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Chapter 11
Accounting for
Taxes on Income
Copyright © 2019 by McGraw-Hill Education (Asia). All rights reserved.
1
Learning Objectives
1.
Understand the concept of temporary differences, and tax base of
an asset and tax base of a liability;
2.
Understand the concept of deferred tax as a liability and an asset;
3.
Apply the balance sheet approach in determining the balances of
a deferred tax liability and a deferred tax asset;
4.
Check the tax expense analytically;
5.
Apply appropriate principles to situations of tax losses;
6.
Present appropriately the tax effects of other comprehensive
income or items taken directly to equity;
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Content
1.
Introduction
2.
Deferred Tax as a Liability and an Asset
3.
Tax as an Expense
4.
The Asset and Liability Approach for Determining Deferred Tax
Liabilities
5.
Determining the Cumulative Taxable (Deductible) Temporary
Differences of Assets (Liabilities)
6.
Overview of the Application of IAS 12
7.
Reconciliation and Analytical Check on Tax Expense in the
Income Statement
3
Content
8.
Temporary Differences Arising from Initial Recognition of Assets
and Liabilities
9.
Assets Carried at Fair Value
10.
Accounting for Unused Tax Losses and Unused Tax Credits
11.
Presentation and Disclosures
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Main Principle in IAS 12
•
Balance sheet approach:
– Entity recognizes an asset or liability when it expects to recover the carrying
amount of the asset or settle the carrying amount of the liability in a future period
− If the recovery or settlement leads to probable higher or lower taxes in future
periods, the entity should recognize these future tax consequences as deferred
tax liability or a deferred tax asset at the same time when the underlying asset or
liability is recognized
•
An asset is a bundle of future economic benefits
– Economic benefits will flow in from realization of an asset and it is likely
that the realization may result in an increase in tax payable
– Future increase in tax payable needs to be accrued
•
Accounting for taxes embodies the principle of accrual accounting
– Tax effects of transactions/events are recognized in the period in which the
transactions/events occurred and not in the period of payment
5
Temporary Differences
•
Temporary differences = Carrying amount of – Tax base of an
an asset or a liability asset or a liability
IAS 12 terminology
•
•
What it means
Taxable temporary differences
Future taxable income
Deductible temporary differences
Future deductions or reductions in future
taxable income
Deferred tax liability
Future tax payable arising from taxable
temporary differences
Deferred tax asset
Reductions in future tax payable arising from
deductible temporary differences
Deferred tax liabilities = tax rate x taxable temporary differences at
reporting date
Deferred tax assets = tax rate x deductible temporary differences at
reporting date
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Content
1.
Introduction
2.
Deferred Tax as a Liability and an Asset
3.
Tax as an Expense
4.
The Asset and Liability Approach for Determining Deferred Tax
Liabilities
5.
Determining the Cumulative Taxable (Deductible) Temporary
Differences of Assets (Liabilities)
6.
Overview of the Application of IAS 12
7.
Reconciliation and Analytical Check on Tax Expense in the
Income Statement
7
Deferred Tax as a Liability
Definition of a liability:
“A present obligation of the entity arising from past events, the
settlement of which is expected to result in an outflow of resources
embodying economic benefits” (The Conceptual Framework)
In the context of taxation
•
Present obligation arising from past events
– Recognition of an asset whose future recovery gives rise to a current or
future taxable profit
– Liability for tax arises in the period when a company earns and
recognizes a profit rather than in the period when that profit is subject to
legal tax
•
Outflow of future economic benefits
– Taxable temporary differences will give rise to future tax cash outflows
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Deferred Tax as an Asset
Definition of an asset:
“A resource controlled by the entity as a result of past events and from
which future economic benefits are expected to flow to the entity” (The
Conceptual Framework)
In the context of taxation
•
Resource controlled by the entity as a result of past events
– The recognition of liability and expense is the past event that justifies
the recognition of the related tax asset
•
Inflow of future economic benefits
– Future tax deductions from settlement of liabilities result in a lower tax
payable
9
Deferred Tax as a Liability or an Asset
Tax liabilities =
Current tax payable
+
Legal tax obligations
based on tax laws
and tax computations
Deferred tax liabilities
Future tax payable arising
from the realization of
each recognized asset
• Generally, assets (liabilities) on the statement of financial position
give rise to deferred tax liabilities (assets)
• Deferred tax is shown as an aggregate amount on the statement of
financial position and not set off against the individual assets or
liabilities that give rise to them
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Content
1.
