1. Accounting for Income Taxes AASB 112

2. Overview  Purpose of AASB 112  Key Concepts  Practical Case Studies

3. Purpose of Standard  All profit motivated entities are required to calculate income tax payable and record the expense in their income statement  AASB 112 has universal application for entities that have taxable income  AASB 112 provides the “direction” to calculate income tax expense

4. Basis – Balance Sheet Approach  Uses a liability method and adopts a balance sheet approach.  This assumes recovery of all assets and settlement of all liabilities have tax consequences and these consequences can be estimated reliably and are unavoidable  AIFRS has different recognition criteria than those set out under tax legislation

5. AASB 112 Challenges  Scope - What is income tax?  Measurement – tax base issues  Recognition – the probability test

6. What is Income Tax?  Does it matter?  Includes all taxes based on taxable “profits” What’s In?What’s Not In?  Income taxes (including withholding taxes)  Income tax equivalents (public sector)  CGT  Royalty taxes on net profits (petroleum resource royalty tax)  Excise taxes  GST  Royalty taxes on revenue

7. Differences A-GAAP and A-IFRS Terminology differences: A-GAAPA-IFRS  Timing difference  Permanent difference  Provision of income tax  Future income tax benefit  Provision for deferred income tax  Temporary difference  - (no direct equivalent)  Current tax liability  Deferred tax asset  Deferred tax liability

8. Differences A-GAAP and A-IFRS  New recognition exceptions  Different recognition criteria for deferred tax assets  Taxes can be recognised directly in equity and as part of a business combination TypeA-GAAPA-IFRS Timing/temporary difference Tax losses/credits Beyond any reasonable doubt Virtually certain Probable

9. Measurement – A Balance Sheet Focus  What determines Tax Base, DTAs/ DTLs? Variables in AASB 112Variables in Tax Act  Initial recognition rule  Management intent  Special rules re:  Business combinations  Investment in subs and associates  Share based payments  Taxable vs. Exempt  Revenue vs. capital  Range of tax relief: 0 – 100%  Floating cost bases

10. Key Terms Carrying Value – the value of assets and liabilities as determined under AIFRS Tax Base – Value that each asset and liability has for tax purposes. i.e. the amount that is allowed for tax purposes Temporary Difference – the difference between the carrying value (AIFRS) and the tax base (tax value)

11. Two Approaches  Simple Approach  Complex  Tax Effect Accounting (aka Deferred Tax)

12. Simple Approach  An entity (company) is required to pay tax on its taxable income in accordance with the ITA Act  Income tax is an expense  Tax is payable to the ATO is a liability

13. Simple Approach  Current tax payable = Taxable income x company tax rate Dr. Income Tax Expense xxx Cr. Income Tax Payablexxx

14. Simple Approach ASR Inc purchased a machine purchased at a cost of $600,000 and has a useful life of 4 years and no salvage value. For tax the machine is depreciated over 3 years. Accounting profit is $500,000 for each of the next 4 years. Tax rate is 30%. Calculate income tax payable for years 1 – 4

15. Simple Approach Calculation of Taxable Income (Year 1- 3): Accounting profit$500,000 Add: Depreciation – accounts150,000 Deduct: Depreciation - tax(200,000) Taxable income450,000 Tax Rate30% Income tax payable$135,000

16. Simple Approach Calculation of Taxable Income (Year 4): Accounting profit$500,000 Add: Depreciation – accounts150,000 Deduct: Depreciation - tax0 Taxable income650,000 Tax Rate30% Income tax payable$195,000

17. Simple Approach - Current Tax Payable YearITP 1135 2 3 4195 600

18. Income Tax Expense – AASB 112 [5] Income Tax Expense =  Current tax expense (current tax income) Plus/(Minus)  Deferred tax expense (deferred tax income)

19. Complex Approach – Deferred Tax  Deferred taxes result from timing differences  AASB 112 requires the balance sheet approach to be used to calculate income tax expense in the income statement  This approach takes into account the difference between accounting income and taxable income  Taxable income does not equal accounting income

20. Deferred Taxes - Calculation Recognition and measurement of deferred taxes The future tax consequences of recovering or settling the carrying amount of an asset or liability Deferred tax Deferred taxes arising from temporary differences Carrying amount Tax Rate Deferred tax Asset/liability Tax Base Temporary Difference Temporary Difference = = x - Deferred taxes arising from carried forward tax losses Deferred Tax Asset Unused tax lossesTax Rate x=

21. Temporary Difference Machine purchased at a cost of $600,000, has a useful life of 4 years and no salvage value. For tax the machine is depreciated over 3 years. Tax rate is 30%. At end of year 1: Carrying Value $ Tax Base $ Temporary Difference $ Machine – cost 600,000 Acc Depr150,000200,000 450,000400,00050,000

22. Deferred Tax Machine purchased at a cost of $600,000, has a useful life of 4 years and no salvage value. For tax the machine is depreciated over 3 years. Tax rate is 30%. At end of year 1: Carrying Value $ Tax Base $ Temporary Difference $ Machine – cost 600,000 Acc Depr150,000200,000 450,000400,00050,000 Tax rate30% DTL15,000

