Accounting for
income taxes
Chapter 18
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Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd
17-1
Learning objectives
•
Recognise differences between income for
accounting and taxation purposes
• Understand how a temporary difference can arise
• Understand how the tax base of assets and
liabilities is determined.
• Understand how deferred tax assets and deferred
tax liabilities arise
• Understand that changes in tax rates will impact
existing deferred tax balances
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Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd
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Learning objectives
•
Account for taxation losses and understand how
taxation losses can lead to the recognition of assets
in the form of deferred tax assets
• Understand how transfer of tax losses to other
entities within the group are accounted for
• Understand how the revaluation of non-current
assets should be treated for deferred tax purposes
• Know the disclosure requirements for income taxes
• Critically evaluate the balance sheet approach to
accounting for taxation and the associated asset,
deferred tax asset, and deferred tax liability.
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Introduction to accounting
for income taxes
Taxation income
• Income for taxation purposes is known as taxable
income.
• Determined in accordance with New Zealand
income tax legislation
– not according to general accounting rules.
•
Differences between accounting principles of
revenue and expense recognition and taxation
principles.
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Introduction to accounting
for income taxes
Tax income:
• Accounting profit is thus not the same as taxable
profit.
• Tax expense for accounting purposes (income
statement) calculated after applying relevant
accounting standards.
• Income tax payable to Inland Revenue (balance
sheet) based on taxable profit derived by the entity
applying the rules of taxation law.
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Balance sheet approach to
accounting for taxation
Accounting for income taxes NZ IAS 12
• Applies the ‘balance sheet’ method
– recognition of assets and liabilities in the balance sheet
based on the differences between accounting and tax
values of assets and liabilities.
•
Focuses on comparing the carrying value of an
entity’s assets and liabilities (determined by
accounting rules) with the tax base for those assets
and liabilities.
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Balance sheet approach to
accounting for taxation
Carrying amount vs. tax base of asset or liability
• Carrying amount is the amount the asset or liability
is recorded at in the accounting records.
• Tax base:
– is the amount attributed to an asset or liability for tax
purposes
– represents the amount an asset or liability would be
recorded at if the balance sheet were prepared applying
taxation rules.
•
Where carrying amount of an asset or liability is
different from the tax base a ‘temporary difference’
arises.
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Balance sheet approach to
accounting for taxation
Two types
• An assessable temporary difference:
– Results in an increase (decrease) in income tax payable
(recoverable) in future periods when the carrying amount of
the asset or liability is recovered or settled
– Creates a liability — deferred tax liability
•
A deductible temporary difference:
– Results in a decrease (increase) in income tax payable
(recoverable) in future periods when the carrying amount of
the asset or liability is recovered or settled