Introduction
2.
Deferred Tax as a Liability and an Asset
3.
Tax as an Expense
4.
The Asset and Liability Approach for Determining Deferred Tax
Liabilities
5.
Determining the Cumulative Taxable (Deductible) Temporary
Differences of Assets (Liabilities)
6.
Overview of the Application of IAS 12
7.
Reconciliation and Analytical Check on Tax Expense in the
Income Statement
11
Tax as an Expense
• Under IAS 12, tax is an expense and should be matched with
accounting income (matching principle)
• Underlying assumptions of the above concept are:
– Tax is a necessary expenditure that has to be incurred to produce
goods and services (cause-and-effect relationship)
– Tax is a productive expenditure and not an involuntary distribution of
income
• IAS 12 requires tax expense to correlate with accounting profit
rather than taxable income
Tax expense
= Current tax rate x
Permanently
Permanently exempted )
(Accounting
income
+ disallowed items – income items
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Temporary Differences
• Temporary differences arise from:
– Timing differences
• Income or expense is included in accounting profit in one period but is
included in taxable profit in a different period
– Different bases of revenue recognition in accounting and tax
• For example, accrual accounting versus cash basis
Type of temporary differences
Taxable temporary difference
Deductible temporary difference
Directions
Examples
Taxable revenue <
Accounting revenue
Completed contracts < Percentage of
completion
Tax deduction >
Accounting expense
Capital allowances > Depreciation
Taxable revenue >
Accounting revenue
Unearned revenue, taxed at the point
of collection
Tax deduction <
Accounting expense
Accrued expenses, deductible only
when paid
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Permanent Differences
•
Permanent differences arises from:
– Differences in definition of what revenue or expense is in the realm of tax and
accounting
Type of permanent
differences
Examples
Effect on
tax expense
Non-deductible accounting
expense
Fines and penalties, disallowed
donations and entertainment expenses
Increase
Non-taxable accounting
revenue
Tax-exempt interest
Decrease
Tax-deductible item that
has no accounting
expense equivalent
Double- or further-deduction of
expenses, investment tax credit
Decrease
Taxable revenue that has
no accounting revenue
equivalent
Imputed revenue on non-arm’s length
transactions
Increase
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Content
1.
Introduction
2.
Deferred Tax as a Liability and an Asset
3.
Tax as an Expense
4.
Theasset
assetand
andliability
liabilityapproach
approachfor
fordetermining
determiningdeferred
deferredtax
tax
4. The
liabilities
liability
5.
Determining the Cumulative Taxable (Deductible) Temporary
Differences of Assets (Liabilities)
6.
Overview of the Application of IAS 12
7.
Reconciliation and Analytical Check on Tax Expense in the
Income Statement
15
The Asset and Liability Approach for
Determining Deferred Tax Liabilities
Tax obligations on the statement of financial position
Current tax liabilities
+
Deferred tax liabilities
Current tax liabilities =
Current tax rate x Taxable income
Taxable income =
Accounting profit +/–
Current temporary differences
+/– Permanent differences
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Interaction between Current Tax
Payable and Deferred Tax Liabilities
Now
“Originating taxable temporary difference”
Current taxable income
Current taxable payable
Deferred tax liability
Future
“Reversal”
Future taxable income
Future tax payable
The deferred tax liability is essentially an accrual for the increase in future tax
payable
E.g. accelerated tax depreciation will result in lower tax payable in current
period and higher tax payable in future periods.
17
Interaction between Current Tax
Payable and Deferred Tax Assets
Now
“Originating deductible temporary difference”
Current taxable income
Current taxable payable
Deferred tax asset
Future
“Reversal”
Future taxable income
Future tax payable
The deferred tax asset is essentially a recognition of the reduction in future tax
payable
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Content
1.
Introduction
2.
Deferred Tax as a Liability and an Asset
3.
Tax as an Expense
4.
The asset and liability approach for determining deferred tax
liability
5.
Determining
differences
Determiningthe
thecumulative
cumulativetaxable
taxabletemporary
(deductible)
temporaryof
differences of assets (liabilities)
liability
6.
Overview of the Application of IAS 12
7.
