Sample Answer
Temporary Differences and Tax Implications for Spencer Ltd
Introduction
Temporary differences arise when the carrying amount of an asset or liability in a company’s financial statements differs from its tax base. These differences create either future taxable amounts (taxable temporary differences) or future deductible amounts (deductible temporary differences). Understanding them is essential for preparing accurate deferred tax calculations in accordance with IAS 12 Income Taxes.
This report identifies and analyses the temporary differences for Spencer Ltd as at 30 June 2018, explains whether they are taxable or deductible, and clarifies the rationale behind each.
Analysis and Calculation of Temporary Differences
To determine Spencer Ltd’s temporary differences, we first identify differences between the carrying amounts of assets and liabilities in the financial statements and their corresponding tax bases according to tax legislation. Each difference must be classified as either taxable or deductible, depending on whether it leads to future taxable income or future tax deductions.
For clarity, let’s consider the following typical examples that would apply to a company like Spencer Ltd at year-end:
Depreciation of Plant and Equipment
If the carrying amount of plant and equipment is £200,000, but the tax written-down value is £150,000, the temporary difference is £50,000.
This difference arises because accounting depreciation and tax depreciation (capital allowances) often differ.
Temporary Difference: £50,000
Type: Taxable
Reason: The carrying amount exceeds the tax base, meaning future taxable income will increase when the difference reverses.
Provision for Doubtful Debts
Assume Spencer Ltd has recorded a £10,000 provision for doubtful debts in the financial statements, but this provision is not yet deductible for tax purposes.
Temporary Difference: £10,000
Type: Deductible
Reason: The tax deduction will be available in the future when the specific debts are written off.
Accrued Expenses
Suppose Spencer Ltd has accrued £8,000 in employee bonuses that have not yet been paid or deducted for tax.
Temporary Difference: £8,000
Type: Deductible
Reason: The expense is recognised in the accounts now but will only be deductible for tax purposes when paid.
Prepaid Income (Unearned Revenue)
If Spencer Ltd has £12,000 of prepaid income recorded as a liability in the accounts but already taxed when received, a temporary difference occurs.
Temporary Difference: £12,000
Type: Deductible
Reason: The income is taxed before it is recognised in accounting profit, leading to future deductible amounts.
