-: So in this session we want to continue our focus
on part A, income tax fundamentals,
but now we're switching to deferred tax
which serves it's own attention
because it's a pretty complicated area,
and this ties in with objective two.
Respect to current and deferred tax assets and liabilities.
Now we're actually going to come back to this idea of
temporary differences during this session.
This is the key here, objective two, deferred tax.
The key table that this part of the module refers to
is table 4.4
and I'm going to go through it with some made up examples
step by step by step
to help you really understand this area well.
So step one, we need to work out what's called the tax base
of assets and liabilities.
And the way I describe this is,
we have our accounting books and then we have
our hypothetical tax books.
So if we were keeping a list of assets and liabilities
for tax purposes, that's what we are doing here.
And the benefit of doing this is it helps us
visualise the differences,
and then we create the temporary differences,
that leads us to the deferred tax assets
and the deferred tax liabilities.
So if we're keeping two accounting books,
we've bought ourselves a tractor, 120000 dollars,
for depreciation, in the accounting books,
five years of depreciation so we divide 120000 by five
and that's going to write off at the end of five years, zero.
For tax purposes, in our tax books,
we're going to write it off over four years, 25% payment.
So it's going to be different every year
until the fifth year, it'll be identical.
So it's going to create temporary differences.
Lets take a look.
Here is the step 1, what is our tax base?
We have an opening balance of 120000 dollars.
Now at the end of one year, what is going to happen?
We're going to have 25% depreciation
because we're depreciating it over four years,
25% is 30000 dollars,
so our depreciation is 30000,
our closing balance in our tax books,
that TB is tax base,
so we're determining the tax base in our tax books.
If I have this in my balance sheet, in my tax books,
90000 at the end of year one.
Now, what about my accounting books?
Well for the accounting name we call it the CA,
the carrying amount.
So always remember, carrying amount, accounting books,
TB, tax base, tax books.
Well it cost exactly the same amount,
carrying amount, tax base to start with,
but I am only depreciating this over five years,
so 120000 divided by five
gives me a 24000 dollar movement.
My closing balance of my CA, my carrying amount,
is 96000.
So I've now determined the tax base,
and now I'm going to compare it to the carrying amount
and you can see that there's a difference here.
So what's my difference?
My difference is 6000 dollars
and this is because of the depreciation schedule
that's in place.
Now this will disappear at the end of five years.
So, now that we have the temporary difference
we work out the deferred tax assets,
and the deferred tax liabilities that arise.
So here's our TD, our temporary difference,
and we have a 6,000 dollar difference
and we multiply it by the tax rate, by 30%,
to give us the deferred tax.
Now is it a deferred tax asset or a deferred tax liability?
We'll look at that in a minute.
In this case, step four,
now we actually only cover step four when we get to part B
but this is the journal entry,
the recognition of the situation.
So step four says recognise the movement
in the DTA's and the DTL's.
So which one did we have?
In this case we a deferred tax liability.
Why do we have that?
Because it is a taxable temporary difference.
Lets go back a step.
In our tax books, our closing balance is 90000
because our depreciation is higher,
our depreciation is 30000 not 24000 so if we depreciate,
that's going to push our taxable profit down.
If our taxable profit goes down, we pay less tax
compared to if we were paying tax on our accounting profit.
If we pay less tax now,
when this temporary difference disappears
at the end of five years,
we're going to end up paying more tax later on.
If we pay more tax later on,
we're going to have a liability to pay that tax
so that is our deferred tax liability.
So here's some definitions or terms
and I've explained some of them already.
The carrying amount,
that is the accounting treatment of an item.
Or it's just like in the accounting books,
we call it the carrying amount.
In this case the tractor, it cost 120000.
That was the carrying amount at the start.
Then we depreciated it
and our closing balance for accounting purposes
is the carrying amount, 96000.
Going back to example 4.1,
our accounting profit was shown here,
this is from the accounting books,
the carrying amount helped us determine things like
depreciation.
Then we get our tax books,
and this is where we talk about the tax base,
the tax treatment of an item.
