAS 12 requires deferred tax assets and liabilities to be measured at the tax rates expected to apply in the period when the assets is realized or liability settled, based on tax rates and laws enacted at the end of the reporting period. In other words, HKAS 12 requires the liability method to be used.

4.25

Example 13 – Changes in tax rates

In November 2011, the government announced that the tax rate which has been 28%, will be lowered to 25% effective from 1 January 2012. A Ltd has to a taxable profit of $100,000 for the year ended 31 December 2011. Its taxable temporary differences have increased from $50,000 as at 31 December 2010 to $60,000 as at 31 December 2011. In this case, the current tax payable will be $28,000, measured based on 28%. The deferred tax liability as at 31 December 2011 will be $15,000 ($60,000 x 25%), measured based on 25%. (The deferred tax liability as at 31 December 2010 was $14,000 ($50,000 x 28%)). The journal entry to record the tax expense will be as follows:   Dr. ($) Cr. ($) Tax expense 29,000   Deferred tax liability   1,000 Tax payable   28,000 The tax expense charged to the income statement for the year ended 31 December 2011 will therefore be $29,000. In the statement of financial position as at 31 December 2011, the current tax payable will be carried at $28,000, and the deferred tax liability will be carried at $15,000.

(b)       Discounting

4.26     HKAS 12 states that deferred tax assets and liabilities should not be discounted because the complexities and difficulties involved will affect reliability. Discounting would require detailed scheduling of the timing of the reversal of each temporary difference, but this is often impracticable.

5.       Disclosure

5.1       The main disclosure are:
(a)        The tax expense (income) should be presented on the face of the income statement.
(b)        The major components of tax expense (income) should be disclosed separately in a note.
(c)        Current and deferred tax charged/credited directly to equity.
(d)        The amount of income tax relating to each component of other comprehensive income.
(e)        An explanation of the relationship between tax expense (income) and accounting profit in either or both of the following forms:
(i)         a numerical reconciliation between tax expense (income) and the profit of accounting profit multiplied by the applicable tax rate(s), disclosing also the basis on which the applicable tax rate(s) is (are) computed.
(ii)        a numerical reconciliation between the average effective tax rate and the applicable tax rate, disclosing also the basis on which the applicable tax rate is computed.

 

Examination Style Questions

Question 1
Julian recognised a deferred tax liability for the year end 31 December 20X3 which related solely to accelerated tax depreciation on property, plant and equipment at a rate 30%. The net book value of the property, plant and equipment at that date was $310,000 and the tax written down value was $230,000.

The following data relates to the year ended 31 December 20X4:

(i)      At the end of the year the carrying value of property, plant and equipment was $460,000 and their tax written down value was $270,000. During the year some items were revalued by $90,000. No items had previously required revaluation. In the tax jurisdiction in which Julian operates revaluations of assets do not affect the tax base of an asset or taxable profit. Gains due to revaluations are taxable on sale.
(ii)     Julian began development of a new product during the year and capitalised $60,000 in accordance with IAS 38. The expenditure was deducted for tax purposes as it was incurred. None of the expenditure had been amortised by the year end.
(iii)    Julian's income statement showed interest income receivable of $55,000, but only $45,000 of this had been received by the year end. Interest income is taxed on a receipts basis.
(iv)    During the year, Julian made a provision of $40,000 to cover an obligation to clean up some damage caused by an environmental accident. None of the provision had been used by the year end. The expenditure will be tax deductible when paid.

The corporate income tax rate recently enacted for the following year is 30% (unchanged from the previous year).

The current tax charge was calculated for the year as $45,000.

Current tax is settled on a net basis with the national tax authority.

Required:

(a)     Prepare a table showing the carrying values, tax bases and temporary differences for each for the items above at 31 December 20X4.
(b)     Prepare the income statement and statement of financial position notes to the financial statements relating to deferred tax for the year ended 31 December 20X4.
Question 2
(a)     Explain, with examples, the nature and purpose of deferred taxation.              (10 marks)

(b)     The information below relates to G for the year ended 31 March 20X3.

The balance on the provision for deferred taxation account at 1 April 20X2 was $35,000. This represented taxation at 35% on cumulative timing differences of $100,000 at 1 April 20X2. Capital allowances (tax depreciation) and depreciation for the year ending 31 March 20X3 are as follows.

	Capital allowances	Depreciation
	$000	$000
20X3 (actual)	100	90

The income tax rate for 20X3 is 30% and is expected to remain at this level for the foreseeable future.