Reconciliation and Analytical Check on Tax Expense in the
Income Statement
19
Determining the Cumulative Taxable
Temporary Differences of Assets
• “Balance sheet liability approach”
– An assessment of future tax consequences of each asset or liability
• Under this approach:
– The amount of an asset or a liability recognized on the statement of
financial position is compared with its tax base
– Tax base of an asset or a liability is the amount attributed to that asset
or liability for tax purposes
• Or amounts recognized on the hypothetical tax statement of
financial position
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Determining of Taxable or Deductible
Temporary Differences
•
Compare the carrying amount of an asset and a liability on the
accounting statement of financial position with its tax equivalent
−
Difference between the amounts gives rise to a taxable or
deductible temporary difference
•
Compare the carrying amount of asset and liability on the
accounting statement of financial position with the tax base
−
Difference between the amounts gives rise to a taxable or
deductible temporary difference
•
Compare the tax recognition of expense or revenue with the
accounting recognition
21
Compare Tax Measurement with
Accounting Measurement
• If tax measurement is synchronous and aligned with accounting
measurement in the same period
– No temporary differences
• However, this approach may require corroboration from the other
two approaches in more complex settings
– Example: If tax depreciation and accounting depreciation are
asynchronous, calculation of tax base and tax balance sheet are
required
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Tax Base of an Asset
• Tax statement of financial position is drawn up using tax rules as
bases of measurement for assets and liabilities
• Taxable or deductible temporary differences:
– Difference between the amounts of assets and liabilities recognized on
the accounting and tax statement of financial position
• Examples of assets on statement of financial position:
Tax rules
Tax statement of financial
position
Taxable temporary
difference (TTD)
Cost of asset is deductible over
tax useful lives or tax
amortization periods
Balance is the unexpired cost
or written down value, after
applying tax depreciation
TTD = Net book value –
Tax written down value
Asset is not deductible for tax
purposes
Balance is zero (non-existent
asset)
TTD = Carrying amount –
Zero tax base
Cost of asset is fully deductible
when sold or consumed or
realized
Balance is the cost
TTD = Carrying value –
Cost
23
Procedural Diagram to Determine
Deferred Tax Liabilities
Deferred tax liabilities
= Tax rate x Cumulative taxable temporary differences
Cumulative taxable temporary differences
= Carrying amount of an asset – Tax base
Carrying amount of an asset
= Balance on the accounting
statement of financial position
Tax base of an asset
= “Amount that will be deductible for tax
purposes against any taxable economic
benefits that flow to an entity when
it recovers the carrying amount of the
asset. If those economic benefits will
not be taxable, the tax base of the asset
is equal to its carrying amount” (IAS 12)
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Conceptual Interpretation of Taxable Temporary
Differences, Carrying Amount and Tax Base of an
Asset
Cumulative taxable
temporary difference
=
Future taxable income
arising from an asset
Future taxable
income x tax rate
Carrying amount of
an asset (SFP)
Future economic
benefits arising
from an asset
(e.g. cash
received or
revenue earned)
–
Tax base
Future tax
deductions that
will reduce future
taxable income
Deferred tax liability
(future tax payable)
25
Tax Base of an Asset
Future Taxability
Tax Base
Where the proceeds from the
realization or recovery of the asset is
taxable
Tax base is the amount that will
be deductible against the taxable
economic benefits from the
recovery of the asset
Where the proceeds from the
realization or recovery of the asset is
tax-exempt
Tax base is equal to the carrying
amount
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Tax Base of an Asset
Example: Interest receivable carried on statement of financial position
at $100,000
• Scenario 1: Interest income is taxed during the period when it is
earned
The proceeds from the realization
– Carrying amount 100,000
is not taxed. Thus, tax base is
Tax base
100,000
equal to carrying value
TTD
0
– Tax treatment and accounting recognition are synchronous
Now
Future
Interest income earned
Interest income taxed
 Current taxable payable
No deferred tax liability
Interest income received
No tax consequence
27
Tax Base of an Asset
• Scenario 2: Interest income is taxed during the period when it is
received
– Carrying amount 100,000
The interest income is to be taxed
Tax base
0
in a future period. Thus, tax base
TTD
100,000
is equal to zero
– There is a misalignment between tax and accounting recognition
Now
Interest income earned
 Current taxable payable
 Deferred tax liability
Future
Interest income received
 Future tax payable
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Tax Base of an Asset
• Scenario 3: Interest income is tax-exempt
– Carrying amount
Tax base
TTD
100,000
100,000
0
The future receipt of interest
income is “tax-exempt”. Thus, tax
base is equal to carrying value
Now
Interest income earned
No tax consequence
No change to current or deferred tax liability
Future
Interest income received
No tax consequence
29
Balance Sheet Liability Approach
Example 1: Fixed Assets
•
•
•
Equipment costing $30,000 was purchased on 1 Jan 20x0.
