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- July 27, 2017 at 6:39 pm #399055
Hi Mike!
I am actually having some serious issues understanding the concept and ideas of deferred tax? Specially temporary differences( depreciation/ tax allowances). What does that mean?
Could you explain what it is all about and how do we account for it?
Thanks.
July 27, 2017 at 6:54 pm #399058Timing differences … the taxman doesn’t like depreciation because different entities will use different rates for writing off their assets. So taxman says “We’re not going to allow you to claim depreciation as a tax deductible expense. However, we shall allow you to claim our equivalent capital allowances (typically at the rate of 25% reducing balance)”
So we have an asset that we are depreciating over 5 years at 20% per annum straight line and the taxman is only allowing us 25% reducing balance
Asset cost $1,000
Carrying value after 1 year $800
Tax value after 1 year $750
Difference +$50
Carrying value after 2 years $600
Tax value after 2 years $562.50
Difference +$37.50
Carrying value after 2 years $400
Tax value after 2 years $421.87
Difference -$21.87
The deferred tax provision is accounted for as recognition of the fact that tax will be payable on, for example, a revaluation surplus when the asset is eventually sold
So you’re normally given the difference between the tax written down values and the carrying values of the assets and there there is a difference – a temporary timing difference
And when that difference crystallises by way of sale, that’s when tax is payable on the element of the gain that is taxable
Here’s what you do:
Open up 2 T accounts, one for deferred tax (DT) and one for current tax (CT)
Put in the figures brought forward as per the trial balance (that is usually the case for questions where deferred tax is an issue)
Be CAREFUL! Put in those brought forward figures from the trial balance but make sure that, if the figure is in the debit column of the trial balance, you put it on the debit side of the relevant T account
The question will either tell you the deferred tax provision to carry forward or tell you the increase in the timing differences (so you can then calculate the increase in the deferred tax provision necessary (tax rate x increase in timing differences))
One way or another you can calculate the deferred tax provision to carry forward
Put that figure in the DT account
Occasionally some of that increase in timing differences is because of a revaluation that has taken place during the year. The tax related to that revaluation is sometimes (not always) credited from DT account and debited to Revaluation Reserve.
A question will normally guide you on that. If it isn’t to be debited to Revaluation Reserve, the question may say something like “Tax on the revaluation is to be expensed through profit or loss”
That deals with the DT account so now balance it off and double enter the balancing figure to the CT account
Can you do the rest?
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