Opening balance, 120,
our depreciation is based over four years,
so our closing balance is 90000 dollars.
From there, we would see this going back to example 4.1,
the numbers that went in to,
for example calculating here,
so these are our tax books, the tax base.
Now we're getting to this idea of the temporary differences.
So, the temporary differences.
What happens is,
when we compare our carrying amount, accounting books,
with our tax base in the tax books,
if they are different we need to deal with that.
It's temporary difference if they reconcile at the end.
And why will these reconcile at the end?
Well we are going to depreciate that 120000 tractor to zero,
so regardless of tax or accounting,
they will both end up at zero,
then there will be no difference between them.
So it's only temporary each year
because of the different depreciation rates.
So what we have here is a temporary difference,
but what type is it?
And going back to example 4.1,
there was a difference in depreciation of 2000 dollars.
So, example 4.1,
higher tax depreciation is a greater expense,
greater expenses push down the profit.
So if your tax expense, tax depreciation is higher,
your taxable profit is lower,
you will pay less tax now.
You'll end up paying more later as a result,
so less tax paid now but more tax paid later
is going to give us a deferred tax Liability.
Later, deferred, and we're going to pay more tax,
that's an outflow of resources,
we have an obligation to pay out more tax,
deferred tax liability.
So these are called a taxable temporary difference.
Then we have something called a
deductible temporary difference
and this is going to give us the opposite,
a deferred tax asset.
So revenue received in advance,
a customer gives you money now
but you haven't delivered the goods.
From a tax office department perspective
they want you to pay tax immediately on that amount.
From an accounting perspective, it's not even revenue yet,
so you're going to pay more tax now but less tax later on.
So if you're going to pay less tax later on,
you are going to have a benefit there,
that is going to give you a deferred tax asset.
So then we have our non temporary differences.
Things like fines and penalties or entertainment expense,
and this is not a deferred tax so be very careful here.
Going back to example 4.1,
there were 3000 in expenses
that were linked to entertainment, not deductible.
So that's a detailed explanation of those first four steps.
Now part A of module four takes you through
these three steps,
and then part B takes you through step four,
and then part C takes you through step four
when we deal with re-evaluations of assets,
so it gets very very complicated.
Our calculation, deferred tax.
Deferred tax feeds into our tax expense calculation
and we need to know our deferred tax
so we work out our temporary difference
between all of our assets and liabilities
and multiply them by the tax rate.
So I'm going to build up a flow chart
that helps you remember every single step we've covered.
So we started off module four by looking at
what is current tax?
And we took the taxable income multiplied by the tax rate.
Now how do you do that?
You do that by taking the accounting profit,
and then you adjust for all of the differences,
things like different depreciation rates, entertainment,
fines and penalties,
so we deal with our non-temporary differences.
And if you did the task flower limited,
this was this situation here.
So step one, deal with current tax.
Then we move into, there's a summary there,
so working out our taxable profit.
Get your accounting profit,
adjust it for temporary and non-temporary differences
and do the calculation.
So current tax, going back to our original formula,
tax profit is not accounting profit.
We must work out our taxable profit
by adjusting the accounting profit,
and multiply it by the tax rate.
So that's the first section of module four,
now we're dropping into the bottom half of it,
deferred tax.
So we need to work out the carrying amount,
and the carrying amount, we looked at that,
the accounting books, we did that with the tractor.
Then you get the tax books,
and you work out the difference there.
And that's going to adjust because of things like depreciation.
Here's another example to take you through step by step.
You have a motor vehicle and it's WDV,
it's written down value is 20000 dollars.
How did we get there?
50000 cost, 30000 accumulated depreciation,
so that is our carrying amount, 20000 dollars.
But for tax purposes,
it's only being held at 10000.
So for tax purposes we call it the tax base.
50000 original amount less 40000 of
tax accumulated depreciation, 10000.
So, what is the tax base?
10000.
Compare the tax base with the carrying amount,
the carrying amount is 20000.
To determine the temporary differences.
So what's our difference here?
Is it a temporary difference deductible?