Capital allowances were fully claimed in 20x0
Accounting depreciation was computed on a straight line basis over 3 years
20x0
20x1
20x2
Cost
$30,000
$30,000
$30,000
Accumulated depreciation
(10,000)
(20,000)
(30,000)
Carrying amount = NBV (1)
$20,000
$10,000
$0
Cost
$30,000
$30,000
$30,000
Capital allowances
(30,000)
(30,000)
(30,000)
$0
$0
$0
$20,000
$10,000
$0
Tax base = tax written down value (2)
Cumulative taxable temporary difference = (1) - (2)
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Balance Sheet Liability Approach
Example 2: Contract assets
•
•
Revenue on a long-term project was earned over a three-year period
For tax purposes, profit was taxed only at the completion date at the end of
20x2
20x0
20x1
20x2
Cumulative revenue
$1,250,000
$1,870,000
$2,500,000
Cumulative costs
$1,000,000
$1,500,000
$2,000,000
$250,000
$375,000
$500,000
Contract assets
$1,250,000
$3,125,000
$5,625,000
Tax base
$1,000,000
$2,500,000
$4,500,000
$250,000
$625,000
$1,125,000
Construction contracts
Contract profits
Cumulative taxable temporary difference
31
Balance Sheet Liability Approach
Example 3: Investments at Fair Value, Profit from Sale of Investments
is Subject to Tax
•
•
Entity classifies bonds as AFS investments and measures them at fair value
at end of each year
Assume that the proceeds from the sale of bonds are subject to tax
Investment at cost
Fair value adjustment
Carrying amount: investment at fair value
Tax base
Cumulative taxable (deductible) temporary
difference
20x0
20x1
20x2
$1,000,000
$1,000,000
$1,000,000
200,000
(50,000)
300,000
1,200,000
950,000
1,300,000
(1,000,000)
(1,000,000)
(1,000,000)
$200,000
$(50,000)
$300,000
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Balance Sheet Liability Approach
Example 4: Inventory is Carried at the Lower of Cost and Net
Realizable Value; Profit from the Sale of Inventory is Taxable
•
Profit from the sale of inventory is subject to tax
20x0
20x1
20x2
Inventory at LCNRV
$1,200,000
$1,200,000
$1,200,000
Tax base
(1,200,000)
(2,000,000)
(2,600,000)
$0
$0
$0
Cumulative taxable temporary difference
33
Determining the Cumulative Deductible
Temporary Differences of Liabilities
•
Deductible temporary differences that arise from liabilities are the future tax
deductions that will arise when the liability is settled or when the unearned
revenue is earned
•
Examples of liabilities on tax statement of financial position:
Tax rules
Tax statement of financial
position
Deductible temporary
difference (DTD)
Expenses are not recognized for
tax purposes (i.e. not deductible
in any period)
Balance is zero
A DTD arises because the
carrying value > tax base.
