CHAPTER I
ACCOUNTING FOR INCOME TAXES
(IAS12)
by Yoseph T (MSc)
1-1
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. Describe the fundamentals of accounting for income taxes.
2. Identify the key concepts of income taxes
3. Distinguish the difference between taxable income and accounting income.
4. Determine the temporary and permanent taxable and deductible differences
5. Differentiate the tax base of an asset and a liability as well as other items.
6. Apply accounting for Deferred tax assets and liabilities,
7. Apply accounting for non-recognized income taxes and identify the effects of
various tax rates on deferred income taxes
8. Apply accounting for net operating loss carry back and a loss carry forward.
9. Know the basic principles of asset-liability method
10. Identify the presentation and disclosure requirements related to income taxes
1-2
PREVIEW OF CHAPTER 1
1-3
Fundamentals of Accounting for
Income Taxes

LEARNING OBJECTIVE 1
Describe the fundamentals of
accounting for income taxes.
Among different types of direct tax, income tax is the one which levied directly
on income of persons or a companies whose earnings exceeds over their
expenses incurred in carrying on the theirs operations..

The term income is used in tax accounting to represent the excess of revenues
earned over the expenses incurred in carrying on the one‟s operations.

IFRS requires an entity to recognize, at each reporting date, the tax
consequences expected to arise in future periods in respect of: the recovery of
its assets, settlement of its liabilities, and other transactions and events of
current period recognized at that date.
1-4
LO 1
Fundamentals of Accounting for
Income Taxes

LEARNING OBJECTIVE 1
Describe the fundamentals of
accounting for income taxes.
Objective of IAS12
 The objective of this Standard is to prescribe the accounting treatment for
income taxes.
 The principal issue in accounting for income taxes is how to account for the
current and future tax consequences of:
(a) The future recovery (settlement) of the carrying amount of assets (liabilities)
that are recognized in an entity‟s statement of financial position; and
(b) Transactions and other events of the current period that are recognized in
an entity‟s financial statements.
1-5
LO 1
Fundamentals of Accounting for
Income Taxes
LEARNING OBJECTIVE 1
Describe the fundamentals of
accounting for income taxes.

Objective of IAS12

This Standard requires an entity to account for the tax consequences of
transactions and other events that the reporting entity expects to recover or
settle the carrying amount of that asset or liability.

If it is probable that recovery or settlement of that carrying amount will make
future tax payments larger (smaller) than they would be if such recovery or
settlement were to have no tax consequences, this Standard requires an entity
to recognize a deferred tax liability (deferred tax asset), with certain limited
exceptions.
1-6
LO 1
Fundamentals of Accounting for
Income Taxes

LEARNING OBJECTIVE 1
Describe the fundamentals of
accounting for income taxes.
Objective of IAS12
 This Standard also deals with;
 The
recognition of deferred tax assets arising from unused tax losses or
unused tax credits,
 The presentation of income taxes in the financial statements and
 The disclosure of information relating to income taxes.
1-7
LO 1
Fundamentals of Accounting for
Income Taxes
LEARNING OBJECTIVE 1
Describe the fundamentals of
accounting for income taxes.
 Scope of IAS12
 IAS12 is applied to accounting for all income taxes, which includes all
domestic and foreign taxes that are based on taxable profits, as well as
withholding and other taxes that are payable by subsidiaries on distributions to
the reporting entity.
 Government grants that are dealt with by IAS 20, Accounting for Government
Grants and Disclosure of Government Assistance, and investment tax credits
are excluded from the application of this standard.
 However, the temporary differences that arise out of these grants and tax
credits are considered.
1-8
LO 1
Fundamentals of Accounting for
Income Taxes
LEARNING OBJECTIVE 1
Describe the fundamentals of
accounting for income taxes.
 Scope of IAS12
 Ethiopian context income taxes includes all taxes levied on taxable income.
 “Taxable Income" shall mean the amount of income
subject to tax after
deduction of all expenses and other deductible items allowed under Income
Tax Proclamation No. 286/2002, its amendments, regulations, directives and
related circulars.
 Excludes taxes that are not based on income tax.
1-9
LO 1
Fundamentals of Accounting for
Income Taxes
LEARNING OBJECTIVE 1
Describe the fundamentals of
accounting for income taxes.
 The main basis of accounting for income taxes is the recognition of the current
and future tax consequences of:
 The transactions that are recognized in the current period and
 Future recovery of assets and settlement of liabilities in the entity‟s statement
of financial position.
 It is also assumed that the entity will settle its liabilities and recover its assets
over a period of time and that the consequences of tax will be determined at
that point in time and
 These consequences can be estimated reliably and cannot be avoided.
1-10
LO 1
Fundamentals of Accounting for
Income Taxes
LEARNING OBJECTIVE 1
Describe the fundamentals of
accounting for income taxes.
 As a result the key objectives of IAS 12 are to prescribe the accounting
treatment for income taxes liability and related disclosures addressing;
 The distinction between permanent and timing differences;
 The future recovery or settlement of the carrying amount of deferred tax
assets or liabilities; and
 Recognizing and dealing with losses for income tax purposes.

Examples Income taxes are;

Domestic and foreign taxes levied on taxable income.

Withholding and other taxes by a subsidiary, associate or joint arrangement on
distributions to the reporting entity.

Temporary differences rises from government grants& investment tax credits.
1-11
LO 1
Fundamentals of Accounting for
Income Taxes
LEARNING OBJECTIVE 1
Describe the fundamentals of
accounting for income taxes.

Income tax has the following features.

a direct tax.

Levied on definite sources.

Calculated on a total amount known as taxable income.

Can be both cash and in kind.

Can be a temporary or permanent.

Can be a lump sum or installments.

Is levied if the taxable income exceeds the maximum taxable limit.

The rates of income tax increases with an increase in the income.
1-12
LO 1
Key Concepts of Income Taxes
LEARNING OBJECTIVE 2
Key concepts of income taxes.
 The following terms are the key concepts for income tax under IAS12;
1.
Accounting profit(loss) is profit or loss for a period before deducting tax
expense.
2.
Taxable profit (tax loss) is the profit (loss) for a period, determined in
accordance with the rules established by the taxation authorities, upon
which income taxes are payable (recoverable).
3.
Tax expense(tax income) is the aggregate amount included in the
determination of profit or loss for the period in respect of current tax and
deferred tax.
 It is a combination of current tax expense (current tax income) and deferred
tax expense (deferred tax income).
1-13
LO 2
Key Concepts of Income Taxes
LEARNING OBJECTIVE 2
Key concepts of income taxes.
 The following terms are the key concepts for income tax under IAS12;
4. Current tax is the amount of income taxes payable (or recoverable) on the
taxable profit (or tax loss) for the current period.
 Current tax is income taxes payable(current tax expense) or the amount of
income taxes recoverable (current tax income) in respect of the tax loss for a
period
5. Deferred taxes are income taxes which arises in one period but because of
timing difference will have to be actually paid in later years.
1-14
LO 2
Key Concepts of Income Taxes
LEARNING OBJECTIVE 2
key concepts of income taxes.
 Deferred taxes are the taxes applicable on the current taxable income, but not
due for payment in the current period because of the difference in the tax
amount reported in the accounting period (tax expenses and the tax amount
reported by the local tax authorities (tax liability).
 The tax expense is determined under IFRS whereas;
 The tax liability is determined under Internal Revenue Code.
 So that deferred tax may be
 Deferred tax liability or
 Deferred tax assets.
1-15
LO 2
Key Concepts of Income Taxes
LEARNING OBJECTIVE 2
Key concepts of income taxes.
6. Deferred tax liabilities are income taxes payable in future periods on taxable
temporary differences arise as a result of capital expenditure being more
rapid than the accounting depreciation treatment.
 Deferred tax liability- arises due to net taxable amounts in the future.
7. Deferred tax assets are the amounts of income taxes recoverable in future
periods for:
 deductible temporary differences;
 the carry-forward of unused tax losses; and
 the carry-forward of unused tax credits.
 Deferred tax assets- arises due to net deductible amounts in the future.
1-16
LO2
Accounting Vs Taxable Income

LEARNING OBJECTIVE 3
Pretax Vs taxable income .
Because IFRS and tax regulations differ in a number of ways, frequently the
amounts reported for the following will differ:

Income tax expense (IFRS)

Income taxes payable (Tax Authority)
1-17
LO 3
Accounting Vs Taxable Income

LEARNING OBJECTIVE 3
Pretax Vs taxable income .
Internal revenue code which governs the accounting for tax liability is not same
as IFRS which governs financial reporting.