Creates an asset — deferred tax asset
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Balance sheet approach to
accounting for taxation
Deferred tax liability
•
The carrying amount of the asset exceeds the tax base.
• Taxation payments have effectively been deferred to
future periods.
• Tax is reduced or ‘saved’ in early years, but additional tax
will need to be paid later.
• Example:
– Carrying amount of a non-current depreciable asset exceeds
the tax base in early years, as depreciation allowable as a
deduction for tax purposes is greater than depreciation for
accounting purposes.
– This will be reversed in later years when no depreciation is
allowable for tax purposes.
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Balance sheet approach to
accounting for taxation
•
Justification for deferred tax liability
– Inherent in recognition of an asset that its carrying amount is
recovered in the form of economic benefits that flow to the
entity in future periods
– When carrying amount exceeds its tax base, the amount of
taxable economic benefits will exceed the amount that
allowed as a deduction for tax purposes
– This difference is a taxable temporary difference and the
obligation to pay the resulting income taxes in future periods
is a deferred tax liability
– As the entity recovers the carrying amount of the asset, the
taxable temporary difference will reverse and the entity will
have taxable profit
– This makes it probable that economic benefits will flow from
the entity in the form of tax payments
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Balance sheet approach to
accounting for taxation
Income tax expense
• The sum of the tax attributable to taxable income,
plus or minus any adjustments relating to temporary
differences.
• Defined in NZ IAS 12 as “the aggregate amount
included in the determination of profit or loss for the
period in respect of current tax and deferred tax”.
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Balance sheet approach to
accounting for taxation
Income tax payable
• The amount of tax generally expected to be paid
within the next financial period.
• Under the ‘taxes payable method’ would be same
as tax expense:
– i.e. the amount payable to the IRD is also treated as the tax
expense by the organisation
– This method not permitted in NZ.
•
Under balance sheet method income tax payable
does not necessarily equate to tax expense
– Tax expense affected by temporary differences.
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Balance sheet approach to
accounting for taxation
Calculation of income tax payable
• Income tax payable is based on taxable income, not
accounting profit.
• Necessary to make adjustments to accounting
profit to determine tax profit e.g.:
– Add back accounting depreciation
– Deduct depreciation for taxation purposes.
•
Calculation of income tax payable
– Tax rate multiplied by tax profit.
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Balance sheet approach to
accounting for taxation
Journal entry if temporary differences result in
deferred tax asset
• To recognise tax expense relating to the temporary
difference:
Dr
•
Deferred tax asset (temp. difference × tax rate)
Cr
Tax expense
To recognise tax expense relating to the entity’s
taxable profit:
Dr
Taxation expense
Cr
Income tax payable
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Balance sheet approach to
accounting for taxation
Journal entry if temporary differences result in
deferred tax liability
• To recognise tax expense relating to the temporary
difference:
Dr
•
Tax expense
Cr
Deferred tax liability (temp. difference ×
tax rate)
To recognise tax expense relating to the entity’s
taxable profit:
Dr
Taxation expense
Cr
Income tax payable
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Balance sheet approach to
accounting for taxation
Reversal in future periods
• In future periods, timing differences will reverse
– Deferred tax asset will be credited
– Deferred tax liability will be debited.
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Tax base of asset and liabilities:
further considerations
Calculation of tax base for assets
• Carrying amount + future deductible amount less
future assessable amount.
• Although assets might be expected to give future
assessable amounts that exceed the asset’s
carrying amount, NZ IAS 12 focuses on tax
consequences of recovering an asset to
the extent of its carrying amount only.
• Where carrying amount of asset exceeds tax base
there is a deferred tax liability
– If the carrying amount of the asset is less than the tax base
there is will be a deferred tax asset.
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Tax base of asset and liabilities:
further considerations
Calculation of tax base for assets
• Consideration of doubtful debts when examining
accounts receivable
– Amounts provided for doubtful debts are not deductible
for tax purposes

Deductible only when the account receivable is actually written
off.
– Any provision for doubtful debts will result in a difference
between carrying amount and tax base

This results in a deferred tax asset.
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Tax base of asset and liabilities:
further considerations
Calculation of tax base for liabilities
• Carrying amount – future deductible amount +
future assessable amount
• Exception to the rule:
– Tax base of a liability that is in the nature of ‘revenue
received in advance’ must be calculated as the liability’s
carrying amount less any amount of the revenue received in
advance that has been included in assessable amounts in
the current or a previous reporting period.
– This results in a deferred tax asset.
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Tax base of asset and liabilities:
further considerations
•
Tax base of a liability for ‘revenue received in
advance’
– Tax base of the liability is equal to the carrying amount
of the liability where the ‘revenue received in advance’
is taxed in a reporting period subsequent to the reporting
period in which received.
– The tax base of the liability is equal to zero where ‘revenue
received in advance’ is taxed in the reporting period when
received.
– Carrying amount – amount of revenue received in advance
that will not be subject to tax in future periods = tax base.
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Deferred tax assets and deferred
tax liabilities
•
Assets
– Deferred tax liability arises when:

carrying amount > tax base.
– Deferred tax asset arises when:

•
carrying amount < tax base.
Liabilities
– Deferred tax liability arises when:

carrying amount < tax base.
– Deferred tax asset arises when:

