Question 3 (21 marks) Cherry Limited was incorporated in Hong Kong. Its financial year end is 31 December. Below is information relevant to Cherry Limited in the determination of deferred tax for the year ended 31 December 2020.

i Cherry Limited purchased a piece of equipment for $180,000 on 1 January 2018. According to the policy of Cherry Limited, the equipment was depreciated on a straight-line basis with an estimated useful life of five years. There was zero residual value for the equipment. For tax purpose, the depreciation expense was not allowed as deductible expense. However, the Inland Revenue Department allowed Cherry Limited to claim a depreciation allowance of $60,000 on the equipment against its income tax each year since its acquisition.

ii Cherry Limited filed a court case on 5 December 2020 to sue Durian Limited, one of the suppliers of Cherry Limited, for the supply of defective products. Cherry Limited expected to incur a large amount of legal expense in 2021 because of this. Therefore, Cherry Limited made a provision of $500,000 for the legal expense. For tax purpose, the expense items are recognized only when cash is paid. The Inland Revenue Department charged 15% as corporate tax rate and allowed Cherry Limited to offset its deferred tax assets and deferred tax liability.

Required: With reference to the relevant financial reporting and accounting standards, explain the purpose of deferred tax accounts and determine, with explanation, the deferred tax assets or deferred tax liability of Cherry Limited as at 31 December 2020.