Expenses are recognized for tax
purposes in the period when
incurred
Balance is the same as the
carrying amount of accounting
accruals or liabilities
No DTD arises
Expenses are recognized for tax
purposes in the period when paid
in a future period
Balance is zero
A DTD arises. The DTD will
reverse when the expenses are
paid off in a subsequent period
However, DTD is not recognized
under IAS 12 Para 15
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Procedural Diagram to Determine
Deferred Tax Asset
Deferred tax assets
= Tax rate x Cumulative deductible temporary differences
Cumulative deductible temporary differences
= Carrying amount of a liability (asset) – Tax base of a liability (asset)
Carrying amount of a liability
= Reported balance of the liability
Tax base of a liability (other than unearned revenue)
= Carrying amount – Amount that will be deductible
for tax purposes in respect of that liability
in future periods
Tax base of unearned revenue
= Carrying amount – Amount of the revenue that will
not be taxable in future periods (IAS 12:8)
35
Conceptual Interpretation of Deductible Temporary
Differences, Carrying Amount and Tax Base of a
Liability and Unearned Revenue
Cumulative deductible
temporary difference
=
Future tax deductions
arising from outflow of
economic benefits
Cumulative deductible
temporary difference
Amount of revenue that
will not be taxable in
future periods
Carrying amount of a
liability (SFP)
Future outflow
of economic
benefits
=
Carrying amount of a
liability (SFP)
Revenue that
will be earned
in future
periods
-
Tax base of
a liability
Carrying amount
of liability – future
deductions
-
Tax base of
a liability
Carrying amount of
liability – amount of
revenue that will not be
taxable in future periods
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Tax Base of a Liability
Types of Liabilities
Tax Base
Future payable
Tax base = carrying amount of the liability –
future deduction arising when the liability is
settled
Unearned revenue
Tax base = carrying amount of unearned
revenue – revenue that will not be taxable in
future periods
37
Tax Base of a Liability
Example: Unearned revenue carried on the statement of financial
position at $100,000
• Scenario 1: Revenue is taxed during the period when it is earned
– Carrying amount
100,000
Revenue is taxed in the future.
Tax base
100,000
Thus, tax base = 100,000 – 0
DTD
0
– No DTD as tax recognition is the same as accounting recognition
Now
Revenue received
Revenue not taxed
No deferred tax asset
Future
Revenue earned
Revenue taxed
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Tax Base of a Liability
• Scenario 2: Revenue is taxed during the period when it is received
– Carrying amount
100,000
Revenue is not taxable in the
Tax base
0
future. Thus, tax base = 100,000 –
100,000
DTD
100,000
– Tax and accounting treatment are asynchronous
Now
Revenue received
Revenue taxed
Future
Revenue earned
Revenue not taxed
 Current tax payable
 Deferred tax asset
39
Tax Base of a Liability
• Scenario 3: Revenue is tax-exempt
– Carrying amount
100,000
Revenue will not be taxable in
Tax base
0
future period. Thus tax base =
$100,000 – $100,000 = 0
DTD
100,000
– However, IAS 12 Para 24 prohibits the recognition of this deductible
temporary differences because it arises on initial recognition of the
liability
– DTD = 0
Now
Future
Revenue received
Revenue not taxed
Revenue earned
Revenue not taxed
 Deferred tax asset (not recognized)
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Balance Sheet Liability Approach
Example 1: Provision for Warranties; Deductible on the Basis of Claims
Made in the Year of Payment
•
•
As at end of 20x0, provision for warranties was $1,000
Amount represents future claims for rectification works
20x0
Carrying amount
$1,000
Tax base
Cumulative deductible temporary difference
$0
$1,000
Provision of warranties not recognized for tax purposes in 20x0
41
Balance Sheet Liability Approach
Example 2: Provision for Loss; Not Deductible in Any Period
•
•
Provision for litigation loss is $200,000
Loss is not deductible for tax purposes in the current or future periods
20x0
Carrying amount
$200,000
Tax base
$200,000
Cumulative deductible temporary difference
Nil
Settlement of the provision will not lead to a decrease in future taxable
income. No tax benefits arise when the provision is settled
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Balance Sheet Liability Approach
Example 3: Accrued Expense; Deductible in the Year of Expensing
•
•
Reporting entity accrues expenses of $100,000 in 20x0 which was paid off
in 20x1
Expenses are deductible for tax when the expense is recognized
20x0
Carrying amount
$100,000
Tax base
$100,000
Cumulative deductible temporary difference
Nil
Accounting and tax recognition of the expense are synchronous
43
Content
1.
Introduction
2.
Deferred Tax as a Liability and an Asset
3.
Tax as an Expense
4.
The Asset and Liability Approach for Determining Deferred Tax
Liabilities
5.
Determining the cumulative taxable (deductible) temporary
differences of (liabilities)
6.
Overviewofofthe
theapplication
ApplicationofofIAS
IAS12
12
Overview
7.
