Income Tax

Which sub-topic are you looking at?

I don’t have a study text so you’ll need to give me more details of the question and how the matter has been dealt with

For example, is this a cash flow question or a question asking for preparation of the financial statements for a single entity

Alternatively, if it’s a past exam question, give me a name, a date and exam reference

First, it’s unlikely that the tax rate will be on a straight line basis – more likely to be reducing balance basis, particularly in an exam question

Next, it’s unnecessary to have a five year period to illustrate the principles – three years would be perfectly adequate

Next, there is an illustration of the principles in the course notes (Chapter 18 example 2)

Finally, if you set the example out in the format of the answer to example 2 and use your figures of $50,000, 25% straight line, 20% straight line and a 40% tax rate, you should be able to arrive at a solution where there is a build up of a deferred tax liability of $1,000 for each of the first four years and the elimination of that liability in the fifth year

Now, to get back to the original question – why is accounting depreciation added back but tax allowances are deducted?

Because that’s how the tax authorities prevent the manipulation of tax liabilities – if they put ALL businesses on the same footing (typically 25% reducing balance) it prevents different entities using a depreciation policy that would allow them to manipulate the tax liabilities (by being allowed to claim as a tax deduction, say, 100% of the cost of their assets in the first year)

So in a tax calculation, we always add back depreciation but then the Taxman allows us his version of depreciation in the form of tax allowances

I assume that you haven’t taken F6 yet!