Question

Milton Ltd is in the consumer goods industry. Its deferred tax liability at the end of the previous year
was $600,000 and this consisted of the tax effect of depreciation loss in excess of depreciation,
its only temporary difference then.
In the current year ended 31 December 20X7, Milton introduced a new range of consumer products where
goods are sold subject to warranty period of two years. In view of the uncertainty surrounding sales of the new
products, the directors of the company have decided to create a provision for product warranty account. The
provision provide for the year was $400,000.
For the year ended 31 December 20X7, the details of the non-current assets of Milton Ltd are as
follow: $
1.1.20X7 (Accounting)
Balance b/d :   Cost 400,000
                         Accumulated depreciation 100,000
31.12.20X7     Current year depreciation 100,000
1.1.20X7 (Taxation)
Balance b/d :   Cost 400,000
                         Accumulated depreciation loss 200,000
31.12.20X7     Current year depreciation loss 150,000
Income tax is 30%
Required:
Prepare the deferred tax account for the year 20X7.

Answer 1

In the present problem two issues are discussed.

1) Provision for product warranty: This provision is made in Company accounts for uncertainity in product returns in warranty period. As the revenue from these products is recognised in current period, so it may be justified for creating a provision for uncertain product warranties. If company comes across any product repairs/ returns under warranty terms than this provision amount can be used for such issues. If no products comes for repairs/ returns during warranty period then this provision can be reversed. But it is prudent to set aside certain expected amount from profits for such uncertain product returns/ repairs under warranties.Anyhow Income tax authorities doesnot recognise these kind of provisions as per Income tax law. They consider the expenses as and when the company incurs. So there comes a difference in the profit calculated as per Company accounts and its accounts as per IT law. So Here Deferred tax asset account is created for in the current period the company will end up in paying more tax compared to its Accounting records since it is already accounting for the provsion in accounting books and in future period the company need not pay higher tax or in other words it will be eligible for tax deduction for the expenses related to warranties.It will end up in lower tax in future periods.So the Defered tax asset is created with amount $ 400000× 30%=$120000 in Accounting records of the Company.

2)Depreciation: As we all know there are differences in the methods and rates of depreciation as per Income tax books for the company and as per Accounting rules for the company. So there are temporary differences and it will create Deferred tax. In the present situation already Company has DTL of $600000 at the end of previous year. So it is clear there is difference in current year depreciation. In the current year there is excess depreciation of $50000 as per Income tax records.This will end up in lesser tax as per Income tax records in current year and more tax in future periods for the current issue. So it will result in Deferred tax liability. This DTL will further increase in current period by $50000×30%=$15000. Since the DTL account already has $600000 balance and the present asset is shown having cost of $400000, so it is understood that this DTL Opening balance of $600000 is also pertaining to some other issues.