Deferred Tax Assets And Liabilities Essay

Qustion:

Discuss about the Deferred Tax Assets and Liabilities.

Answer:

Introduction:

The title of the report is AASB 112 and analysis of financial statements. As the title suggests the main aim of the report is to understand the concept of the deferred tax assets and deferred tax liabilities. The purpose is to analyze the extent to which the disclosure relating to the Australian accounting standard has prescribed and second purpose is to analyze how the users of the financial statements finds the information relating to taxes as helpful and useful. After that the financial statements of Woolworths Limited and Common Wealth Bank has been analyzed for the year ending 2015 and 2016.

The standard has been criticized majorly on the premise that it has not followed the uniform application of the accounting policies and procedures relating to the asset or liability. The critical evaluation has been done in respect of the recognition and the measurement of the respective asset or the liability. Before evaluating the aspect of the standards, it is vital to understand the aim of the formation of standard. The main aim of this standard is to provide the means of accounting treatment as to how the same shall be done for taxes. The tax in the accounting standard has not only defined the current tax but has also provided for the tax aspect that can be generated in the future or can have impact on the future (Ayers, 2008). In the beginning of the standard it has been made clear that this accounting standard provides for the consequences on tax both for current and upcoming of the:

  • Offsetting of carrying amount that the assets or the liabilities will have respectively in the future which are further shown in the annual report of the company showing the financial health and
  • Other transactions relating to the current reporting year and that is stated in the annual report of the company (Deloitte, 2016).

The concept of deferred tax asset and deferred tax liability has been originated majorly from the difference between the accounting income and taxable income. The accounting profit is originated from the booking of the events of the company in the accounting books as per the accounting standards of the company and the taxable profit is the profit which is basically calculated for the purpose of calculating as to how much tax will be paid by the company for the current year. It is calculated as per the provisions of the Income Tax laws of the country in which the company is operating its functions and not as per the rules of accounting or the principles of the respective accounting standards (Petree, 2005). In accordance with the Statement of Accounting concepts number 109 on accounting for income tax read with accounting standard, it is to compare the carrying amount of the asset or liability with the tax base of the respective asset or the respective liability. Tax base is the amount which is directly related to the respective asset or the respective liability for the income tax purposes. In case any difference arises then either the asset or the liability is created and is recognized in the financial statements of the company. The creation of the deferred tax asset or the deferred tax liability has been criticized greatly because of the major reason that the said creation does not connects in any manner with the conceptual framework of presentation of the financial statements and also with the statement of financial concepts. These two major criticisms are:

  • Definition of the Asset – The accounting standard along with the statement of accounting concepts have detailed that the asset shall be recognized in the books of accounts only it is identifiable, measurable and most importantly is able to generate the economic benefits for the company in future. It means the asset shall be embodied with the future economic benefits. But in the case of the deferred tax asset, the company has no claim to receive from someone and it will be reversed only if the company will have sufficient income and the tax thereon can be adjusted from the deferred tax asset so created (Mackintosh, 2006).
  • Definition of Liability – The liability is defined as the amount which is created as the result of the event of the past and which will be settled in the future which entails the outflow of the resources of the entity. Deferred tax liability does not carry any outflow of the resources in cash or bank.

Although it has been critically analyzed by the users but it is necessary to account for the effect that has been arisen from the temporary differences. Thus, the deferred tax asset or liability so created is against the conceptual framework of accounting for reporting purpose and the statement of accounting concepts and in some manner adds confusion to the users while taking the decisions on the financial statements of the company.

In actual, the current accounting treatment and disclosures hinders users. AASB 112 is the Australian accounting standard issued by the Australian accounting standard board on income taxes. It has been issued on the 15th of July of two thousand and four and has been made applicable for the reporting periods starting from first of January two thousand and five only. The standard has prescribed the accounting treatment of the differences generated in reconciling the accounting profit and the taxable profit and thus provides the guidelines as to how the same shall be recognized in the financial statements of the company as the deferred tax liability, deferred tax asset, deferred tax expense and the deferred tax income (Schipper, 2003).