As a result taxable income reported to IRS using cash basis of accounting may
not be the same as pretax profit that is reported to shareholders using accrual
basis of accounting.

Likewise the amount of tax liability due to IRS may not be the same as income
tax expense that is reported on the income statement.

We, therefore, speak of book accounting income (income reported to
shareholders) and taxable income (income reported o IRS).
1-18
LO 3
Accounting Vs Taxable Income

LEARNING OBJECTIVE 3
Pretax Vs taxable income .
That is there may be differences between these two incomes which can be
temporary differences when the book income higher than tax income this
year but lower in future years, so that cumulative profit will same for both or

There may be permanent differences which will not reverse arises due to
IFRS treating some items as income or expenses that IRS does not, such as
municipal bond income that is treated as income under GAAPS/IFRS but not
taxed by the IRS.

Generally differences between accounting and taxable income arises due to;

Differences in allowances of expenses in income tax acct.

Provisions for bad/ doubt full debts.

Charging depreciation and amortization

Accrual basis Vs cash receipt basis and so on.
1-19
LO 3
Accounting Vs Taxable Income

Example 1.1

Consider a company that depreciates its assets
LEARNING OBJECTIVE 3
Pretax Vs taxable income .
using SLM for financial
reporting purposes and an accelerated method for tax purposes which is
atypical for most companies. Assume that income before depreciation is
$15,000, then the pretax (financial reporting) and taxable (IRS) income might
be reported as follows.

Pre-tax
Taxable
15,000
15,000

Income before depreciation

Depreciation expense
2,000
3,000

Pretax/taxable income
13,000
12,000
Here taxable income is lower than accounting income, however, over the life of
the asset the same amount of dep‟n will be reported under both methods and
as a result taxable income and tax liability will be higher in future years.
1-20
LO 3
Accounting Vs Taxable Income

LEARNING OBJECTIVE 3
Pretax Vs taxable income .
We know the first year of the asset‟s life that taxable income will be higher in
future years when accelerated depreciation is less than straight-line.

We also know that the company‟s tax liability will be higher as well.

Since the future tax liability exists and computed its amount we need report in
the company's SFP(this is essence of deferred tax).

A deferred tax liability is accrued for the future tax liability(taxable income *
firm‟s tax rate) and this liability will remain on SPF until taxable income is, in
effect, higher and the tax liability is paid.

It is now time to know the concepts of tax expense reported in the come
statement which is sum of tax liability currently payable plus the change in the
deferred tax liability: (TI*TR=TL, TL+∆DT=Income tax expense for FR).

So if we have a deferred taxes, tax expense will not be equal to tax paid.
1-21
LO 3
Accounting Vs Taxable Income
LEARNING OBJECTIVE 3
Pretax Vs taxable income .

Example 1. 2

Chelsea, Inc. reported revenues of $130,000 and expenses of $60,000 in each
of its first three years of operations. For tax purposes, Chelsea reported the
same expenses to the tax authority in each of the years. Chelsea reported
taxable revenues of $100,000 in 2019, $150,000 in 2020, and $140,000 in
2021. What is the effect on the accounts of reporting different amounts of
revenue for IFRS versus tax?
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LO 3
LEARNING OBJECTIVE 3
Pretax Vs taxable income .
Accounting vsTaxable Differences
IFRS Reporting
2019
2020
2021
Total
Revenues
$130,000
$130,000
$130,000
$390,000
Expenses
60,000
60,000
60,000
180,000
Pretax financial income
$70,000
$70,000
$70,000
$210,000
Income tax expense (40%)
$28,000
$28,000
$28,000
$84,000
2019
2020
2021
Total
Tax Reporting
Revenues
$100,000
$150,000
$140,000
$390,000
Expenses
60,000
60,000
60,000
180,000
Taxable income
$40,000
$90,000
$80,000
$210,000
Income taxes payable (40%)
$16,000
$36,000
$32,000
$84,000
1-23
LO 3
LEARNING OBJECTIVE 3
Comparison of Income
Tax Expense to Income Taxes
Payable
Book vs. Tax Differences
Comparison
2019
2020
2021
Total
Income tax expense (IFRS)
$28,000
$28,000
$28,000
$84,000
16,000
36,000
32,000
84,000
Difference
$12,000
$(8,000)
$(4,000)
Income tax expense (40%)
$28,000
$28,000
$28,000
Income tax payable (TA)
Are the differences accounted for in the financial statements?
1-24
Year
Reporting Requirement
2019
Deferred tax liability account increased to $12,000
2020
Deferred tax liability account reduced by $8,000
2021
Deferred tax liability account reduced by $4,000
$0
$84,000
Yes
LO 3
Financial Reporting for 2019
Statement of Financial Position
Assets:
Income Statement
2019
2019
Revenues:
Expenses:
Liabilities:
Deferred taxes
Equity:
12,000
Income tax expense 28,000
Net income (loss)
Where does the “deferred tax liability” get reported in the financial
statements?
1-25
LO 3
Temporary Vs Permanent Differences
LEARNING OBJECTIVE 4
Temporary vs permanent d/ces
 As we have seen above there are differences between carrying/book amount
set by IFRS of an asset or liability and its tax base set by IRS reported in the
financial statements that will result in taxable amounts(Deferred Tax Liability) or
deductible amounts(Deferred Tax Assets)- in future years.
 Some of these differences are temporary and can reverse over time.
 Others are permanent and do not reverse.
 Temporary differences are differences between carrying/book amount of an
asset and liability in the SFP and its tax base.
 Carrying amount: The amount attributed to that asset or liability as per IFRS.
 Temporary differences are differences between TI and AI for a period that
originate in one period are capable of reversal in one or more subsequent
period that will result in taxable amounts or deductible amounts in future years.
1-26
LO 4
Temporary Vs Permanent Differences
LEARNING OBJECTIVE 4
Temporary vs permanent d/ces
 Deferred Tax Liability - is the deferred tax consequences attributable to taxable
temporary differences.
 In other words, a deferred tax liability represents the increase in taxes payable
in future years as a result of taxable temporary differences existing at the end
of the current year.
 Deferred Tax Assets- is the deferred tax consequence attributable to deductible
temporary differences.
 In other words, a deferred tax asset represents the increase in taxes
refundable (or saved) in future years as a result of deductible temporary
differences existing at the end of the current year.
1-27
LO 4
Temporary Vs Permanent Differences