Reconciliation and Analytical Check on Tax Expense in the
Income Statement
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Summary of Procedures for Accounting for
Income Taxes
Tax expense in income statement = Current tax expense +/– Deferred tax expense (income)
= Change in deferred tax
Analytical check:
liability (DTL)
Tax expense = [Current tax rate x (profit
before tax +/– permanent differences)] +/–
= Ending DTL – Beginning DTL
[change in tax rate x cumulative taxable
(deductible) temporary difference at
beginning of period]
Tax liabilities = Current tax liabilities + Deferred tax liabilities (assets)
Current tax liabilities = Current tax rate x Taxable income
Taxable income = Profit before tax +/– Change in
temporary deductible (taxable) differences +/–
Permanently disallowed (exempted) items
Deferred tax liabilities
(assets) = Current tax
rate x Cumulative
taxable (deductible)
differences
Cumulative taxable
(deductible) temporary
differences= Carrying
amount – Tax base
45
Accounting for Taxes in a Nutshell
• Tax expense:
– Is made up of current and future tax
– Must correlate with accounting profit
• Current tax is the legal tax due to government based on taxable
income
• Future tax is the tax that will arise when the temporary differences
“reverse”
– It must be accrued at the point when the income is generated
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Content
1.
Introduction
2.
Deferred Tax as a Liability and an Asset
3.
Tax as an Expense
4.
The asset and liability approach for determining deferred tax
liability
5.
Determining the cumulative taxable (deductible) temporary
differences of asset (liability)
6.
Overview of the Application of IAS 12
7.
Reconciliationand
andanalytical
analyticalcheck
checkon
ontax
taxexpense
expense in the
Reconciliation
income statement
47
Reconciliation and Analytical Check on Tax
Expense in the Income Statement
• IAS 12 requires a reconciliation between tax expense (income) and
accounting profit (loss) in one of the following two forms:
– Tax expense reconciliation:
• Between the reported tax expense (income) and the theoretical tax expense
(i.e. Accounting profit x current tax rate)
– Tax rate reconciliation:
•
Between the average effective tax rate (i.e. Tax expense / Accounting profit)
and the applicable tax rate
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Tax Reconciliation
• Tax expense = Profit before tax x Current tax rate
• Effective tax rate = tax expense/profit before tax
= current tax rate
• The above relationship does not hold if there are:
– Permanently disallowed items or tax-exempt income; or
– Changes in tax rates:
Changes in
tax rates
Impact on deferred tax liability
at the beginning of the year
Impact on deferred tax asset at
the beginning of the year
Increase
• Liability at the beginning of the
year will be adjusted upwards
• Tax expense increases
• Asset at the beginning of
the year will be adjusted upwards
• Tax expense decreases
Decrease
• Liability at the beginning of the
year will be adjusted downwards
• Tax expense decreases
• Asset at the beginning of
the year will be adjusted
downwards
• Tax expense increases
49
Tax Expense Reconciliation
• In the analytical check, the following additional items have to be
included as reconciliation items:
– Utilization of previously unrecognized deferred tax assets
• Unutilized tax losses are not recognized in the year of the loss if they are
deemed less than probable
• In a subsequent year when a profit is made, the unrecognized tax losses are
utilized to reduce taxable income
• This causes a mismatch in the relationship between tax expense and
accounting income (loss)
– Use of different tax rates
• May cause the average effective tax rate of the group to be different from
the statutory tax rate of the parent company
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Tax Expense Reconciliation
Tax expense in the income statement (without tax loss)
= Tax rate x (Profit before tax +/– Permanently disallowed items (tax-exempt
income))
+/– (Increase (decrease) in tax rate x Cumulative taxable (deductible)
temporary differences at the beginning of the reporting period)
Tax expense in the income statement (with tax loss utilization)
= Tax rate x (Profit (loss) before tax +/– Permanently disallowed items (taxexempt income))
+/– (Increase (decrease) in tax rate x Cumulative taxable (deductible)
temporary differences at the beginning of the reporting period)
+/– Tax rate x Unrecognized loss in the year of origination / (tax rate x
recognized loss)
51
Illustration 10.1 Deferred Tax and
Analytical Check on Tax Expense
• The following information pertains to Company XYZ (Year 1 - 20x1):
