Question

Orca Ltd applies the principles of tax-effect accounting as per AASB 112/IAS 12 in accounting for company income tax. Orca Ltd calculates depreciation expense on its plant using the straight-line method, but applies an accelerated method for tax purposes. Tax depreciation in the current year is then larger than the related accounting expense..

Orca Ltd has also recognised rent received in advance from buildings that it owns. These revenues are included in the current year’s taxable profit but shown in the financial statements as a liability.

Required:

Determine how Orca Ltd should account for the above differences for accounting and tax.

Analyse under what circumstances Orca Ltd should raise deferred tax accounts and how they should be classified in the statement of financial position.

Answer 1

If tax depreciation is higher than the depreciation as per books of accounts (since Orca Ltd applies accelerated method for tax purposes), it implies that the taxable profit for tax purposes is lower when compared to the book profit. It further implies that Orca Ltd pays less tax currently, and will pay more tax in future. Since this is in the nature of a timing difference, this will result in the creation of deferred tax liability (DTL) in the books of accounts as on today.

Rent received in advance from buildings is in the nature of a permanent difference and will be ignored while creation of books of accounts as on today.

When the future benefits for which any deferred tax asset (DTA) is made is realised in future then the DTA is reversed and same for the DTL.

DTA, DTL is disclosed under a separate heading in the balance sheet separately from current assets and current liabilities and is reviewed at each Balance Sheet date and written-up/down to reflect the amount that is reasonably/virtually certain to be realised.