23. Deferred Tax Machine purchased at a cost of $600,000, has a useful life of 4 years and no salvage value. For tax the machine is depreciated over 3 years. Tax rate is 30%. At end of year 3: Carrying Value $ Tax Base $ Temporary Difference $ Machine – cost 600,000 Acc Depr450,000600,000 150,0000 Tax rate30% DTL45,000

24. Complex Approach – Deferred Tax Calculation of Taxable Income (Year 1- 3): Accounting profit$500,000 Add: Depreciation – accounts 150,000 Deduct: Depreciation - tax(200,000) Taxable income450,000 Tax Rate30% Income tax payable$135,000

25. Complex Approach – Deferred Tax Calculation of Taxable Income (Year 4): Accounting profit$500,000 Add: Depreciation – accounts150,000 Deduct: Depreciation - tax0 Taxable income650,000 Tax Rate30% Income tax payable$195,000

26. Deferred Tax - Example Machine purchased at a cost of $600,000, has a useful life of 4 years and no salvage value. For tax the machine is depreciated over 3 years. Accounting profit is $500,000. Tax rate is 30%. At end of year 1: YearITEITPDTL 115013515 215013515 315013515 4150195(45) 600 0

27. Temporary Differences  Arise due to the different recognition of expenses and revenues in different periods between the ITA Act and AIFRS  Generally the ITA Act will not allow recognition until a cash flow has occurred  Temporary differences occur between the two measures which “balance out” over time (they reverse!)

28. Activity What types of differences have you encountered?

29. Activity Case Study

30. Temporary Differences - Classification  Deferred Tax Asset (DTA) – result from Deductible Temporary Differences or  Deferred Tax Liability (DTL) – result from Taxable/Assessable Temporary Differences

31. Assessable Temporary Difference Temporary differences that will result in an increase in income tax payable in future reporting periods when the carrying amount of the asset or liability is recovered or settled. (Gives rise to DTLbecause tax is paid in the future) Examples:

32. Deductible Temporary Difference Temporary differences that will result in a decrease in income tax payable in future reporting periods when the carrying amount of the asset or liability is recovered or settled. (Gives rise to DTA because tax is paid now and recovered in future periods) Examples:

33. Classifying Temporary Differences DTLDTA Asset carrying amount > Tax BaseX Asset carrying amount < Tax BaseX Liability carrying amount > Tax BaseX Liability carrying amount < Tax BaseX Assessable in future Deductible in future

34. Tax Base - Assets Carrying amount Future Deductible Amount Tax Base Future Taxable Amount = + - - = - $5,000 $ Nil $5,000$ Nil Example – STS Prepaid Insurance $5,000 + Taxable income increases in future years creates an Assessable Temporary Difference or DTL

35. Tax Base - Liabilities Carrying amount Future Deductible Amount Tax Base Future Taxable Amount = +- $20,000 $ Nil + = $20,000 - Example - Provision of annual leave - $20,000 Taxable income reduced in future years creates a Deductible Temporary Difference or DTA

36. Tax Rate  Rate expected to apply in period when the asset is realised or liability settled. Usually rate which is currently enacted.  Rate should be that applicable to tax that has been applied. E.g. capital gain tax

37. Discounting  DTA and DTLs should NOT be discounted  Too difficult to estimate timing of reversal of each temporary difference

38. Recognition – The Probability Test  “More likely than not” future taxable profits  Consider:  Taxable temporary differences that reverse  Probability of future taxable profits  Sources of losses  Business continuity and other tax restrictions  Forecast period  Tax planning opportunities

39. Current and Deferred Tax - Recognition  As income or expense in income statement for both current and deferred tax (face)  Transaction in equity – charged/credited directly to equity e.g. revaluations  Tax on business combination at time of acquisition as identifiable asset or liability  Current tax assets and current tax liabilities only offset if legal right and intent to settle net with same tax authority

40. Recognition – Example St Kilda Beach Co. has:  DTA of $100 expected to reverse in 20 years  History of profits, no reason not to continue  Prepares budgets for 2 years only Should a DTA be recognised for the full amount? Y/N

41. Measurement Issues Business Combination Issues  Additional temporary differences such as:  Fair value adjustments  Temporary differences on assets not previously recognised (e.g. intangibles)  Form expectation of whether will put in tax consolidated group

42. Disclosure  Explanation of relationship between tax expense and accounting profit  Basis on which tax rate has been computed and explain any changes thereon  Current and deferred tax recognised in equity  Aggregate of temporary differences associated for which no DTL has been recognised  Net deferred tax balances of current and previous period analysed by types of temporary difference and unused tax losses or unused tax credits.

43. A Real Example – A Client’s Position – HELP!  The client, Dakis Inc, currently has approximately $20m worth of carried forward losses, and for the first time since we commenced the audit they are in a net profit position of approximately $1million for the year ended 31 December 2006. The client has budgeted approximately $2million net profit per year for the next few years and as such wants to recognise a deferred tax asset for the entire amount of the carried forward losses it currently has at its disposal. (By the way, the profit this year includes $800,000 in unrealised exchange gains.) Question:  Is Dakis Inc client allowed to bring to account the entire value of the deferred tax asset to account, if not how much is a reasonable amount to bring to account?  How far can we look ahead in analysing budgeted figures and assumptions in quantifying the net profit position?  What criteria could you suggest to be met for the carried forward losses to be brought to account?

44. Activity – The Ultimate Case Study Final Questions