carrying amount > tax base.
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Changes in tax rates
•
•
If tax rates change, the estimate of future tax
savings or amount owing will change.
NZ IAS 12, para 47 requires deferred tax assets
and liabilities to be measured at the tax rates that
are expected to apply to the period with the asset is
realised or liability settled
– Opening balance on deferred tax needs to be restated
to reflect the new tax rate.
– Effect of change must be recognised in profit and loss.
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Unused tax losses
•
Deferred tax assets can arise as a result of tax
losses
– Losses incurred in previous years can generally be carried
forward to offset taxable income derived in future years.
•
•
Tax losses can generate subsequent benefits in the
form of tax payments saved in future profitable
periods.
Consistent with the test for deferred tax assets
generated by temporary differences, deferred tax
assets generated as a result of unused tax losses
must also be able to satisfy the ‘probable’ test
before they are recognised.
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Unused tax losses
NZ IAS 12 (par. 34):
• A deferred tax asset shall be recognised arising
from the carry-forward of unused tax losses and
unused tax credits to the extent that it is probable
that future taxable profit will be available against
which the unused tax losses and unused tax credits
can be utilised.
• As a general principle applicable to all deferred tax
assets it is a requirement that they be reviewed at
each reporting date to ensure that the assets are
not overstated.
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Transfer of tax losses
•
•
•
Transfer of tax losses within a group or economic
entity is not addressed in NZ IAS 12.
Loss transfer rules in section IC5 of the Income Tax
Act 2007 permits, subject to certain requirements,
losses incurred by a company within a group of
companies to be transferred to other companies
within the group.
Guidance is provided by SSAP-12 ‘Accounting
for income tax’
– The paying company should disclose the payment.
– The receiving company should disclose the receipt.
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Revaluation of non-current assets
•
•
•
According to NZ IAS 12 (par. 20) revaluations of
non-current assets can create temporary
differences.
Revaluation increments are not deductible for tax
purposes, even though depreciation for accounting
purposes will be based on the revalued amount.
The tax base is not affected by the revaluation
because depreciation for tax purposes will be based
on the original cost of the asset.
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Revaluation of non-current assets
•
•
Any increase in the carrying value of a non-current
asset through a revaluation undertaken to recognise
an increase in fair value implies an expected
increase in the future flow of economic benefits.
This increase can be taxable and can lead to a
deferred tax liability if the carrying amount is greater
than the tax base.
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Revaluation of non-current assets
•
Unlike previous examples where the temporary
difference is adjusted against income tax expense,
asset revaluations give rise to a special case.
• NZ IAS 12 requires that, to the extent that the
deferred tax relates to amounts that were previously
recognised in equity as either direct credits or direct
debits, the journal entry to recognise the deferred tax
asset or liability must also be adjusted against the
equity account.
• NZ IAS 12 (par. 61):
– Current tax and deferred tax shall be charged or credited
directly to equity if the tax relates to items that are credited or
charged, in the same or a different period, directly to equity.
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Revaluation of non-current assets
•
As the revaluation is adjusted against equity
(revaluation surplus account), the accounting entry to
record the recognition of the deferred tax liability is:
Dr
•
•
Revaluation surplus
Cr
Deferred tax liability
Recognition of future tax associated with an asset
that has a fair value in excess of its cost as
recognised by a revaluation acts to reduce the
amount of the revaluation surplus account.
Entry assumes that the revalued amount of the asset
will be recovered by the entity’s continued use of the
asset.
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Revaluation of non-current assets
•
If there is an expectation that the revalued asset
is to be sold:
– Journal entries to record the deferred tax liability will be
different.
– If a non-current asset is sold there is often a ‘tax break’
given to the organisation as the tax base is increased by
an index that reflects general price increases.
– If the tax that will be assessed in future is to be reduced
because of capital gains indexation

the reduction in the amount of tax that would be paid is
accounted for by debiting the deferred tax liability and crediting
the revaluation reserve.
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Revaluation of non-current assets
•
Result:
– the tax base of an asset depends on the manner in which
the entity's management expects to recover the benefits
inherent in the asset.
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Future changes in accounting for tax
•
The IASB released an exposure draft in 2009.
• Anticipated that final standard will be finalised in
2010, applicable from 2011/2012.
• No fundamental changes expected.
• A simplification expected—basic approach will
remain the same.
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Summary
•
•
•
There is a difference between accounting and tax
profits.
Differences can be great.
NZ IAS 12 uses balance sheet approach to
accounting for tax
– Differences occur between tax bases and accounting carrying
value.
– Multiplying by tax rate gives the deferred tax liabilities and
assets.
– Tax loss transferrals within a group need to be accounted for.
– Revaluations result in additional temporary differences.
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