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In: Accounting

Part C Question 3 Accounting for Income Taxes                                   

Part C Question 3 Accounting for Income Taxes                                                   

Reed Ltd is a manufacturer of surfboards which commenced operations on 1 July 2019. The Statement of Comprehensive Income and the Statement of Financial Position were compiled on 30 June 2020. The following information was available:

Statement of Comprehensive Income for the year ended 30 June 2020

  $                      $

Sales

430,000

Less

Cost of Goods Sold

130,000

Administrative expense

    70,000

Warranty expense

60,000

Depreciation- machine

    40,000

Insurance expense

   20,000

   320,000

Profit before income tax

110,000

Following information was extracted from the Statement of Financial Position at 30 June 2020:

2019

2020

Prepaid insurance

24,000

36,000

Machine

400,000

400,000

Less: Accumulated depreciation

40,000

80,000

Provision for warranty

34,000

28,000

Other information was available for the year ended 30 June 2020:

  1. Sales are recorded for income tax purpose at the time the sales are made.
  2. Cost of Goods Sold and administrative expense incurred have been paid. They are allowed as a tax deduction at the year end.
  3. Warranty expense was accrued. Deduction for income tax purpose is available only when the amount is paid.
  4. The machine was purchased two years ago at a value of $400,000. It is depreciated evenly over its useful life and it has no residual value. The useful life is ten years based on accounting policy, but it is depreciated over eight years according to the taxation rule.
  5. Insurance is allowed as a tax deduction when it is paid.
  6. Income tax rate is 30%.

Required: (Narrations are not required in this question)

  1. Determine the amount of taxable income for the year ended 30 June 2020.
  2. Determine the amount of income tax expense for the year ended 30 June 2020.
  3. Prepare a journal entry to record current tax liability on 30 June 2020.
  4. Determine the amount of tax base for machine.
  5. Determine the amount of temporary difference for machine.
  6. The temporary difference for machine is deductible in this question, is this correct? Explain.
  7. Provide journal entry to record DTA or DTL for machine.

Solutions

Expert Solution

(a) Statement showing taxable income of Reed Ltd.
for the year ended 30th June, 2020
Particulars Amount
Profit before income tax (as per books) 110000
Add:
Warranty expense 60000
Insurance expense 20000
Depreciation on machine (as per accounting policy) 40000 120000
230000
Less:
Warranty paid -66000
Insurance paid -32000
Depreciation on machine (as per Taxation rule) -50000
Taxable income 82000
(b) Income tax expense for the year ended 30th June, 2020
Taxable income 82000
Tax Rate 30%
Tax expense 24600
(c) Journal entry to record current tax liability
Income tax expense Dr 24600
     To Income Tax payable 24600
(being tax expense for the year 2019-2020 recorded)
(d) Calculation of tax base of machine
Cost 400000
Life as per Tax rules 8
Depreciation allowable per year 50000
Life utilized of machine 2
Depreciation allowed for 2 years 100000
Tax base of machine on 30th june, 2020 300000
(e) Calculation of temporary difference of machine
Cost 400000
Accumulated depreciation (in books) 80000
Carrying value on 30th June, 2020 320000
Tax base of machine on 30th june, 2020 300000
Temporary difference of machine 20000
(f) Temporary difference arises when there is difference between tax base and
carrying value of an asset or liability.
Temporary differences can be of two types:
1. Taxable temporary difference. These differences give rise to deferred tax liability.
2. Deductible temporary difference. These differences result in deferred tax asset.
In the given question, the temporary difference is not deductible as the amount of
tax base is lower than the carrying value of machine.
This means that it is a taxable temporary difference as it will result in a taxable amount in
future while determining the taxable income when the life of machine will be utilized
completely. It will result in deferred tax liability in the current period.
(g) Journal entry to record deferred tax liability
Income tax expense Dr 6000
     To deferred tax liability 6000
(being deferred tax liability recognised)
OR
Profit and Loss a/c Dr 6000
     To deferred tax liability 6000
(being deferred tax liability recognised)

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