Question

Adam & Smith Ltd purchases a machine on 1/07/2019 for $450,000. Expected life is 6 years using straight-line method and no residual value. For tax purposes, ATO allows the company to depreciate over 5 years. The profit before tax of the company for the year ended at 30 June 2020 is $550,000. Tax rate is 25%. Required: a) What is the amount of the temporary difference? Does this give rise to a deferred tax asset or a deferred tax liability? Provide relevant journal entries that relates to the temporary difference at 30 June 2020. b) Determine the taxable profit and the taxes payable and provide relevant journal entries at 30 June 2015. c) Provide one example of temporary differences that create a deferred tax asset and one example of a deferred tax liability. (7 marks. Word limit for part c: minimum 120 to maximum 250 words)

Please provide unique answer from others.

Answer 1

a)

Depreciation for Tax purpose = 450000/5 = 90000

Depreciation for Accounts purpose = 450000/6 = 75000

Temprory Difference = 15000

As Depreciation is less as per accounts purpose , tax will be more as per accounts purpose .

Therefore Tax Payable will be more , But we save now and pay later , So it is a Deferred Tax Liability.

Journal Entries :

Depreciation a/c Dr 90000

To Machine a/c 90000

P&L a/c Dr 90000

To Depreciation a/c 90000

b)

Taxable profit = 550000-90000=460000

Tax Payable as per accounts = 460000*25/100 = 115000

>Tax Payable A/C Dr 90000

To bank a/c 75000  

To Deferred Tax Liability a/c 15000

>P&L a/c Dr 90000

To Tax Payble a/c 90000

c)

DTA – Suppose, book profit of an entity before taxes is Rs 1,000 and this includes provision for bad debts of Rs.200. For the purpose of tax profit, bad debts will be allowed in future when it’s actually written off. Hence taxable income after this disallowance will be Rs. 1200 and let’s say income tax rate is 20% then the entity will pay taxes on Rs. 1200 i.e (1200*20%) Rs. 240.

If bad debts were not disallowed, entity would have paid tax on Rs. 1000 amounting Rs 200 i.e 1000*20%. For the additional Rs. 40 which is already paid now, we have to create DTA. Entry for recording the DTA is as under:

• Deferred Tax Asset Dr 40
• To Deferred Tax Expense Cr        40

(Being DTA of Rs. 40 accounted in the books)

DTL – Common example of DTL would be depreciation. When the depreciation rate as per the Income tax act is higher than the depreciation rate as per the Companies act (generally in the initial years), entity will end up paying less tax for the current period. This will create deferred tax liability in the books: