Corporation Tax
In this session we shall look at how corporation tax charges for a financial period are recorded in the Statement of Profit or Loss and in the Statement of Financial Position. We shall also look at how under- or over-provisions of corporation tax in a previous period should be dealt with.
Corporation tax is a tax paid by companies on the profits they make in a financial period. Corporation tax is included as an expense in the Statement of Profit or Loss and as a current liability in the Statement of Financial Position.
[If a corporation tax refund arises, it will be recorded as a negative expense in the Statement of Profit or Loss and as a current asset in the Statement of Financial Position.]
Most companies pay their corporation tax liability with a single payment made nine months after the end of the financial period it relates to. Larger companies however, have to pay their corporation tax more quickly by making estimated payments on account that start part way through the financial period and end with a balancing payment after the end of the financial period.
Recording the corporation tax charge for the financial period
Once a company has calculated its corporation tax charge for a financial period, it will be recorded as an expense and as a current liability of the company.
Illustration
Adrastus plc’s Statements of Profit or Loss and Statement of Financial Position are shown below. These statements have yet to be updated for its corporation tax charge for the year of £64,000.
The postings to record tax charge for the year are shown below:
Dr Taxation (in the Statement of Profit or Loss) £64,000
Cr Taxation (in the Statement of Financial Position) £64,000
These postings would result in the statements changing as follows:
Question
A company’s corporation tax charge for the year has been calculated as £25,994.
a) Prepare a journal to record this tax charge
b) State whether the company’s net assets will increase, decrease or stay the same as a result of the journal
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- a) Journal to record the company’s corporation tax charge for the year
- Debit Taxation (in the Statement of Profit or Loss) £25,994
- Credit Taxation (in the Statement of Financial Position) £25,994
- b) The company’s net assets will decrease as the company’s liabilities will rise
Under- and Over-Provisions of Corporation Tax
Occasionally, a company might record its corporation tax charge incorrectly in its financial statements. Where this occurs a company will make an amendment in its financial statements for the next financial period. An under-provision in the previous period means that the tax charge in the previous period financial statements was too low and an additional amount must therefore be recorded in the current period to correct this error. An over-provision means that the tax charge was too high in the previous period and a reduction will be recorded in the current period to correct this error.
Question
A company recorded a tax charge for the year of £81,445 in its financial statements. The actual tax charge for the year turned out to be £81,722.
a) Was the tax charge under-provided or over-provided?
b) When the error is corrected in the company’s financial statements for the next year, will the error be added to or deducted from the year’s tax charge?
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a) The tax charge was under-provided as the recorded tax charge was too low
b) The error will be added to the tax charge in the financial statements for the next year
Process to correct the error where there has been an under-provision in a previous period
- Increase the corporation tax charge in the Statement of Profit or Loss for the current period by the under-provision
- Increase the corporation tax liability (or reduce the corporation tax asset) in the Statement of Financial Position for the current period by the amount of the under-provision
Process to correct the error where there has been an over-provision in a previous period
- Decrease the corporation tax charge in the Statement of Profit or Loss for the current period by the over-provision
- Decrease the corporation tax liability in the Statement of Financial Position for the current period by the over-provision
Illustration
Iocaste Ltd recorded a corporation tax charge for the year ended 31/01/2019 of £14,800 in its financial statements. The directors then discovered that the tax charge for this year should have been recorded as £15,200 and this amount was paid by the company in October 2019. The under-provision of £400 is to be corrected when the financial statements for the year ended 31/01/2020 are prepared. The statements before the corporation tax adjustments are made are shown below:
The company’s corporation tax for the year ended 31/01/2020 was calculated as £20,500.
The under-provision for the previous year and the corporation tax charge for the year ended 31/01/2020 would be recorded in the following journals:
The tax charge in the Statement of Profit or Loss would therefore be £20,900 (calculated as the tax charge for the year of £20,500 plus the previous period’s under-provision). The tax liability in the Statement of Financial Position will be £20,500, that is, the current period’s tax charge. The updated financial statements are shown below.
Question
A company is preparing its financial statements for the year ended 31/07/2020 and has calculated that it owes corporation tax of £8,194 on the profits made in this year.
In its financial statements for the year ended 31/07/2019 the company recorded a tax charge and liability of £6,227 in its financial statements. It was later found however, that the tax charge for the year ended 31/07/2019 should have been recorded as £6,207.
What is the tax charge to be recorded in the company’s Statement of Profit or Loss for the year ended 31/04/2020?
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The answer is £8,174. This is calculated as the tax charge of £8,194 for the year ended 31/07/2020 less the over-provision for tax recorded in the year ended 31/07/2019 (i.e. £6,227 less £6,207).
Question
A company is preparing its accounts for the year ended 30/09/2020. In the year ended 30/09/2019 the company accidentally under-provided its corporation tax by £560.
Record a journal for the year ended 30/09/2020 to correct this under-provision
Click here to reveal the answer
- Journal to correct an under-provision of tax made in the previous year
- Debit Tax (in the Statement of Profit or Loss) £560
- Credit Tax (in the Statement of Financial Position) £560
Effects of corporation tax on the other financial statements
Recording a corporation tax charge and an over- or under-provision of tax in a previous period will affect the profit for the period made by a company and will therefore affect the Retained Earnings recorded in the Statement of Changes in Equity.
Corporation tax will also be recorded in the Statement of Cash Flows although the amount recorded in this statement will be the corporation tax that was actually paid in the financial period.