Required:

State, with reasons, how to account for deferred tax in the year ended 31 March 20X3.
(5 marks)
(Total 15 marks)

Question 3
(a)     HKAS 12 Income Taxes details the requirements relating to the accounting treatment of deferred taxes.

Required:

Explain why it is considered necessary to provide for deferred tax and briefly outline the principles of accounting for deferred tax contained in HKAS 12 Income taxes.
(4 marks)

(b)     Bowtock purchased an item of plant for $2,000,000 on 1 October 20X0. It had an estimated life of eight years and an estimated residual value of $400,000. The plant is depreciated on a straight-line basis. The tax authorities do not allow depreciation as a deductible expense. Instead a tax expense of 40% of the cost of this type of asset can be claimed against income tax in the year of purchase and 20% per annum (on a reducing balance basis) of its tax base thereafter. The rate of income tax can be taken as 25%.

Required:

In respect of the above item of plant, calculate the deferred tax charge/credit in Bowtock's income statement for the year to 30 September 20X3 and the deferred tax balance in the statement of financial position at that date.                                                                                              (6 marks)

Note. Work to the nearest $'000.                                                            (Total = 10 marks)
(Amended ACCA 2.5 Financial Reporting December 2003 Q5(a))

Question 4

AB acquired non-current assets on 1 April 2003 costing $250,000. The assets qualified for accelerated first year tax allowance at the rate of 50% for the first year. The second and subsequent years were at a tax depreciation rate of 25% per year on the reducing balance method.

AB depreciates all non-current assets at 20% a year on the straight line basis.

The rate of corporate income tax applying to AB for 2003/04 and 2004/05 was 30%. Assume AB has no other qualifying non-current assets.

Required:

Apply HKAS 12 Income Taxes and calculate:

(i)      the deferred tax balance required at 31 March 2004;
(ii)     the deferred tax balance required at 31 March 2005;
(iii)    the charge to the income statement for the year ended 31 March 2005.
(5 marks)
(Adapted CIMA P7 Financial Accounting and Tax Principles May 2005 Q2(a))

Question 5

BC, a small entity, purchased its only non-current tangible asset on 1 October 2003. The asset cost $900,000, all of which qualified for tax depreciation.

BC’s asset qualified for an accelerated first year tax allowance of 50%. The second and subsequent years qualified for tax depreciation at 25% per year on the reducing balance method.

BC’s accounting depreciation policy is to depreciate the asset over its useful economic life of five years, assuming a residual value of $50,000.

Assume that BC pays tax on its income at the rate of 30%.

Calculate BC’s deferred tax balance required in the balance sheet as at 30 September 2005 according to HKAS 12 Income taxes.
(4 marks)
(Adapted CIMA P7 Financial Accounting and Tax Principles November 2005 Q1.7)

Question 6

CY had the following amounts for 2003 to 2005:

Year ended 31 December:	2003	2004	2005
	$	$	$
Accounting depreciation for the year	1,630	1,590	1,530
Tax depreciation allowance for the year	2,120	1,860	1,320
At 31 December 2002, CY had the following balances brought forward:
Cost of property, plant and equipment qualifying for tax depreciation			20,000
Accounting depreciation			5,000
Tax depreciation			12,500

CY had no non-current asset acquisitions or disposals during the period 2003 to 2005.

Assume the corporate income tax rate is 25% for all years.

Calculate the deferred tax provision required by HKAS 12 “Income Taxes” at 31 December 2005.
(3 marks)
(Adapted CIMA P7 Financial Accounting and Tax Principles May 2006 Q1.8)

Question 7

On 31 March 2006, CH had a credit balance brought forward on its deferred tax account of $642,000. There was also a credit balance on its corporate income tax account of $31,000, representing an over-estimate of the tax charge for the year ended 31 March 2005.

CH’s taxable profit for the year ended 31 March 2006 was $946,000. CH’s directors estimated the deferred tax provision required at 31 March 2006 to be $759,000 and the applicable income tax rate for the year to 31 March 2006 as 22%.

Calculate the income tax expense that CH will charge in its income statement for the year ended 31 March 2006, as required by IAS 12 Income Taxes.                                                                                     (3 marks)
(Adapted CIMA P7 Financial Accounting and Tax Principles May 2006 Q1.20)

Question 8
A government wanted to encourage investment in new non-current assets by entities and decided to change tax allowances for non-current assets to give a 100% first year allowance on all new non-current assets purchased after 1 January 2005.