Or is it a taxable temporary difference,
which way does it fall?
We are going to pay less tax now, why?
Because our accumulated depreciation,
our accelerated depreciation each year,
is greater for tax purposes.
See, we've got 40000 worth of depreciation
versus 30.
More depreciation has lowered our tax profit,
so we pay less tax now.
We are going to pay more tax later as a result
when the temporary differences reconcile,
so that means we've got a taxable difference.
So if we have a look here, taxable temporary difference.
And because we're going to pay more tax later,
that is going to lead to a liability amount.
So, we have a taxable temporary difference,
a higher tax depreciation reduces taxable profit
so less tax payable now, more tax payable later,
therefore DTL.
I try and talk through these step by step
because I want you, as you do questions,
to actually have this self talk.
Oh I've paid more tax now, I'm going to pay less later,
DTL recognise like this.
Or I've paid too much tax now, I'll pay less later,
I'm going to get a benefit, so how does it work?
So the more you can talk through the steps and explain it
rather than just trying to memorise calculations,
the more effective you'll be.
So our temporary difference is 10000,
that was the difference between the 20000 carrying amount
and the 10000 dollar tax base.
So, tax base ten, carrying amount 20,
so the temporary difference is ten,
multiply this by the tax rate
and that will give us the deferred tax asset,
deferred tax liability, that's step three.
So we measure it at 3000, how do we get that?
So multiply it by the tax rate
and we know it's a DTL
because it's a taxable temporary difference
because we're going to pay more tax later
because it'll reduce that taxable profit now.
So step four we look at more in part B
but what's the journal entry?
Debit, what we call DTE, deferred tax expense,
credit, DTL, deferred tax liability.
Now the one thing to be very careful here,
it's 3000.
The total difference between the two items was 10000
but that is the temporary difference.
From there we have to measure the tax asset or tax liability
by multiplying the difference by 30%.
So here's example 4.3, that helps you practise this again.
The employee benefits expense was 20000.
Now I've mentioned earlier that the tax department
normally doesn't let you recognise an expense
until you pay out the cash, but for accounting purposes,
if we have a provision for annual leave
or long service leave,
we have to recognise that,
otherwise our expenses would be understated
and we wouldn't be showing a true picture.
So, we have employee benefits expense of
20000 dollars unpaid,
so we have a liability attached.
So what is the tax base of the liability?
In the accounting books, we have a 20000 dollar liability,
but in the tax books there's nothing there.
There's no journal entry to recognise this
because you cannot recognise this expense
or the liability for tax purposes.
It doesn't exist until it's paid.
So our tax base is zero.
So if we have a zero tax base
and a 20000 dollar liability for accounting purposes,
what's the difference?
The temporary difference is 20000.
Why is it temporary?
Because next year when you pay out the 20000
you'll get a tax deduction.
For accounting purposes you've already acknowledged it
so you won't recognise it again
and therefore it will balance out over time.
Don't forget to adjust the temporary difference
by the tax rate.
So our temporary difference of 20,
gives us a DT, a deferred tax item of 6000.
Now in the motor vehicle example
we had a DTL, a deferred tax liability,
but now we have a DTA, recognised deferred tax asset.
So two things to note,
firstly now we do the debit to the asset,
previously it was a credit to the liability,
and have a look at the account name,
deferred tax income, why?
Because this is a good outcome for the organisation.
So previously when you recognise a DTL,
we had a deferred tax expense, debit DTE.
Now deferred tax income and deferred tax expense
are really an identical account.
It's a bit like GST.
Often in a business you have GST receivable and payable,
but it's really just one account.
You can call this deferred tax expense,
you can call it deferred tax income,
it's combined together and netted off
but this is just helping explain it clearly.
So why do we have a DTA?
Because for tax purposes we do not recognise this expense,
so our tax profit is going to be higher,
'cause this has been ignored,
and if our profit is higher,
we will pay more tax now but less tax comparatively later
so therefore we have this benefit,
the benefit will give us the DTA.
So I hope you found that overview of
the first couple of steps useful
and we will start climbing into more of the other steps
short--