– Non-deductible tax items:
• Capital transactions of $15,000
• Repairs and renovations of $20,000
– Disallowed expenses relating to entertainment, motor vehicle expenses
and fines amounted to $14,000
– Dividends of $10,000 were tax-exempt
– Expenses in respect of general provisions of $180,000 were disallowed
for tax purposes. However, actual claims and utilizations of $129,500
were deductible
– Depreciation for the year was $80,000,capital allowances claimed
amounted to $708,355. Cost of fixed assets was $1,500,000
– Net profit before tax was $4,000,000 and tax rate was 22%
– 20x1 was the first year of operations
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Illustration 10.1 Deferred Tax and
Analytical Check on Tax Expense
(a) Prepare a tax computation to determine the tax payable
Company XYZ
Tax computation for year ended 31 Dec 20x1
Accounting income
Add / (less):
Expenses relating to general provisions
Utilization of general provisions
4,000,000
Depreciation
Capital allowances
Expenses relating to deemed capital transactions
Repairs and renovations
Disallowed expenses
Tax-exempt dividends
Taxable income
Tax payable at 22%
180,000
(129,500)
50,500
80,000
(708,355)
(628,355)
15,000
20,000
14,000
(10,000)
3,461,145
761,452
53
Illustration 10.1 Deferred Tax and
Analytical Check on Tax Expense
(b)
taxbetween
liability using
theamount
balanceand
sheet
(b)Determine
Determinethe
thedeferred
difference
carrying
theapproach
tax base
Carrying amount
Property,
plant and
equipment
Provisions
Tax base
Balance
Balance
= Cost – Accumulated
depreciation
= Cost – Capital
allowances to date
= $1,500,000 – $80,000
= $1,500,000 –
$708,355
= $1,420,000
= $791,645
Balance
Balance
= Provision – Claims
Nil
Cumulative taxable
(deductible)
temporary difference
$628,355
($50,500)
= $180,000 – $129,500
= (50,500)
Net taxable temporary differences
$577,855
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Illustration 10.1 Deferred Tax and
Analytical Check on Tax Expense
(c) Movement in deferred tax liability
Balance, 1 Jan
Deferred tax liability
Increase / (decrease)
Balance, 31 Dec
$127,128
= 22% x $577,855
= $127,128
Nil
31 Dec 20x1
Dr Tax expense
Cr Tax payable
Cr Deferred tax liability
888,580
761,452
127,128
(d) Perform an analytical check on tax expense
Tax expense = 22% x ($4,000,000 + $39,000 Permanent differences)
= $888,580
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Content
8.
Temporary
Temporary differences
Differencesarising
Arisingfrom
frominitial
Initialrecognition
Recognitionofofassets
Assets
and
andliability
Liabilities
9.
Assets Carried at Fair Value
10.
Accounting for Unused Tax Losses and Unused Tax Credits
11.
Presentation and Disclosures
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Temporary Differences Arising from Initial
Recognition of Assets and Liabilities
• When part or all of the cost of an asset is not deductible for tax
purposes:
– A temporary difference will arise on the first day an asset or liability is
recognized
• The initial recognition of a deferred tax liability is prohibited under
IAS 12 Para 15
– A deferred tax liability or asset is never recognized from:
(a) The initial recognition of goodwill;
(b) The initial recognition of an asset or liability that is
(i) Not a business combination; and
(ii) At the time of the transaction, affects neither accounting profit nor
taxable profit (or tax loss)
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Non-deductible Expenditures on an
Intangible Asset
Example:
• Development expenditures of $300,000 were capitalized on 1 Jan
20x0:
– Amortized over a 3-year period commencing 1 Jan 20x0; and
– Was not deductible for tax purpose
• Assumed tax rate of 20%
Balance sheet liability approach
Intangible asset
Accumulated amortization
Carrying amount
Tax base
Cumulative taxable temporary difference
Deferred tax liability
1 Jan 20x0
31 Dec 20x0
$300,000
0
$300,000
0
$300,000
60,000
$300,000
(100,000)
$200,000
0
$200,000
40,000
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Example 10.8 Non-deductible
Expenditures on an Intangible Asset
• Without the prohibition in IAS 12, the deferred tax liability had to be
recognized on Jan 20x0 as follows:
Dr Intangible asset
Cr Deferred tax liability
60,000
60,000
• This adjustment will makes the financial statements “less transparent”
− capitalization of tax expense in asset cost on initial recognition implies
that the initial outlay on the asset goes beyond actual expenditures
− Tax burden arising from the non-deductibility of the actual expenditures
is included in the cost of the asset
• Thus under IAS 12, the deferred tax liability is ignored
59
Content
8.
