Question

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.

Answer 1

(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)