Question

1. What are the main principles of tax effect accounting?

2. In relation to tax effect accounting, what is a deductible temporary difference? Give two examples of deductible temporary differences.

Answer 1

Principle of Tax effect Accounting

According to matching concept, Income tax is accrued in the same period as the revenue and expenses to which they relate.

In some cases, taxable income may be significantly different from the accounting income.

The principle of tax effect accounting is that, irrespective of when the tax effect will occur, the tax consequences of transactions that occur in one period should be recognized in the profit or loss of the period.

The principle of tax effect accounting is how to account current and future tax consequences of

1. The future recovery or settlement of the carrying amount assets or liabilities that are recognized in the financial statement

2. Transactions and events of the current period that are recognized in the financial statements.

Deductible temporary differences

Deductible temporary differences are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. These are temporary differences that will be deducted in future when computing the tax liability. This will reduce tax liability.

Example of Deductible temporary differences

1. An entity may provide provisions for long service employee benefits such as gratuity in accounting . The accounting provision is made as and when the liability accures, but a tax deduction will be given only when the payment is made. This gives rise to a future tax saving; that is, less tax will be paid in the future. Assume an entity provide for gratuity $ 10000 in accounting. Tax rate 30%. The Tax base of the liability is NIL. In settling the liability for its carrying amount, the entity will reduce its future taxable profits by $10000 and consequently, reduce its future tax payments $ 3000 ie $10000*30%. The difference between the carrying amount of $10000 and the tax base of NIL is a deductible temporary difference

2. Account receivable of an entity is $ 100 000 as at 31^st December 2019, however entity now has a provision for doubtful debts at 31^st December 2019 of $ 5 000. The balance in the provision for doubtful debts of $ 5000 has already been recorded as an expense for the purpose of accounting. A tax deduction is only be allowed when the doubtful debts proves to be uncollectible. So an entity can claim a future deductible amount up to the amount of the balance of the provision for doubtful debts.