LEARNING OBJECTIVE4
Temporary Vs permanent
Differences
The difference between deferred tax liability and deferred tax asset
Deferred Tax Liability
Deferred Tax Asset
1. Accounting income is higher than
1. Accounting income is lower than
taxable income.
2. The carrying amount of an asset is
higher than the tax base.
3. The carrying amount of a liability is
lower than the tax base.
taxable income.
2. The carrying amount of the asset is
lower than the tax base.
3. The carrying amount of a liability is
higher than the tax base.
4. Expenses and losses deductible for
4. Revenues and gains included in
accounting income but are taxable
in the future periods.
1-28
tax purposes in the current period
but also deductible for accounting
purposes in future periods.
LO 4
Examples of Temporary Differences
LEARNING OBJECTIVE 4
Temporary Vs Permanent
Differences
Revenues or gains are taxable after they are recognized in financial income.
An asset (e.g., accounts receivable or investment) may be recognized for revenues
or gains that will result in taxable amounts in future years when the asset is
recovered. Examples:
1. Sales accounted for on the accrual basis for financial reporting purposes and on
the installment (cash) basis for tax purposes.
2. Contracts accounted for under the percentage-of-completion method for financial
reporting purposes and the cost-recovery method (zero-profit method) for tax
purposes.
3. Investments accounted for under the equity method for financial reporting
purposes and under the cost method for tax purposes.
4. Gain on involuntary conversion of non-monetary asset which is recognized for
financial reporting purposes but deferred for tax purposes.
5. Unrealized holding gains for financial reporting purposes (including use of the fair
1-29value option) but deferred for tax purposes.
LO 2
Examples of Temporary Differences
LEARNING OBJECTIVE 4
Temporary Vs Permanent
Differences
Expenses or losses are deductible after they are recognized in financial income.
A liability (or contra asset) may be recognized for expenses or losses that will
result in deductible amounts in future years when the liability is settled.
Examples:
1. Product warranty liabilities.
2. Estimated liabilities related to discontinued operations or restructurings.
3. Litigation accruals.
4. Bad debt expense recognized using the allowance method for financial
reporting purposes; direct write-off method used for tax purposes.
5. Share-based compensation expense.
6. Unrealized holding losses for financial reporting purposes (including use of
the fair value option), but deferred for tax purposes.
1-30
LO 4
Examples of Temporary Differences
LEARNING OBJECTIVE 4
Temporary Vs Permanent
Differences
Revenues or gains are taxable before they are recognized in financial income.
A liability may be recognized for an advance payment for goods or services to
be provided in future years. For tax purposes, the advance payment is
included in taxable income upon the receipt of cash. Future sacrifices to
provide goods or services (or future refunds to those who cancel their orders)
that settle the liability will result in deductible amounts in future years.
Examples:
1. Subscriptions received in advance.
2. Advance rental receipts.
3. Sales and leasebacks for financial reporting purposes (income deferral) but
reported as sales for tax purposes.
4. Prepaid contracts and royalties received in advance.
1-31
LO 4
Examples of Temporary Differences
LEARNING OBJECTIVE 4
Temporary Vs Permanent
Differences
Expenses or losses are deductible before they are recognized in financial income.
The cost of an asset may have been deducted for tax purposes faster than it was
expensed for financial reporting purposes. Amounts received upon future
recovery of the amount of the asset for financial reporting (through use or sale)
will exceed the remaining tax basis of the asset and thereby result in taxable
amounts in future years. Examples:
1. Depreciable property, depletable resources, and intangibles.
2. Deductible pension funding exceeding expense.
3. Prepaid expenses that are deducted on the tax return in the period paid.
4. Development costs that are deducted on the tax return in the period paid.
1-32
LO 4
Summary of Temporary Differences
LEARNING OBJECTIVE4
Temporary Vs Permanent
Differences
Revenues or gains are taxable after they are recognized in financial income.
Expenses or losses are deductible after they are recognized in financial income.
Revenues or gains are taxable before they are recognized in financial income.
Expenses or losses are deductible before they are recognized in financial income.
1-33
LO 4
Temporary Vs Permanent Differences
LEARNING OBJECTIVE 4
Temporary Vs permanent
Differences
 Permanent Differences(PD) are substantive differences between TI & AI
for the period that originate in period and do not reverse subsequently and
will appear every time such as;
Items are recognized for financial reporting purposes but not for tax purposes.
Examples:
1. Interest received on tax exempt securities/on certain types of government obligations/.
2. Expenses incurred in obtaining tax-exempt income.
3. Tax penalties, surcharges, fines and expenses resulting from a violation of law.
4. Charitable donations recognized as expense but sometimes not deductible for tax purposes.
5. Life insurance premium.
Items are recognized for tax purposes but not for financial reporting purposes.
Examples:
1. “Percentage depletion” of natural resources in excess of their cost.
2. Tax -exempt dividend received from other corporations and etc.
1-34
LO 2
Temporary Vs Permanent Differences
LEARNING OBJECTIVE 4
Temporary Vs permanent
Differences
Permanent Differences are specific differences pertain to non-taxable
revenue and nondeductible expenses;

Result from items that
► enter
into pretax financial income but never into taxable income or
► enter
into taxable income but never into pretax financial income.

Affect only the period in which they occur.

Do not give rise to future taxable or deductible amounts.

There are no deferred tax consequences to be recognized.
1-35
LO 4
Summary of Permanent Differences
LEARNING OBJECTIVE4
Temporary Vs Permanent
Differences
Items recognized for financial accounting purposes, but not for tax purposes
Items recognized for tax purposes, but not for financial accounting purposes
1-36
LO 4
Tax base of An asset Vs A liability
LEARNING OBJECTIVE5
Differentiate items‟ tax base
Before going to see accounting treatment on both temporary and

permanent differences it is better to know what is a tax base of an asset
and a liability as well as tax base of other items.
The tax base of an asset or liability is the amount attributed to that asset

or liability for tax purposes.
The Tax Base of an Asset
 Is
the amount deductible for tax
purposes against any taxable
economic benefits that will flow to
the entity as it recovers the
carrying amount of the asset
through use or sale.
1-37
The Tax Base of a liability
 Is
an amount taxable for tax
purposes in respect of the tax
liability in future periods.
LO 5
The Tax Base For An Asset Vs A Liability Examples

LEARNING OBJECTIVE5
Differentiate items‟ tax base
Certain assets give the rise to tax liability i.e. trade receivables;
Trade receivables(asset) ----------xx
Income (income statement) ---------- xx
 Income
* current tax rate= tax liability;
Tax expense------------xx
Tax liability ------------------xx
 If
the item is not taxed in the year of recognition, but in later years, the tax
liability is deferred causing a taxable temporary differences, and
 These
temporary differences reverse when the tax liability becomes due and
is recognized as a current tax expense for that period.
1-38
LO 5
The Tax Base For An Asset Vs A Liability Examples Cont.

LEARNING OBJECTIVE5
Differentiate items tax base
Certain liability give the rise to decrease tax liability or a tax asset i.e. accrued
expenses;
Accrued expenses ------------xx
Accrued liability -----------------xx
 Expense
* current tax rate= deduction in tax liability;
Tax liability -----------------xx
Tax expenses ----------------xx
 If
the tax asset is not deductible in the year of recognition, but in later years,
the tax asset is deferred causing a deductible temporary differences, and
reverse when the tax liability is reduced or a tax claim is made.
1-39
LO 5
The Tax Base For An Asset Vs A Liability Examples Cont.

LEARNING OBJECTIVE5
Differentiate items‟ tax base
In summary tax base of an asset is the tax deductible against taxable income
at the time when the carrying amount of the asset is recovered.

If income at that time is not taxable, then the carrying amount=tax base (no
tax liability);examples

Dividend receivable that are not taxable;

Loan receivable with no tax consequences on repayment.

Tax written down value of a machine.
1-40
LO 5
The Tax Base For An Asset Vs A Liability Examples Cont.

