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Chapter 13

Example 1

Deferred tax liability

On 1 April 20X2 Wilf bought a machine for $200,000. Wilf depreciates the
machine over its estimated life of 4 years on a straight line basis. The
machine attracts an initial tax allowance of 100%, and Wilf’s rate of tax is
30%.

Explain the impact of deferred tax on Wilf’s financial statements for the year
ended 31 March 20X3.

Solution

In the year to 31 March 20X3 Wilf charged depreciation of $50,000 ($200,000
× ¼). The carrying amount of the asset at 31 March 20X3 was therefore
$150,000 ($200,000 – $50,000).

In the year to 31 March 20X3 Wilf received a tax allowance in respect of the
machine of the full $200,000. The tax value (cost less allowance) of the
machine is therefore nil, and there is a temporary difference between the
carrying amount and the tax value of $150,000, representing future
depreciation which will not be offset by tax allowances.

Wilf needs to create a liability for deferred taxation to recognise the future
liability to tax that will arise as this temporary difference reverses. The
deferred tax liability is calculated by multiplying the temporary difference by
the tax rate.

Wilf’s deferred tax liability at 31 March 20X3 is $45,000 ($150,000 × 30%)
and this is created by the following journal:
Debit income tax expense 45,000

Credit deferred tax liability 45,000

Each year the temporary difference will be calculated and the deferred tax
provision adjusted. Movements in the deferred tax liability will be reflected in
the income tax expense.

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