Question

Question 3.

Castle Towers Ltd reported the following assets and liabilities in its draft balance sheet as at 30 June 2017, and profits before tax in its draft income statement for the year ending 30 June 2017. Both the financial year and tax year end on 30 June. The tax rate is 30 per cent, and the company meets its own tax obligations. The company has not yet completed its tax effect entries.

Required: Provide the relevant journal entries to account for the tax effect of each of the following on 30 June 2017, showing your calculations:

(a) Reported machinery in the balance sheet with $80,000 carrying value. The notes to the accounts revealed that the cost of machinery was $100,000 and accumulated depreciation was $20,000. For tax purposes machinery is depreciated over four years on a straight-line basis, and there is no expected salvage value.

(b) Reported interest revenue that was received in advance, in the balance sheet of $50,000. The revenue for accounting purposes relates to the financial year ending 30 June 2018. The Australian Taxation Office taxes revenue when it is received.

(c) Reported provision for warranty repairs in the balance sheet of $20,000. No provision was paid during the year. There were no provisions for warranty repairs in previous years.

(d) Reported buildings were revalued at 30 June 2017 to $450,000. At that time the tax base of buildings was $350,000.

(e) Reported accounts receivable (net) in the balance sheet of $35,000. The notes to the accounts revealed that there was an allowance for doubtful debts of $5,000. During the year debts written off as not recoverable were $2,000.

(f) Reported a loan in the balance sheet of $70,000. The repayment of the loan is not deductible.

(g) Reported profits before tax for the year ending 30 June 2017 are $500,000. Notes to the accounts revealed that in the year ending 30 June 2016, the company incurred an accounting loss of $200,000.

Answer 1

a) Deferred tax liability
WORKING

Particulars	Books of accounts	Tax return
Income	500000	500000
Depreciation	20000	25000
Pretax Income	480000	475000
Tax (30%)	144000	142500

JOURNAL ENTRY

Account	Debit	Credit
Current tax expense	144000
Deferred Tax expense	1500
Income tax payable		144000
Deferred tax liability		1500

b) Income received in advance
Since The Tax Office taxes revenue when it is received irrespective of when it is earned,book profit is nil while taxable income is $50000. Deferred tax asset needs to be created.

Account	Debit	Credit
Deferred Tax Asset	15000
Deferred Tax expense		15000

c)Provision on warranty
Such provision is taxable as the provision in itself does not lead to actual loss or cash outflow until such time the repair actually has to be done and cost incurred. Differences in accounting income and taxable income create timing differences so Deferred tax asset has to be created

Account	Debit	Credit
Deferred Tax Asset	6000
Deferred Tax expense		6000

d)Difference in valuation of buildings
Revaluation of building has increased its value compared to tax base. When the asset is sold the book profit will be greater than taxable income, hence, Deferred Tax Liability has to be created.

Account	Debit	Credit
Deferred Tax expense	3000
Deferred Tax Liability		3000

e)Bad Debts
The provision for bad debts is $5000 but actual bad debts written off is only $2000. This means book profit is more than taxable profit by $3000 with respect to which a deferred tax liability will be created

Account	Debit	Credit
Deferred Tax expense	900
Deferred Tax Liability		900

f) Repayment of loan
Repayment of loan is not deductible. It has no tax consequences. Tax base is $70000

g)Carry forward of losses
Prior period loss carried forward reduces current period profit in books as compared to current period taxable income. Hence deferred tax asset needs to be created

Account	Debit	Credit
Deferred Tax asset	6000
Deferred Tax expense		6000