LEARNING OBJECTIVE5
Differentiate items‟ tax base
Tax base of a liability: carrying amount(CA) - amount deductible for tax in
future periods(TDfp)

Example accrued expense $100
1. Deduct against taxable income when cash paid (future periods)
CA-TDfp= null; 100-100= null
2. Deduct against taxable income in current year
CA-TDfp= 100; 100-0= 100
3. Accrued disallowed expenses(not tax deductible eg fines &penalties)
CA-TDfp =CA; CA-0=CA
4. Loans repayment have no tax consequences therefore; CA-0= CA.
1-41
LO 5
The Tax Base For Revenue in Advance.
LEARNING OBJECTIVE5
Differentiate items‟ tax base
 Tax base of revenue in advance: CA-revenue not taxable in future periods or
any amount taxed in past& current periods.
 Example interest revenue received in advance $100 is taxed when cash was
received; CA-taxed=nill;100-100=nill
1-42
LO 5
The Tax Base For Other Items.
LEARNING OBJECTIVE5
Differentiate items‟ tax base
 All items may not recognized with the tax bases of assets and liabilities,
examples
 Research costs $100; Dr. research cost and Cr. Cash
 If $60 is allowed as a tax deductible in future periods ($40 is disallowed)
 CA-TDfp=nill-$60=$60.
 There is no CA in SFP and there is a temporary difference between the
accounting profit and tax profit of $60.
 There is a permanent difference between the accounting profit and tax profit
of $40.
1-43
LO 5
Recognition of Current Tax Liabilities and
Current Tax Assets
 Recognize
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
a current tax liability for

Tax payable on taxable profit for the current and past periods (current tax)

Current tax liabilities is unpaid charge for current and prior periods
 Recognize
a current tax asset for

The extent to which the amount paid exceeds the amount payable

The benefit of a tax loss that can be carried back to recover tax paid in a
previous period

Is the amount claimed for overpaid for current and prior periods and
recognized as tax receivable.

1-44
Tax loss carried back to prior periods tax profit to recover current charge of
the prior period and recognized as tax receivable.
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets
 Recognize

LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
a current tax asset for

Recognized in period that loss occurs.

Probable that benefit will flow to the entity and can be reliably measured
Measure current tax liability (asset) at;

The amount the entity expects to pay (recover) using substantively enacted
tax rates.
1-45
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets

LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Government specifies that:

Each year entities
must pay a tax on taxable profit for the year (i.e.
business income tax 30% in Ethiopian case)

Taxable profit is determined in accordance with IFRS adjusted for specified
expenses that are excluded from the calculation of taxable income (i.e.
donations and entertainment)

If the determination of taxable business income results in a loss in a tax
period, that loss may be set off against taxable income in the next five (5)
tax periods, earlier losses being set off before later losses.
1-46
LO 6
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Recognition of Current Tax Liabilities and
Current Tax Assets
Difference
between AI
and TI
Permanent
Temporary
Deductible
1-47
Taxable
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets

LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
IAS 12 considers deferred tax by taking a “balance sheet approach” to the
accounting problem between the carrying values and the tax base of assets
and liabilities.

Recognize a deferred tax asset (liability) for tax recoverable (payable) in
future periods as a result of past transactions or events.

For example, when it is probable that recovery of the carrying amount of an
asset will make future tax payments larger than they would be if such
recovery were to have no tax consequences.
1-48
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets

LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
By exception, deferred tax liability is not recognized on;

The initial recognition of goodwill (unless goodwill is deducted when
calculating taxable income);and

Outside of a business combination, when the initial recognition of an asset
or a liability affects neither taxable profit nor accounting income.

1-49
Assets and liabilities that do not affect accounting or taxable profit/ loss.
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets

LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Deferred tax asset is recognized only to the extent that its recovery is
probable.

Probable is not defined in IAS12

Consistently with IAS37 entities often take probable to mean „more likely
than not‟. however, IAS12 does not prohibit a higher threshold

a „virtually certain‟ threshold should not be used.

Probable is generally agreed to mean „at least more likely than not (i.e. a
probability of greater than 50%)‟
1-50
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets

LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Exception: DTA is not recognized on deductible temporary difference arising
initial recognition of asset and liabilities on;

Not part of business combination.

That do not affect accounting or taxable profit and loss.

The possibility that the temporary difference is expected to continue into the
foreseeable future and there are no taxable profits available against which
the temporary difference can be offset.

Deferred tax assets also arise from the carry forward of unused tax losses
and tax credits.
1-51
LO 6
Summary for Recognition of Current Tax
Liabilities and Current Tax Assets
Asset A
Asset B
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Carrying Tax Base
Assessment
Amount
10
8
There is taxable temporary difference (i.e., the
entity recognizes a deferred tax liability).
There is deductible temporary difference (i.e.,
8
10
the entity recognizes a deferred tax asset).
Liability A
10
8
There is deductible temporary difference (i.e.,
the entity recognizes a deferred tax asset).
Liability B
8
10
There is taxable temporary difference (i.e., the
entity recognizes a deferred tax liability).
1-52
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Example 1.3.

An asset that costs Br 600,000 has a carrying amount of Br 430,000.
Cumulative depreciation for tax purposes is Br 200,000 and the tax rate is
30%.
1. What is the tax base of the asset?
2. What is the temporary difference?
3. Is it taxable or deductible temporary difference?
4. What is the deferred tax?
5. Is it a deferred tax asset or liability?
1-53
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Solution for Ex1.3.
1. TB= Br 600,000- Br 200,000=400,000
2. TD= Br 430,000- Br 400,000= 30,000
3. Taxable temporary difference
4. DT= Br 30,000 x 30%= 9,000
5. Deferred tax liability
1-54
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Example1.4
At the beginning of 2013, GK Company purchased equipment for Br 200,000.
The equipment had a carrying amount of Br 180,000 at the beginning of 2014
and Br 160,000 at the end of 2014. The accumulated depreciation of the item
as per the income tax law is Br 50,000 at the beginning of 2014 and Br 80,000
at the end of 2014. The tax rate is 30%. The accounting income before tax is
Br 700,000 for 2013 and Br 900,000 for 2014.
1-55
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Example1.4 ; Required
1. What was the tax base of the equipment for 2013 and 2014?
2. What is the taxable income for 2013 and 2014?
3. What is the temporary difference for 2013 and 2014? Is it taxable or
deductible temporary difference?
4. What is the deferred tax for 2013 and 2014? Is it deferred tax asset or
deferred tax liability?
5. What is the current tax expense for 2013 and 2014?
6. What is the deferred tax expense for 2013 and 2014?
7. What is the appropriate journal entry for 2013 and 2014?
1-56
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Solution for Example1.4
1-57
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Solution for Example1.4
1-58
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Example1.5

In 2014, its first year of operation, North Company has pretax financial
income of Br 250,000, a total of Br 28,000 of taxable temporary differences,
and a total of Br 8,000 of deductible temporary differences. The tax rate is
30%.

In 2015, North Company has pretax financial income of Br 450,000,
aggregate taxable and deductible temporary differences of Br 75,000 and Br
36,000, respectively, and the tax rate remains 30%.
1. Determine the taxable income for 2014
2. Make the necessary journal entries for 2014 to record the deferred taxes
3. Determine the taxable income for 2015
4. Make the necessary journal entries for 2015 to record the deferred taxes
1-59
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Solution for Example1.5
1-60
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Soln Ex1.5
1-61
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Soln Ex1.5
1-62
LO 6
Recognition of Current Tax Liabilities and
Current Tax Assets
LEARNING OBJECTIVE 5
Recognition of criteria for
CTL&CTA.
Example 1.6

Loan receivables has a carrying amount of Br 8 million for which general bad
debt provisions amounting to Br 100,000 have been made. These provisions
have not yet been deducted for tax purposes but are expected to give rise to
future deductible amounts.
1. What is the tax base of the receivable?
2. Is the temporary difference taxable or deductible?

