March/june 2017 holly co

I do not have immediate access to this Q & A but as you may be sitting the exam on Monday I am replying now in relation to the topic – rather than the specific question – for expediency.
You must know from FR (F7) the basic principles of deferred tax. Temporary differences will arise between the carrying amount of an asset and its tax base. Let’s say that an asset costs $10,000 in 20X6 and is depreciated on a straight-line basis over 4 years and capital allowances/tax allowable depreciation is 25% of the carrying amount (i.e. equivalent to reducing balance).There will be no temporary difference as at 31/12/20X6 because the carrying amount of the asset in the FS will be $7,500 and the tax base will also be $7,500. As at 31/12/20X7, the carrying amount will be $5,000, but the tax base will be $5,625 (i.e. $7,500 – 25% x $7,500). This means that there is a tax deductible temporary difference of $625. If the tax rate is 30%, this would reduce an overall deferred tax liability/increase an overall deferred tax asset by $187.50 (i.e. 30% x $625).
But now let’s suppose that in 20X7, management decided that the useful life of the asset is not 4 years (i.e. remaining useful life 3 years), but 6 years (i.e. remaining useful life 5 years). This would not affect the tax base (still $5,625) but the carrying amount would now be $6,000 (i.e. ($7,500 – 1/5 x $7,500)). There is now a taxable temporary difference of $375 (i.e. $6,000 – $5,625) which would increase an overall deferred tax liability/reduce an overall deferred tax asset by $112.50.
Please refer to Chapter 15 of the FR notes if you need to refresh your memory further.