Question - Gravatt Ltd, which operates in the mining industry, decided not to comply with the accounting standard AASB112 on tax-effect accounting. If it had done so, its profit would have been significantly reduced. The annual report of the company revealed that the auditors had qualified the accounts. The auditors noted that no deferred tax liability had been recognised, in contravention of the accounting standard.
Gravatt Ltd declared a profit of $54 million for the year, with no tax expense, but it admitted in the notes to the accounts that it would have had a notional income tax expense of $24.3 million if it had followed the accounting standard.
The company also would have had a deferred tax liability of $80 million if it had followed the standard. This compares with total equity of $570 million.
The directors believed that neither current tax liability nor a deferred tax liability was necessary as the company was making tax losses because of huge allowable deductions available for exploration and development costs. These exploration and development costs were treated as assets in the accounting records.
The directors stated that a deferred tax liability should be recorded only when it is probable that the company will be liable to pay income tax. At this stage it is unclear when that will be.
Required
1. Explain how exploration and development costs create a deferred tax liability.
2. Analyse the arguments presented by the directors in light of the AASB Framework for the Preparation and Presentation of Financial Statements and the requirements of AASB 112 Income Taxes, and discuss the information utility to readers of Gravatt Ltd's annual report of including/excluding the deferred tax liability.