ED purchased new machinery for $400,000 on 1 October 2005 and claimed the 100% first year allowance. For accounting purposes ED depreciated the machinery on the reducing balance basis at 25% per year. The rate of corporate income tax to be applied to ED’s taxable profits was 22%. Assume ED had no other temporary differences. Calculate the amount of deferred tax that ED would show in its balance sheet at 30 September 2007.

Assume ED had no other temporary differences.

Calculate the amount of deferred tax that ED would show in its balance sheet at 30 September 2007.
(3 marks)
(Adapted CIMA P7 Financial Accounting and Tax Principles November 2007 Q1.10)

Question 9 – Temporary differences of assets
The cost of a machine is HK$1,000,000. The carrying amount of the machine is HK$800,000, after deducting accumulated depreciation of HK$200,000. The machine is used with other assets to generate taxable operating income. For tax purposes, capital allowance of HK$300,000 has already been deducted in the current and prior periods and the remaining tax written value of HK$700,000 will be deductible in future periods, either as annual capital allowances or a deduction on disposal.

Required:

(a)     Is there any temporary difference associated with the machine? Explain your answer in detail.
(b)     How would your answer be different if the carrying amount of the machine is HK$500,000?

 

 

Question 10 – Temporary differences of liabilities
The balance sheet of a reporting entity has the following liabilities:
(1)     an interest payable with a carrying amount of HK$100,000, the whole amount of which will be deductible for tax purposes when it is paid;
(2)     a foreign currency loan payable with a carrying amount of HK$900,000. On initial recognition, the carrying amount of the foreign currency loan was HK$1,000,000. The carrying amount was subsequently reduced to HK$900,000 to reflect the change in exchange rates, that is, a foreign exchange gain was recognised. In accordance with the relevant tax regulations, exchange gains are taxable only when they are realised, that is, when the entity settles the foreign currency loan; and
(3)     interest received in advance with a carrying amount of HK$100,000, which has been taxed when the interest was received.

Required:

(a)     Is there any temporary difference associated with these liabilities? Explain your answer in detail.
(b)     How would your answer in a) for item 3) be different if the interest received in advance is not taxable, either when the interest was received or in the future period when the interest is recognised as revenue?
(c)     How would your answer in a) for item 3) be different if the interest received in advance has not been taxed when the interest was received, but will be taxed in the future period when the interest is recognised as revenue?

Question 11 – Measurement of Deferred Tax Assets and Liabilities
An item of property, plant and equipment was acquired in 2002 at a cost of HK$100,000,000. At 31 December 2006, the accumulated depreciation was HK$20,000,000 and the asset was revalued for the first time to HK$150,000,000. Depreciation charge for the year ended 31 December 2006 was HK$5,000,000.

The revaluation was disregarded for tax purposes and the cumulative depreciation for tax purposes at 31 December 2006 was HK$30,000,000. If the asset were sold for an amount greater than or equal to cost, the cumulative tax depreciation of HK$30,000,000 would have been included in the taxable amount, but sales proceeds in excess of cost would not be taxable (the asset is not subject to capital gain tax). Depreciation charge for the year ended 31 December 2006 for tax purposes was HK$10,000,000. Tax rate is 30%.

Required:

(a)     Account for any deferred tax arising during the year ended 31 December 2006, assuming that the carrying amount of the asset will be recovered through use.
(b)     How would your answer in 1) be different if the entity decided to dispose of the asset and the carrying amount of the asset will be recovered through sale (owner-occupation ended at 31 December 2006)?
(c)     How would your answer in 1) be different if the sales proceeds in excess of the cost of the asset would be taxed at 40%?
(d)     How would your answer in 2) be different if the sales proceeds in excess of the cost of the asset would be taxed at 40%?

Assume the entity has adopted HKAS 12 Income Taxes since 2002.
Explain your calculations where it is necessary.

Question 12 – Measurement of Deferred Tax Assets and Liabilities
An entity is in a jurisdiction where income taxes are payable at a higher rate of 50% on undistributed profits and a lower rate of 35% on distributed profits. The difference is refundable when profits are distributed. At the balance sheet date, the entity does not recognise a liability for dividends of HK$100,000 declared after the balance sheet date. Taxable income for the year is HK$1,000,000. The net taxable temporary difference for the year is HK$400,000.

Required:

How should the entity account for the current and deferred taxes in relation to the dividends in its financial statements for the current and subsequent period?