Question

Question 3
Part a
JKL Ltd bought an item of equipment at $4 million on 1 January 2017, it had estimated life of 8 years and residual value at $800,000. The equipment was depreciated on straight line basis. However, the Inland Revenue Department does not allow depreciation as deductible expenses. Instead, tax expenses of this type of asset can be claimed against income tax in the year of purchase and 20% per annum (on reducing balance basis) of tax base thereafter. The rate of income tax was taken as 25 %.

Required
In respect of above items of equipment, calculate the deferred tax charge (i.e. tax expenses) or tax credit (i.e. tax benefit) in JKL Ltd’s books for the year ended 31 December 2019 through the journal entry.
Note: Extract of income statement is not required

Part b
Why did companies provide for deferred tax items in its financial statement? (Total 15 marks)

Answer 1

Solution:

Part - A

Journal Entry

Working Note:

Part - B

Why did companies provide for deferred tax items?

When companies record some expenses or incomes in its books of accounts and as per tax laws, there is a different treatment for that same expenses of incomes then deferred tax is brought into accounts to make clear picture of current tax and future tax as per matching concept of accounting. Like if we take some advantage of any tax law provision and pay less tax in current year, we may have to pay tax in future on that advantage being reverse. In the same way if we have to pay more tax by not allowing any expense in current year, it will be allowed in future and have to pay less tax.

So due to these different treatment of expense or income in income tax, there would be difference in book profit and taxable profit. There would also difference in between tax expense as per books and actual tax payable to tax department. This difference will be called as Deferred Tax Assets or Liabilities as per situation.

Deferred tax is being only calculated on temporary difference not on permanent difference. Temporary difference means there is a difference of treatment which will be reversed in future. If difference will not be reversed in coming future then it is called as permanent difference and no deferred tax will be created.