Solution The tax base of the loan receivable is Br 8.1 million which results in
a deductible temporary difference of Br 100,000.
1-63
LO 6
Reversal of Temporary Difference
LEARNING OBJECTIVE6
Accounting for DTLs
For example in Chelsea‟s situation, the only difference between the book basis
and tax basis of the assets and liabilities relates to accounts receivable that
arose from revenue recognized for book purposes. Chelsea reports accounts
receivable at $30,000 in the December 31, 2019, IFRS-basis statement of
financial position. However, the receivables have a zero tax basis.
ILLUSTRATION 19.5
Temporary Difference, Accounts Receivable
1-64
LO 6
Illustration on Future Taxable Amounts & DTLs
LEARNING OBJECTIVE6
Accounting for DTLs
Illustration: Reversal of Temporary Difference, Chelsea Inc.
ILLUSTRATION 19.6
Chelsea assumes that it will collect the accounts receivable and report
the $30,000 collection as taxable revenues in future tax returns. Chelsea
does this by recording a deferred tax liability.
1-65
LO 6
LEARNING OBJECTIVE6
Accounting for DTLs
Illustration on Future Taxable Amounts&DTLs
Deferred Tax Liability
A deferred tax liability represents the increase in taxes payable in
future years as a result of taxable temporary differences existing at
the end of the current year.
2019
2020
2021
Total
$28,000
$28,000
$28,000
$84,000
16,000
36,000
32,000
84,000
Difference
$12,000
$(8,000)
$(4,000)
Income tax expense (40%)
$28,000
$28,000
$28,000
Income tax expense (IFRS)
Income tax payable (TA)
$0
$84,000
ILLUSTRATION 19.4
Comparison of Income Tax Expense
to Income Taxes Payable
1-66
LO 6
Illustration on Future Taxable Amounts&DTLs
LEARNING OBJECTIVE6
Accounting for DTLs
Because it is the first year of operations for Chelsea, there is no deferred tax
liability at the beginning of the year. Chelsea computes the income tax
expense for 2019 as follows:
ILLUSTRATION 19.9
Computation of Income Tax Expense, 2019
1-67
LO 6
Illustration on Future Taxable Amounts&DTLs
LEARNING OBJECTIVE6
Comparison of Income Tax
Expense to Income Taxes Pay
2019
2020
2021
Total
$28,000
$28,000
$28,000
$84,000
16,000
36,000
32,000
84,000
Difference
$12,000
$(8,000)
$(4,000)
Income tax expense (40%)
$28,000
$28,000
$28,000
Income tax expense (IFRS)
Income tax payable (TA)
$0
$84,000
Chelsea makes the following entry at the end of 2019 to record
income taxes.
Income Tax Expense
1-68
28,000
Income Taxes Payable
16,000
Deferred Tax Liability
12,000
LO 6
Illustration on Future Taxable Amounts&DTLs
LEARNING OBJECTIVE6
Comparison of Income Tax
Expense to Income Taxes Pay
2019
2020
2021
Total
$28,000
$28,000
$28,000
$84,000
16,000
36,000
32,000
84,000
Difference
$12,000
$(8,000)
$(4,000)
Income tax expense (40%)
$28,000
$28,000
$28,000
Income tax expense (IFRS)
Income tax payable (TA)
$0
$84,000
Chelsea makes the following entry at the end of 2020 to record
income taxes.
Income Tax Expense
28,000
Deferred Tax Liability
8,000
Income Taxes Payable
1-69
36,000
LO 6
Illustration on Future Taxable Amounts&DTLs
LEARNING OBJECTIVE6
Comparison of Income Tax
Expense to Income Taxes Pay
2019
2020
2021
Total
$28,000
$28,000
$28,000
$84,000
16,000
36,000
32,000
84,000
Difference
$12,000
$(8,000)
$(4,000)
Income tax expense (40%)
$28,000
$28,000
$28,000
Income tax expense (IFRS)
Income tax payable (TA)
$0
$84,000
Chelsea makes the following entry at the end of 2021 to record income taxes.
Income Tax Expense
28,000
Deferred Tax Liability
4,000
Income Taxes Payable
1-70
32,000
LO 6
Illustration on Future Taxable Amounts&DTLs
LEARNING OBJECTIVE6
Comparison of Income Tax
Expense to Income Taxes Pay
The entry to record income taxes at the end of 2021 reduces the Deferred
Tax Liability by $4,000. The Deferred Tax Liability account appears as follows
at the end of 2021 .
ILLUSTRATION 19.12
Deferred Tax Liability Account after Reversals
1-71
LO 6
Financial Statement Presentation for DTI
LEARNING OBJECTIVE 7
SFP Presentation,
Deferred Tax Liabilities
SFP Presentation
 The DT classification related to its underlying asset or liability.
 Classify the DT amounts as current or as non-current.
 Sum the various DTA and DTL classified as current.
 If net result is an asset, report as current asset, whereas
 If net result is liability, report as current liability.
 Sum the various DTA and DTL classify as non current.
 If net result is an asset, report as long term asset, and
 If net result is liability, report as long term liability
1-72
LO 6
Financial Statement Presentation for DTI
LEARNING OBJECTIVE 7
SFP Presentation,
Deferred Tax Liabilities
Income Statement Presentation
 Income tax expense is allocated to;
 Continuing operations
 Discontinued operations
 Extraordinary items
 Cumulative effects of an accounting change(see FAS154)
 Prior period adjustments and
 Disclose other significant components such as Current tax expense and
Deferred tax expense/benefits and etc.
1-73
LO 6
LEARNING OBJECTIVE 7
SFP Presentation,
Deferred Tax Liabilities
Financial Statement Effects
2019
2020
2021
2019
2020
2021
ILLUSTRATION 19.14
Income Statement Presentation,
Income Tax Expense
1-74
LO 6
LEARNING OBJECTIVE 7
SFP Presentation,
Deferred Tax Liabilities
Financial Statement Effects
2019
2020
2021
ILLUSTRATION 19.14
Income Statement
Presentation, Income
Tax Expense
ILLUSTRATION 19.15
Components of Income Tax Expense
1-75
LO 6
Illustration on Future Taxable Amounts&DTLs
LEARNING OBJECTIVE7
Accounting for DTLs
Example 1.7: Starfleet Corporation has one temporary difference at the end of
2014 that will reverse and cause taxable amounts of $55,000 in 2015, $60,000
in 2016, and $75,000 in 2017. Starfleet‟s pretax financial income for 2014 is
$400,000, and the tax rate is 30% for all years. There are no deferred taxes at
the beginning of 2014.
Instructions
a) Compute taxable income and income taxes payable for 2014.
b) Prepare the journal entry to record income tax expense, deferred income
taxes, and income taxes payable for 2014.
1-76
LO 6
LEARNING OBJECTIVE 7
Accounting for DTLs
Solution for Example 1.7
Illustration:
Current Yr.
INCOME:
2014
Financial income (IFRS)
400,000
Temporary Diff.
Taxable income (TA)
Tax rate
Income tax
b.
1-77
a.
2015
2016
2017
(190,000)
55,000
60,000
75,000
210,000
55,000
60,000
75,000
a.
Income Tax Expense (plug)
30%
63,000
30%
16,500
30%
18,000
30%
22,500
120,000
Income Taxes Payable
63,000
Deferred Tax Liability
57,000
LO 6
Reversal of Temporary Difference
LEARNING OBJECTIVE 7
Accounting for DTAs
Example 1.8: During 2019, Cunningham Inc. estimated its warranty costs
related to the sale of microwave ovens to be $500,000, paid evenly over the
next two years. For book purposes, in 2019 Cunningham reported warranty
expense and a related estimated liability for warranties of $500,000 in its
financial statements.
For tax purposes, the warranty tax deduction is not
allowed until paid.
ILLUSTRATION 19.16
Temporary Difference, Warranty Liability
1-78
LO 6
Illustration Future Deductible Amounts and DTAs
Solution: Reversal of Temporary Difference.
LEARNING OBJECTIVE7
Accounting for DTAs
ILLUSTRATION 19.17
When Cunningham pays the warranty liability, it reports an expense (deductible
amount) for tax purposes. Cunningham reports this future tax benefit in the
December 31, 2019, statement of financial position as a deferred tax asset.
A deferred tax asset represents the increase in taxes refundable (or saved) in
future years as a result of deductible temporary differences existing at the end
of the current year.
1-79
LO 6
Illustration Future Deductible Amounts and DTAs
LEARNING OBJECTIVE7
Accounting for DTAs
Example 1.9: Hunt Company has revenues of $900,000 for both 2019 and
2020. It also has operating expenses of $400,000 for each of these years. In
addition, Hunt accrues a loss and related liability of $50,000 for financial
reporting purposes because of pending litigation. Hunt cannot deduct this
amount for tax purposes until it pays the liability, expected in 2020. As a
result, a deductible amount will occur in 2020 when Hunt settles the liability,
causing taxable income to be lower than pretax financial information. Shows
the IFRS and tax reporting over the two years.
1-80
LO 6
ILLUSTRATION 19.18
IFRS and Tax Reporting, Hunt Company
1-81
LO 6
Illustration Future Deductible Amounts and DTAs
LEARNING OBJECTIVE6
Accounting for DTAs
Example1.9 Cont.: Hunt records a deferred tax asset of $20,000 at the end
of 2019 because it represents taxes that will be saved in future periods as a
