Question43 West Limited had the following deferred tax balances at reporting date: [table]
| $ Deferred tax assets | 60 000 Deferred tax liabilities | 33 000
[/table] Effective from the first day of the next financial period, the company rate of income tax was reduced from 30% to 25%. The adjustment to income tax expense to recognise the impact of the tax rate change is: CR $1 350 No entry is required CR $4 500 DR $4 500 DR $1 350 ResetMaximum marks: 1 Flag question undefined

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BlackTom AI · Accepted Answer

Re-state the scenario and options to set the stage for analysis.
Question: West Limited has deferred tax assets of 60,000 and deferred tax liabilities of 33,000 at the reporting date. The enacted tax rate changes from 30% to 25% from the start of the next financial period. The adjustment to income tax expense to recognise the impact of the tax rate change is to be selected from:
- CR $1 350
- No entry is required
- CR $4 500
- DR $4 500
- DR $1 350

Now, let’s examine what a rate change does in deferred tax accounting. The carrying amounts of deferred tax assets and liabilities are measured at the enacted tax rate that is expected to apply when the assets are recovered or the liabilities settled. A change in the rate requires remeasurement of both DTA and DTL and the difference affects income tax expense.

Option 1: CR $1 350. This would imply a credit to income tax expense of 1,350. A rate decrease generally reduces the value of both DTAs and DTLs proportionately, and the net effect on the income tax expense should reflect the net remeasurement of the deferred balances. If the net effect were a credit to tax expense, that would indicate a reduction in tax expense, which is inconsistent with the typical outcome when net deferred balances decrease due to a rate change. Therefore this option is unlikely unless there is an opposite interpretation of the net balance movement.

Option 2: No entry is required. Given a rate change that affects the measurement of deferred tax balances, IFRS/IAS 12 requires adjusting the temporary differences to reflect the new rate. Therefore, the change cannot be ignored; this option is incorrect.

Option 3: CR $4 500. A credit to income tax expense of 4,500 would imply a reduction in expense (or a negative tax expense impact). As noted, a rate reduction typically decreases the value of both DTAs and DTLs, but the net effect on income tax expense is generally an increase in expense (not a decrease) if the net deferred tax asset declines. This option would typically be inconsistent with the direction of the required remeasurement when the net balance falls. Thus this option is unlikely.

Option 4: DR $4 500. A debit to income tax expense of 4,500 aligns with an increase in current tax expense due to the decrease in the value of net deferred tax balances when the tax rate falls. Since the net deferred tax position is reduced by the lower rate (the components DTA and DTL both remeasured downward, and the net effect is a reduction in the net deferred tax asset), the adjustment to income tax expense would be a debit (increase in expense) by the amount of the net decrease in the deferred tax balance expressed at the new lower rate. This is a plausible and typical presentation for recognizing the impact of a rate decrease on the deferred tax net position.

Option 5: DR $1 350. This would be a debit to income tax expense of 1,350. While some analyses of rate changes yield a 1,350 amount as the net impact in certain simplified cases (e.g., net balance movement of 27,000 at a 5 percentage-point change relative to 30%), the provided data (60,000 DTA and 33,000 DTL) implies a particular remeasurement of both sides that, in this setup, more consistently supports a larger net movement than 1,350. Therefore this smaller amount is unlikely to be the correct adjustment in the general formulation given.

Putting the pieces together, the option that aligns with recognizing a larger increase in income tax expense due to the downward remeasurement of the net deferred tax balance under a rate change is DR $4 500. The other choices either contradict the expected direction of the adjustment, ignore the requirement to remeasure under the new rate, or imply an unlikely impact magnitude given the balances provided.

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