In this workout we're asked to calculate the current tax liability, deferred tax liability, tax expense, and ETR for a company. We've got the depreciation expense that is in the income statement. However, we've also got the tax deductible depreciation, that figure's 3205.7. So we're going to start off by correcting the depreciation figures. We need to strip out the wrong one, put the correct one in, and then we can calculate the tax figures correctly. So we start with profitable tax.

Add back the 2,500, we don't want that. We do want the tax authorities allowable figure. So my profits that are actually subject to taxes for the period are 18490.3. On that figure, I can now calculate tax. Take my 35.4% tax rates on that figure and now I've got tax due at the statutory rate of 6545.6.

However, my tax expense is on the income statement and for this, we'll do something different. Instead, we take the 35.4% and we multiply that by the PBT from the income statement. Now, if there was a permanent difference between the depreciation expenses, we wouldn't be doing that with the tax expense. If there was a permanent difference, then instead, my tax expense would just be forced to be the same as the tax due at statutory rate. But we don't have a permanent difference here. What we have is a temporary difference.

While those depreciation figures are different this year, they are referring to one asset or one group of assets, and over the life of the assets, the differences will all offset. As it's a temporary difference, thus, we calculate the tax expense of 35.4% on PBT in the income statement. This now means I've got a problem, oh dear, I've got two different figures! I've got a figure that I have to pay, 6,500, and a tax expense of 6,700. Let's just check with the ETR, as we were asked to calculate the ETR. ETR is your tax expense divided by PBT and it is 35.4%, exactly the same as the MCR. If you've only got temporary differences, then your MCR and your ETR should be the same. So how do we reconcile these two different figures? We need to create a deferred tax item. I'm gonna take my income tax expense for the period, 6795. I'll take the income tax liability, 6545. And the difference between them is going to be a deferred tax liability. Why is that a liability and not an asset? Well, this amount here, your income tax liability, that's the amount that's actually paid in cash. So cash will be paid here. However, you thought you'd have to pay 6795 rather than 6545. Because I am first underpaying, I'm paying less than I expected, that means I've got a liability, I know I'll have to pay more in the future. Let's just check the accounting for that. Here I've got my accounting formula, assets equal liabilities plus equity. What's happened? Well my retained earnings will have gone down due to the tax expense. Accrued taxes, that's a liability that has gone up.

Unfortunately, my accounting formula is not balancing at the moment, my deferred taxes is going to create the other one. So my equity has gone down by 6795 and my liabilities have gone up by the same amount.

There is a second way that we could have calculated the deferred tax liability. In this case, we could have taken the depreciation expense at beginning 2500, compared that to the tax deductible depreciation figure of 32050.7, taken the difference between the two, and then applied the tax rate to that. So 35.4% times by the temporary difference gets you to the same deferred tax liability, 249.8, exactly the same as it was before.