result of a deductible temporary difference existing at the end of 2019.
ILLUSTRATION 19.19
Computation of Deferred Tax Asset, End of 2019
1-82
LO 6
Illustration Future Deductible Amounts and DTAs
LEARNING OBJECTIVE7
Accounting for DTAs
Hunt can also compute the deferred tax asset by preparing a schedule that
indicates the future deductible amounts due to deductible temporary
differences.
ILLUSTRATION 19.20
Schedule of Future Deductible Amounts
1-83
LO 6
LEARNING OBJECTIVE7
Accounting for DTAs
Illustration Future Deductible Amounts and DTAs
Assume that 2019 is Hunt‟s first year of operations, and income tax
payable is $200,000, compute income tax expense.
ILLUSTRATION 19.21
Computation of Income
Tax Expense, 2019
Hunt made the entry at the end of 2019 to record income taxes.
Income Tax Expense
Deferred Tax Asset
Income Taxes Payable
1-84
180,000
20,000
200,000
LO 6
Illustration Future Deductible Amounts and DTAs
Computation of Income Tax Expense for 2020.
LEARNING OBJECTIVE7
Accounting for DTAs
ILLUSTRATION 19.22
Computation of Income
Tax Expense, 2020
Hunt made the entry at the end of 2020 to record income taxes.
Income Tax Expense
Deferred Tax Asset
Income Taxes Payable
1-85
200,000
20,000
180,000
LO 6
Financial Statement Effects
LEARNING OBJECTIVE 7
SFP Presentation, DTA
Illustn 19.24
Income Statement
Presentation,
Deferred Tax Asset
The entry to record income taxes at the end of 2020 reduces the
Deferred Tax Asset by $20,000 as shown below.
1-86
ILLUSTRATION 19.25 Deferred Tax Asset Account after Reversals
LO 6
Illustration Future Deductible Amounts and DTAs
LEARNING OBJECTIVE7
Accounting for DTAs
Example 1.10: Columbia Corporation has one temporary difference at the
end of 2018 that will reverse and cause deductible amounts of $50,000 in
2019, $65,000 in 2020, and $40,000 in 2021. Columbia‟s pretax financial
income for 2018 is $200,000 and the tax rate is 34% for all years. There are
no deferred taxes at the beginning of 2018.
Columbia expects to be
profitable in the future.
Instructions
a) Compute taxable income and income taxes payable for 2018.
b) Prepare the journal entry to record income tax expense, deferred income
taxes, and income taxes payable for 2018.
1-87
LO 6
Solution for Example10.5
Illustration
LEARNING OBJECTIVE 6
Accounting for DTAs
Current Yr.
INCOME:
2018
Financial income (IFRS)
200,000
Temporary Diff.
Taxable income (Tax)
Tax rate
a.
Income tax
2019
2020
2021
155,000
(50,000)
(65,000)
(40,000)
355,000
(50,000)
(65,000)
(40,000)
34%
34%
34%
(17,000)
(22,100)
(13,600)
34%
120,700
a.
b.
Income Tax Expense
68,000
Deferred Tax Asset
52,700
Income Taxes Payable
1-88
120,700
LO 6
Accounting for Additional Issues for Income Taxes
 Deferred Tax Asset (Non-Recognition)
 A company should reduce a deferred tax asset if it is probable that it will
not realize some portion or all of the deferred tax asset.
 “Probable” means a level of likelihood of at least slightly more than 50
percent.
1-89
LO 7
Deferred Tax Asset (Non-Recognition)
Example1.11
Callaway Corp. has a deferred tax asset account with a
balance of €150,000 at the end of 2018 due to a single cumulative temporary
difference of €375,000. At the end of 2019, this same temporary difference
has increased to a cumulative amount of €500,000. Taxable income for 2019
is €850,000. The tax rate is 40% for all years.
Instructions:
Assuming that it is probable that €30,000 of the deferred tax asset will not be
realized, prepare the journal entry at the end of 2019 to recognize this
probability.
1-90
LO 7
Deferred Tax Asset (Non-Recognition)
Illustration:
INCOME:
LEARNING OBJECTIVE 8
Identify additional issues in
accounting for income taxes.
Current Yr.
2018
Financial income (IFRS)
2019
2020
725,000
Temporary difference
375,000
125,000
(500,000)
Taxable income (TA)
375,000
850,000
(500,000)
Tax rate
Income tax
Income Tax Expense
Deferred Tax Asset
40%
150,000
40%
340,000
Deferred Tax Asset
1-91
40%
(200,000)
40%
-
290,000
50,000
Income Taxes Payable
Income Tax Expense
2021
340,000
30,000
30,000
LO 7
Income Statement Presentation
LEARNING OBJECTIVE 8
Identify additional issues in
accounting for income taxes.
Formula to Compute Income Tax Expense
ILLUSTRATION 19.27
Formula to Compute
Income Tax Expense
In the income statement or in the notes to the financial statements, a
company should disclose the significant components of income tax expense
attributable to continuing operations.
1-92
LO 7
Income Statement Presentation
Given the previous information related to Chelsea Inc., Chelsea
reports its income statement as follows.
ILLUSTRATION 19.28
1-93
LO 7
Specific Differences
Originating and Reversing Aspects of Temporary Differences.
 The
specific differences can be future deductible amount, future taxable
amount or permanent difference.
 Originating
temporary difference is the initial difference between the book
basis and the tax basis of an asset or liability.
 Reversing
difference occurs when eliminating a temporary difference that
originated in prior periods and then removing the related tax effect from the
deferred tax account.
1-94
LO 7
Specific Differences
Example1.12: Havaci Com reports pretax financial income of €80,000 for
2019. The following items cause taxable income to be different from
pretax financial income.
1.Depreciation on the tax return is greater than depreciation on the
income statement by €16,000.
2.Rent collected on the tax return is greater than rent earned on the
income statement by €27,000.
3.Fines for pollution appear as an expense of €11,000 on the income
statement.
Havaci‟s tax rate is 30% for all years, and the company expects to report
taxable income in all future years. There are no deferred taxes at the
beginning of 2019. Prepare the journal entry to record income tax
expense, deferred income taxes, and income taxes payable for 2019.
1-95
LO 7
Specific Differences
E19-4:
Current Yr.
Deferred
Deferred
INCOME:
2019
Asset
Liability
Financial income (IFRS)
€ 80,000
Excess tax depreciation
(16,000)
Excess rent collected
27,000
Fines (permanent)
11,000
Taxable income (TA)
Tax rate
Income tax
Income Tax Expense
Deferred Tax Asset
Deferred Tax Liability
Income Tax Payable
1-96
102,000
€ 16,000
(€ 27,000)
(27,000)
16,000
30%
30%
30%
€ 30,600
(€ 8,100)
€ 4,800
27,300
8,100
4,800
30,600
LO 7
Examples of Temporary and permanent Differences
Example1.13: Assume that Bio-Tech reports pretax financial income of
€200,000 in each of the years 2020, 2021, and 2022. The company is
subject to a 30% tax rate and has the following differences between
pretax financial income and taxable income.
1. Bio-Tech reports an installment sale of €18,000 in 2020 for tax
purposes it recognizes the sales over an 18-month period at a constant
amount per month beginning January 1, 2021. It recognizes the entire
sale for book purposes in 2020.
2. It pays life insurance premiums for its key officers of €5,000 in 2021
and 2022. Although not tax-deductible, Bio-Tech expenses the
premiums for book purposes.
1-97
LO 7
Examples of Temporary and permanent Differences
Example1.13Cont. The installment sale is a temporary difference,
whereas the life insurance premium is a permanent difference. Table
shows the reconciliation of Bio-Tech‟s pretax financial income to taxable
income and the computation of income taxes payable.
1-98
LO 7
Examples of Temporary and permanent Differences
Example1.13Cont. Bio-Tech records income taxes for 2020, 2021, and
2022 as follows.
1-99
LO 7
Tax Rate Considerations
Future Tax Rates
A company must consider presently enacted changes in the tax rate that
become effective for a particular future year(s) when determining the tax rate
to apply to existing temporary differences.
If new rates are not yet enacted for future years, use the current rate.
1-100
LO 7
Future Tax Rates
Example1.14
Wang Group at the end of 2016 has the following
cumulative temporary difference of ¥300,000, computed as shown.
ILLUSTRATION 19.33
Computation of
Cumulative Temporary
Difference
Assume that the ¥300,000 will reverse and result in taxable amounts
in the future, with the enacted tax rates shown.
1-101
ILLUSTRATION 19.34
Deferred Tax Liability Based on Future Rates
LO 7
Future Tax Rates
Example1.14.Cont. Assume that the ¥300,000 will reverse and result
in taxable amounts in the future, with the enacted tax rates shown.
ILLUSTRATION 19.34
The total deferred tax liability at the end of 2016 is ¥108,000.