Whenever any type of differences has been identified between the accounting profit and the taxable profit then the corresponding deferred tax asset or the deferred tax liability is accounted for in the books of accounts of the company. The differences so observed are regarded as the temporary differences and are liable for getting reversed in the future. These temporary differences are generally grouped under the two heads – one difference is that which is known as the taxable difference and the other one is known as the deductible difference. In the first case of the difference, deferred tax liability is created as the taxable difference will increase the liability of the company to pay the tax in the future periods and in the second case of the difference, deferred tax asset is created as the deductible difference and will result in the decrease of the tax which will be paid in the future periods to come (Schrand, 2003). The accounting treatment of these two differences is first done in the form of journal entry after doing the calculations. In the first case deferred tax expense account is debited and the deferred tax liability account is credited. In the second case the deferred tax asset account is debited and the deferred tax expense account is credited.

After making the accounting entry the presentation of the same is done in the financial statements of the company. The deferred tax expense either credited or debited is shown in the statement of the profit and loss after the Current Tax Expense and the deferred tax liability or the deferred tax asset so created is disclosed in the Statement of affairs on the liability and asset side respectively. The paragraph number 79 to 81 of the accounting standard number 112 has prescribed the disclosure requirements and given the exhaustive list of the requirements (AASB, 2015). Few of them have been mentioned below which are also relevant for the users of the financial statements:

  • A detailed explanation of the connection between the deferred tax asset or liability is required to be given
  • A detailed explanation of the changes in the rates applicable to the company for the current financial year
  • The amount of the temporary differences which has been identified while reconciling the accounting profit and the taxable profit of the company (Skinner, 2008)
  • In reference to each of the temporary differences so identified, quantify the amount of the deferred tax assets and the deferred tax liabilities which has been arrived by multiplying the effective tax rate to the temporary differences

The aforementioned four disclosures gives the users of the financial statements as the insights as to how the company is operating its functions and how the company has been able to reconcile the accounting profit and the taxable profit and accordingly how the company has complied with the provisions of the accounting standards of the company. But the users will not be able to understand the actual tax expense of the current financial year in much better manner. It is because all the companies whether it is manufacturing or service provider will find the effective rate on its own and as per the Tax Transparency code of Australia, lower the effective tax rate higher will be the chances of getting an scrutiny before Australian Taxation office (Pozen, 2007).


Thus, in this manner, the accounting treatment and the disclosure will not assist the users.

Common Wealth Bank - The note number four of the annual report of the company has provided the detail of Income Taxes. At first for the consecutive period of last three years, the current tax expense has been calculated and accordingly applicable tax percentage is calculated and identified.

Woolworths Limited - The note number fourteen of the annual report of the company has provided detail of the Income Taxes. The income tax expense has been detailed with the comparative amount for the reporting year ending 2016 and 2015.

In both the cases, the temporary differences has been detailed like provision for employee benefits, lease financing, intangible assets, the investments made in associates, subsidiaries, joint ventures and others (Company Official Website, 2016).

The figures of DTA and DTL’s along with the disclosures in the notes to the annual report of the company give the users detail of items which are reversible in future and may either set off the tax liability in future or will generate the future tax liability. The differences helps the users of the financial statements to have knowledge of the movements of various items including the tax effect on dividends paid to the shareholders of the company.

Ratio Analys

WOOLWORTHS LIMITED - RATIO ANALYSIS

COMMON WEALTH BANK - RATIO ANALYSIS

S. No.

Particulars

2016

2015

S. No.

Particulars

2016

2015

1

Without Deferred Tax

1

Without Deferred Tax

a)

Net Profit before Tax

1359

3296

a)

Net Profit before Tax

12854

12612

Income

58275

59001

Income

44379

45327

NP Ratio

2.33

5.59

NP Ratio

28.96

27.82

b)

Turnover

58275

59001

b)

Turnover

44379

45327

Total Assets

22392

24581

Total Assets

933078

873446

Total Assets Turnover

2.60

2.40

Total Assets Turnover

0.048

0.052

2

With Deferred Tax

2

With Deferred Tax

a)

PAT

840

2300

a)

PAT

9247

9084

Income

58275

59001

Income

44379

45327

NP Ratio

1.44

3.90

NP Ratio

20.84

20.04

b)

Turnover

58275

59001

b)

Turnover

44379

45327

Total Assets

23502

24336

Total Assets

932733

872991

Total Assets Turnover

2.48

2.42

Total Assets Turnover

0.048

0.052

The above table has been made to understand as to how far the value of the deferred assets and the deferred expense are valuable for users of the financial statements while taking the decision.