Temporary Differences Arising from Initial Recognition of Assets
and Liabilities
9.
Assets
AssetsCarried
Carriedat
atFair
FairValue
Value
10.
Accounting for Unused Tax Losses and Unused Tax Credits
11.
Presentation and Disclosures
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Assets Carried at Fair Value
• Taxable or deductible temporary differences may arise from assets
carried at fair value if:
– The tax base of the revalued assets remain at cost
• IAS 12 requires the recognition of deferred tax liability/asset even if:
– The entity does not intend to dispose off the asset
• The fair value adjustments will be realized through use rather than disposal
– The entity does not have to pay capital gains tax on disposal
• If the proceeds will be reinvested in similar assets which will generate
taxable profit from use or ultimate sale, the deferred tax liability on the fair
value change is recognized
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Assets Carried at Fair Value
• IAS 12 sets the basis of recovery for two types of assets:
– Non-depreciable asset measured using the revaluation model
• Deemed to be recovered through sale
• Reporting entity should use the tax rate and the tax base that are consistent
with the expected manner of recovery or settlement
– Investment property measured using the fair value model of IAS 40
• Deemed to be recovered through sale unless business model for holding the
investment property is to consume substantially all the benefits of the
property through time than through sale
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Content
8.
Temporary Differences Arising from Initial Recognition of Assets
and Liabilities
9.
Assets Carried at Fair Value
10.
Accounting
Accountingfor
forUnused
Unused Tax
Tax Losses
Losses and
and Unused
Unused Tax Credits
11.
Presentation and Disclosures
63
Accounting for Unused Tax Losses and
Unused Tax Credits
• Deferred tax asset should be recognized to the extent that unused
tax losses and unused tax credits will be utilized to set off probable
future taxable profit
– Deferred tax asset has to pass the test of “probable” likelihood of future
profits
Now
Loss
 DTA (if deemed probable)
 Tax expense
Future
Taxable profit, hence utilization of loss
 Current tax payable
 DTA
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Accounting for Unused Tax Losses and
Unused Tax Credits
Does the company have a
history of recent losses?
No
Recognize deferred tax asset in full
Yes
Does the company have
other convincing evidence
to support that future profit
exists?
Recognize deferred tax asset to the extent of
losses that may be used to offset the probable
future profits that are projected
Yes
No
Does the company have
cumulative net taxable
temporary differences?
Recognize deferred tax asset in full if: Cumulative
taxable temporary differences > Tax loss carryforward
Yes
Recognize partially to the extent of cumulative
taxable temporary differences on hand if:
cumulative taxable differences < tax loss carryforward
No
No deferred tax asset is
recognized
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Accounting for Unused Tax Losses and
Unused Tax Credits
Example:
•
•
•
Company has tax losses of $1,000,000
Cumulative net taxable temporary differences (CTD) of $600,000
Tax rate is 20%
Now
Future
Reversal, taxable income  $600,000
CTD $600,000
Tax losses $1,000,000
Utilization of loss, taxable income  $600,000
In view of future effects,
recognize DTA = DTL = $120,000
Tax loss of up to $600,000 can be used to offset the future taxable
income of $600,000 arising from the cumulative net taxable
temporary differences.
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Content
8.
Temporary Differences Arising from Initial Recognition of Assets
and Liabilities
9.
Assets Carried at Fair Value
10.
Accounting for Unused Tax Losses and Unused Tax Credits
11.
11.
Presentation
Presentationand
andDisclosures
Disclosures
67
Presentation and Disclosures
• Major disclosure items (IAS 12:77 – 88) includes:
– Tax expense (income) relating to ordinary activities presented on the
face of the income statement
– Aggregate current and deferred tax relating to items that are charged or
credited directly to equity
– An explanation of the relationship between tax expense and accounting
profit
– Amount of deductible temporary differences, unused tax losses and
unused tax credits for which no deferred tax asset is recognized in the
statement of financial position
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Tax Effects of Other Comprehensive Income
and Items Taken Directly to Equity
• Tax attributable to other comprehensive income and items credited
or charged directly to equity is deducted from the related item and
disclosed separately
• Amount taken to equity will be on a “net of tax” basis
– Tax relating to the revaluation surplus is not taken to the income statement but is
deducted from the revaluation surplus in other comprehensive income
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