Wang may only use tax rates other than the current rate when the future
tax rates have been enacted.

If new rates are not yet enacted for future years, Wang should use the
current rate.
1-102
LO 7
Tax Rate Considerations
Revision of Future Tax Rates
When a change in the tax rate is enacted, companies should record its
effect on the existing deferred income tax accounts immediately.
A company reports the effect as an adjustment to income tax expense in
the period of the change.
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LO 7
Revision of Future Tax Rates
Example1.14: Assume that on Dec10, 2018, a new income tax act is
signed into law that lowers the company tax rate from 40 percent to 35
percent, effective January 1, 2020. If Hostel Co. has one temporary
difference at the beginning of 2018 related to $3 million of excess tax
depreciation, then it has a Deferred Tax Liability account with a balance of
$1,200,000 ($3,000,000 × 40%) at January 1, 2018. If taxable amounts
related to this difference are scheduled to occur equally in 2019, 2020,
and 2021, the deferred tax liability at the end of 2018 is $1,100,000.
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ILLUSTRATION 19.35
Schedule of Future Taxable Amounts and Related Tax Rates
LO 7
Revision of Future Tax Rates
Hostel, therefore, recognizes the decrease of $100,000 ($1,200,000 −
$1,100,000) at the end of 2018 in the deferred tax liability as follows.
ILLUSTRATION 19.35
Schedule of Future Taxable Amounts and Related Tax Rates
Deferred Tax Liability
Income Tax Expense
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100,000
100,000
LO 7
Accounting for Net Operating Losses
LEARNING OBJECTIVE 3
Explain the accounting for loss
carrybacks and loss
carryforwards.
Net operating loss (NOL) = tax - deductible expenses exceed taxable
revenues.
Tax laws permit taxpayers to use the losses of one year to offset the
profits of other years (loss carryback and loss carryforward).
Under this provision, a company pays no income taxes for a year in
which it incurs a net operating loss.
In addition, it may select one of the two options.
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LO 8
Accounting for Net Operating Losses
Loss Carryback

Back 2 years and forward 20 years and receive refunds for income
taxes paid in those years.

Losses must be applied to earliest year first.

It may carry forward any loss remaining after the two-year carryback up
to 20 years to offset future taxable income.
ILLUSTRATION 19.36
1-107 Loss Carryback Procedure
LO 8
Accounting for Net Operating Losses
Loss Carryforward
 May
 Use
elect to forgo loss carryback and
only the loss carry forward option, offsetting future taxable
income for up to 20 years(Carry forward losses 20 years).
ILLUSTRATION 19.30
Loss Carryforward Procedure
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LO 8
Loss Carryback Example
Example1.15: Groh Inc. has no temporary or permanent differences. Groh
experiences the following.
Year
2015
2016
2017
2018
Taxable
Income of Loss
$
50,000
100,000
200,000
(500,000)
Tax
Rate
35%
30%
40%
$
Tax
Paid
17,500
30,000
80,000
0
In 2018, Groh incurs a net operating loss 500,000 that it decides to carry
back. Prepare Gron‟s entry to record the effect of the loss carryback.
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LO 8
Loss Carryback Example
Illustration:
2015
2016
2017
2018
Financial income
Difference
Taxable income (loss)
$
Rate
Income tax
50,000
$
35%
100,000
$
30%
200,000
$
(500,000)
$
(500,000)
40%
$
17,500
$
30,000
$
80,000
$
50,000
$
100,000
$
200,000
NOL Schedule
Taxable income
Carryback
(100,000)
Taxable income
50,000
Rate
Income tax (revised)
Refund
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35%
$
17,500
$
$
(200,000)
-
-
30%
40%
-
30,000
$
$
-
80,000
300,000
(200,000)
0%
$
-
$110,000
LO 8
Loss Carryback Example
Ex1.15 Cont.: Groh Inc. reports the account credited on the income
statement for 2018 as shown.
ILLUSTRATION 19.38
Recognition of Benefit of the Loss Carryback in the Loss Year
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LO 8
Loss Carryforward Example
In addition to recording the $110,000 Benefit Due to Loss Carryback, Groh
Inc. records the tax effect of the $200,000 loss carry forward as a deferred tax
asset of $80,000 assuming that the enacted future tax rate is 40 percent for
2018. The entry is made as follows:
Illustration:
2015
2016
2017
2018
NOL Schedule
Taxable income
$
50,000
$
Carryback
50,000
Rate
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$
(100,000)
Taxable income
Income tax (revised)
100,000
35%
$
17,500
$
200,000
(200,000)
-
-
30%
40%
-
$
$
-
(500,000)
300,000
(200,000)
40%
$
(80,000)
LO 8
Carryforward (Recognition)
Ex1.15.Cont.:The two accounts credited are contra income tax expense
items, which Groh presents on the 2018 income statement as shown below.
ILLUSTRATION 19.39
Recognition of the Benefit of the Loss Carryback
and Carryforward in the Loss Year
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LO 8
Carryforward (Recognition)
For 2019, assume that Groh returns to profitable operations and has taxable
income of $250,000 (prior to adjustment for the NOL carryforward), subject to
a 40 percent tax rate.
2018
2019
NOL Schedule
Taxable income
$
Carryback (carryforward)
$
300,000
Taxable income
50,000
40%
$
(80,000)
250,000
(200,000)
(200,000)
Rate
Income tax (revised)
(500,000)
40%
$
20,000
Groh records income taxes in 2019 as follows:
Income Tax Expense
Deferred Tax Asset
Income Taxes Payable
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100,000
80,000
20,000
LO 8
Carryforward (Recognition)
The 2019 income statement does not report the tax effects of either the
loss carryback or the loss carryforward because Groh had reported both
previously.
ILLUSTRATION 19.41
Presentation of the Benefit of Loss Carryforward Realized in 2019, Recognized in 2018
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LO 8
Carryforward (Non-Recognition)
Assume that Groh will not realize the entire NOL carryforward in future years.
In this situation, Groh does not recognize a deferred tax asset for the loss
carryforward because it is probable that it will not realize the carryforward.
Groh makes the following journal entry in 2018.
Income Tax Refund Receivable
110,000
Benefit Due to Loss Carryback (Income Tax Expense)
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110,000
LO 8
Carryforward (Non-Recognition)
Groh‟s 2018 income statement presentation is as follows:
ILLUSTRATION 19.42
Recognition of Benefit of Loss Carryback Only
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LO 8
Carryforward (Non-Recognition)
In 2019, assuming that Groh has taxable income of $250,000 (before
considering the carryforward), subject to a tax rate of 40 percent, it
realizes the deferred tax asset. Groh records the following entries.
Deferred Tax Asset
80,000
Benefit Due to Loss Carryforward
Income Tax Expense
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80,000
100,000
Deferred Tax Asset
80,000
Income Taxes Payable
20,000
LO 8
Carryforward (Non-Recognition)
Assuming that Groh derives the income for 2019 from continuing
operations, it prepares the income statement as shown.
ILLUSTRATION 19.43
Recognition of Benefit of Loss Carryforward When Realized
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LO 8
Non-Recognition Revisited
Whether the company will realize a deferred tax asset depends on whether
sufficient taxable income exists or will exist within the carryforward period
available under tax law.
ILLUSTRATION 19.44
1-120 Possible Sources of Taxable Income
LO 8
Financial Statement
Presentation
LEARNING OBJECTIVE 4
Describe the presentation of
deferred income taxes in
financial statements.
Statement of Financial Position
Deferred tax assets and deferred tax liabilities are also separately
recognized and measured but may be offset in the statement of financial
position.
The net deferred tax asset or net deferred tax liability is reported in the non-
current section of the statement of financial position.
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LO 8
Statement of Financial Position
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ILLUSTRATION 19.45
Classification of Temporary Differences
LO 8
Financial Statement Presentation
Income Statement
Companies allocate income tax expense (or benefit) to
1-123

