Question

Identify and explain the steps required in order to calculate deferred tax

BELOW ARE THE STEPS: -Determine the carrying amount of the asset/liabilities

-Multiply the temporary differences with the tax rates that are expected to apply

PROVIDE THE EXPLANATION

Answer 1

Answer :

Deferred Tax is the tax effect of temporary differences between Taxable income and Accounting income. To calculate deferred tax first to list out all assets and liabilities with their carrying amounts and then calculate tax base of respective assets and liability, then determine the relevant tax rate and calculate. Respective journal entries has to pass in the books after summarising the deferred tax.

Temporary difference = Carrying amount - Tax base

Deferred tax asset or liability = Temporary difference x Tax rate

Determining of Carrying Amount:

Carrying value is an accounting value based on the figures in the respective company's balance sheet. Listing this out and tax base if deducted we will get temporary difference.

Deferred Tax Liability / Asset:

Now multiply the tax rate with the temporary differance to get the defferred tax liability / asset.

Respective journal entries to be passed for Deferred tax liability and Asset. The entries shall be as under:-

Deferred Tax Asset A/c -- (DR)

To Profit & Loss Account (CR)

(For Deferred Assets )

Profit & Loss A/c (Dr)

To Deferred Tax Liability A/c

(For Deferred liability)

Example for a Deferred Asset is suppose a depreciation @ 30% is used for tax purposes while @ 25% is used for accounting purposes, it will create a difference in actual tax paid and tax on the Income statement. Then, the Company will record deferred tax assets (DTA) in the balance sheet.

Example for a Deferred Liability: An oil company with a 20% tax rate that produced 12,000 barrels of oil at a cost of $15 per barrel in year one. In year two, due to rising labor costs, the company produced 12,000 barrels of oil at a cost of $18 per barrel. If the oil company sells 12,000 barrels of oil in year two, it records a cost of $1,80,000 under FIFO for financial purposes and $2,16,000 under LIFO for tax purposes. The $36,000 is a temporary difference that gives rise to a deferred tax liability of $7,200 ($36,000 × 20%).