In the case of the Woolworths Limited, the net profit ratio of the company for both the financial years has been reduced considerably which indicates that the amount of the deferred tax expense plays the very important role in declaring the earning generated per share of the company. It is calculated by proportioning the net profit available for the shareholders of the company by the number of the stock outstanding at the end of the financial year. As the Earning per share disclosed is decreased figure and hence the users of the financial statements is required to consider the effect of the deferred tax expense (Phillips, 2004).

In the case of Common Wealth Bank, if rather checking the net profit ratio, the total assets turnover is analyzed, it is observed that the company has been able to utilize the assets of the company in the same manner as the company has made in the earlier years and there are no such differences. In this manner, the deferred tax assets and liabilities does not have much relevance in analyzing the financial positions of the company like in the ratios as – Net worth of the company, net assets of the company.

Therefore, the relevance is very less for the users it is because the figure is very immaterial to affect the decision of the stakeholders of the company.

Conclusion

Each and every company shall follow the correct accounting treatment and the correct financial disclosures which are mentioned in the relevant accounting standards as prescribed by the accounting standard board and other standard setting bodies, statement of accounting concepts and conceptual framework of accounting and reporting. In the report, the Australian accounting standard 112 on income taxes has been deeply analyzed with an understanding as to how the accounting treatment is done for the transactions of the company relating to deferred tax asset or the deferred tax liability. Also the disclosure requirements have been identified and analysed and then the accounting standard has been critically evaluated as to how the deferred tax asset or liability have helped the users of the financial statements of the company in understanding the financial position and the financial performance of the company and whether it has been found useful. For the purpose of the report, the financial statements of two companies have been analysed for the year 2015 and 2016. These two companies are Woolworths Limited and Common wealth Bank. In order to conclude the report, the accounting and disclosure of the taxes shall be done in accordance with provisions of the accounting standards.

References

AASB, (2015), “Income Taxes”, available at accessed on 15-10-2017

Ayers, B.C, (2008), “Deferred tax accounting under SFAS No. 109: An empirical investigation of its incremental value-relevance relative to APB No. 11” Accounting Review, pp.195-212

Company Official Website, (2016), “Annual Report”, available at accessed on 15-10-2017

Company Official Website, (2016), “Annual Report”, available at accessed on 15-10-2017

Deloitte,(2016), “IASB 16”, available at accessed on 15-10-2017

Mackintosh, N.B. (2006). “Accounting-truth, lies, or "bullshit"? A philosophical investigation:

Commentary, the FASB and accounting for economic reality” Accounting and the Public Interest 6

Petree, T.R., (2005), “Evaluating deferred tax assets”. Journal of Accountancy, 179(3), p.71.

Phillips, J.D, (2004) “Decomposing changes in deferred tax assets and liabilities to isolate earnings management activities”. Journal of the American Taxation Association, 26(s-1), pp.43-66.

Pozen, R. (2007). “Discussion Paper for Consideration by the SEC Advisory Committee on Improvements to Financial Reporting”. Security Exchange Commission.

Schipper, K. (2003). “Principles-based accounting standards”. Accounting Horizons, 17, 61-72

Schrand, C.M.,( 2003). “Earnings management using the valuation allowance for deferred tax assets under SFAS No. 109”. Contemporary Accounting Research, 20(3), pp.579-611.

Skinner, D.J., (2008). “The rise of deferred tax assets in Japan: The role of deferred tax accounting in the Japanese banking crisis”. Journal of Accounting and Economics, 46(2), pp.218-239.

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