continuing operations,

discontinued operations,

other comprehensive income, and

prior period adjustments.
LO 8
Income Statement
Components of income tax expense (benefit) may include:
1. Current tax expense (benefit).
2. Any adjustments recognized in the period for current tax of prior
periods.
3. Amount of deferred tax expense (benefit) relating to the origination
and reversal of temporary differences.
4. Amount of deferred tax expense (benefit) relating to changes in
tax rates or the imposition of new taxes.
5. Amount of the benefit arising from a previously unrecognized tax
loss, tax credit, or temporary difference of a prior period that is
used to reduce current and deferred tax expense.
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LO
LO84
Financial Statement Presentation
Tax Reconciliation
Companies either provide:

A numerical reconciliation between tax expense (benefit) and the
product of accounting profit multiplied by the applicable tax rate(s),
disclosing also the basis on which the applicable tax rate(s) is (are)
computed; or

A numerical reconciliation between the average effective tax rate and
the applicable tax rate, disclosing also the basis on which the applicable
tax rate is computed.
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LO 8
Review of the Asset-Liability Method
The IASB believes that the asset-liability method (sometimes referred to as
the liability approach) is the most consistent method for accounting for
income taxes.
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ILLUSTRATION 19.50
Basic Principles of the Asset-Liability Method
LO 9
ILLUSTRATION 19.51
Procedures for Computing
and Reporting Deferred
Income Taxes
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LO 9
Required Presentation and Disclosures
 A. Taxation balances should be presented as follows:
 The balances are shown separately from other assets and liabilities in the
Statement of Financial Position.
 Current tax payable is always shown as a current liability and deferred tax
balances are noncurrent and should distinguished from current tax balances.
 Current and deferred tax balances should be shown as separate items cannot
be offset.
 Deferred tax assets or liabilities should not be discounted.
 The tax expense (income) related to profit or loss from ordinary activities shall
be presented as part of profit or loss in the statement(s) of profit or loss and
other comprehensive income.
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LO 10
Required Presentation and Disclosures
 Current tax balances can be offset when:
there is a legal enforceable right to offset the recognized amounts; and
there is an intention either to settle on a net basis, or to realize the asset
and settle the liability simultaneously.
 Deferred tax balances can be offset when:
there is a legal enforceable right to set off current tax assets against current
tax liabilities; and
deferred tax assets and liabilities relate to income tax levied by the same tax
authority on either:
o the same taxable entity; or
o different taxable entities which intend either to settle current tax liabilities
and assets on a net basis, or to realize the assets and settle the liabilities
simultaneously in each future period.
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LO 10
Required Presentation and Disclosures
B. The statement of comprehensive income and notes should contain:
 Major
components of tax expense (income), shown separately, including:
a) current tax expense (income);
b) any adjustments recognized in the period for current tax of prior periods;
c) the amount of deferred tax expense (income) relating to the origination and
reversal of temporary differences;
d) the amount of deferred tax expense (income) relating to changes in tax
rates or the imposition of new taxes;
e) the amount of tax benefits arising from a previously unrecognized tax loss,
tax credit or temporary difference of a prior period that is used to reduce
the current or deferred tax expense as relevant;
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LO 10
Required Presentation and Disclosures
f) the amount of the benefit from a previously unrecognized tax loss, tax
credit or temporary difference of a prior period that is used to reduce
deferred tax expense;
g) deferred tax arising from the write-down (or reversal of a previous writedown) of a deferred tax asset; and
h) the amount of tax expense (income) relating to those changes in
accounting policies and fundamental errors that are included in profit or
loss in accordance with IAS 8, because they cannot be accounted for
retrospectively.
i) Exchange differences on deferred foreign tax liabilities or assets which
can be deferred asset or liability and is most useful to users of financial
reports.
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LO 10
Required Presentation and Disclosures

Reconciliation between tax amount and accounting profit or loss in monetary
terms, or a numerical reconciliation of the applicable tax rate;

The amount of income tax relating to each component of other
comprehensive income;

in respect of discontinued operations:

the amount of tax expense related to the gain or loss on discontinuance;

the amount of tax expense related to the profit or loss from ordinary
activities of discontinued operation for the period;

Explanation of changes in applicable tax rates compared to previous
period(s); and

For each type of temporary difference, and in respect of each type of unused
tax loss and credit, the amounts of the deferred tax recognized in the
Statement of Comprehensive Income.
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LO 10
Required Presentation and Disclosures
c. The statement of financial position and notes should include:

Aggregate amount of current and deferred tax charged or credited directly to
equity;

Amount of deductible temporary differences, unused tax losses, and unused
tax credits for which no deferred tax asset is recognized;

Aggregate amount of temporary differences associated with investments in
subsidiaries, branches, associates, and joint ventures for which deferred tax
liabilities have not been recognized;

Amount of a deferred tax asset and nature of the evidence supporting its
recognition.
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LO 10
Required Presentation and Disclosures

The mount of a loss in either the current or preceding period;

amount of income tax consequences of dividends to shareholders that were
proposed or declared before the reporting date, but are not recognized as a
liability in the financial statements; and

the nature of the potential income tax consequences that would result from
the payment of dividends to shareholders, that is, the important features of
the income tax systems and the factors that will affect the amount of the
potential tax consequences of dividends.
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LO 10
End of Chapter-I
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AcFn 4101 By Yoseph T
Saturday, November 11, 2023