IAS 12
Handout 4
Essentials Deferred Tax
B. Questions and answers- Specific issues
Question 1 – Consolidated accounts
Entity A manufactures and sells products to a foreign subsidiary (B Ltd), who in turn sells them to
third parties. Tax rate of Entity A is 30%, whilst the tax rate of B Ltd is 40%. During the year Entity
A has sold products to B Ltd for Shs 200,000, recording a profit of Shs 20,000 in its own books. At
the end of 20X4, the unsold inventory is stated in the Group’s consolidation balance sheet at Shs
90,000, i.e. net of the unrealised profits of Shs 10,000. No equivalent adjustment to inventory is
made for tax purposes.
What is the amount of the deferred tax asset/liability related to this transaction at the end of 20X4?
Answer 1 – Consolidated accounts
Unrealised profits on intra-group transactions are eliminated from the carrying amount of assets but
no equivalent adjustment is made for tax purposes. The tax base of the relevant asset is the amount
before eliminating the unrealised profit. The deductible temporary difference represents the amount
of the unrealised profit.
Shs 000s
Carrying amount - net of provision for unrealised profit (consolidated accounts)
90
Tax base - carrying value before deducting provision (accounts B Ltd)
100
Deductible temporary difference
Debit deferred tax asset (10 @ 40%  tax rate of B Ltd)
Credit deferred tax income (10 @ 40%)
10
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Question 2 – Initial recognition exemption
At 14 June 20X4, entity A purchases a luxury car from a car producer. The car is for the use of the
company’s chief executive officer. The purchase price of the car is Shs 5,000,000. The car will be
depreciated over 5 years for accounting purposes. The cost of the car that can be depreciated for tax
purposes is restricted to Shs 1,000,000. The income tax rate is 30%.
Carrying amount of the car
Tax base of the car
5,000,000
1,000,000
What amount of deferred income tax should be recognised at 14 June 20X4?
Answer 2 – Initial recognition exemption
No deferred tax liability should be recognised because of the initial recognition exemption rule.
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IAS 12
Handout 4
Essentials Deferred Tax
Question 3 - Assets carried at fair value
Entity A buys the following on 1 January 2004:
 Freehold land for shs 10 million
 An industrial building for Sha 102 million
 An office building for Shs 51 million.
At 31 December 2004 the carrying values were:
 Freehold land – Shs 10 million
 Industrial building – Shs 100 million
 Office building – Shs 50 million.
Tax allowances, including an investment deduction, were claimed on the industrial building and the
residual value for tax purposes at 31 December 2004 was Shs 40 million. The income tax rate is
30%. There is no capital gains tax.
The company revalued its assets on 1 January 2005 to:
 Freehold land – Shs 15 million
 Industrial building – Shs 120 million
 Office building – Shs 65 million.
Compute the deferred tax liability to be recognised in entity A’s balance sheet relating to each asset
at 1 January 2004, 31 December 2004, and 1 January 2005.
On 2 January 2005, 100% of the issued shares of entity A were acquired by entity B. The valuation
amounts above were considered to be the fair values of the assets on the acquisition of the business.
Compute the deferred tax liability that entity B should recognise in respect of the above assets for
the purposes of determining the goodwill on acquisition.
Answer 3 – assets carried at fair value
At 1 January 2004
Nil – the temporary differences on the office building has arisen on initial recognition and the
exemption applies. The tax base (for capital gains tax purposes) for the freehold land is assumed to
be its cost.
31 December 2004



Freehold land: nil – the tax base for capital gains tax purposes continues to be its cost;
Industrial building: carrying value is Shs 100 m and tax base is Shs 40 m. Temporary
difference (not arising on initial recognition) is therefore Shs 60 m. Deferred tax should be
computed at the income tax rate of 30% = Shs 18m;
Office building: nil – although the temporary difference has reduced due to depreciation, it
is still a temporary difference that arose on initial recognition.
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IAS 12
Handout 4
Essentials Deferred Tax
At 1 January 2005



Freehold land: nil – the capital gains tax rate applies to the revaluation surplus since the land
is non-depreciable
Industrial building: the carrying value is now Shs 120 m; the tax base remains at Shs 40 m.
The temporary difference is therefore Shs 80 m and deferred tax of Shs 24 m should be
provided (at 30%). The increase of Shs 6 m should be debited to the revaluation surplus in
equity;
Office building: the temporary difference has been increased by Shs 15 m. The increase did
not arise on initial recognition of the asset, therefore deferred tax should be provided on it of
15 m x 30% = Shs 4.5 m.
On acquisition by entity B
The carrying values and tax bases remain the same, but now all the temporary differences arose on a
business combination, so do not qualify for the initial recognition exemption. In arriving at the
figure for goodwill, entity B should recognise the following deferred tax liabilities:
 Freehold land: nil – the capital gains tax rate still applies
 Industrial building: Shs 24 m (no change, since there was no initial recognition exemption
before)
 Office building: Shs 19.5 m (Shs 65 m x 30%) since the initial recognition exemption no
longer applies to a building acquired as part of a business combination.
Question 4 – Strategy to implement an exit plan
An entity has a history of recent losses. Management has developed an exit plan in which a lossmaking activity will be discontinued. Management intend to implement the measures from March
20X5.
Management expects to reverse the losses over the two years following the implementation of the
exit plan, and proposes that a deferred tax asset is recognised in respect of the losses incurred using
the exit plan to justify the recognition of the deferred tax asset.
Management is preparing the 31 December 20X4 financial statements. The current date is January
20X5 and the plan has not yet been made public.
Can management recognise a deferred tax asset based on a strategy to implement an exit plan?
Answer 4 – Strategy to implement an exit plan
No, a deferred tax asset should only be recognised if there is a high degree of certainty that
sufficient profits will be earned to utilise the losses. The history of recent losses raises significant
concerns about whether the plan is achievable.
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IAS 12
Handout 4
Essentials Deferred Tax
Consideration should be given to the following factors in assessing the likelihood of the projected
profits being realised:
a) the probability that management will implement the plan;
b) management's ability to implement the plan (for example, obtaining concessions from labour
unions); and
c) the level of detailed analysis and sensitivity analysis that management has prepared; and
d) the extent to which the plan can be verified objectively.
Question 5 – Recognition of deferred tax asset
In 20X4, a company has taxable temporary differences of Shs 40,000, which result in a deferred tax
liability, that are expected to reverse in 20X8. The company also has deductible temporary
differences of Shs 60,000, which would result in a deferred tax asset, that are expected to reverse in
20X8. The management of the company expects that the company will have a taxable gain for the
first time in its history in 20X8. No business plan is available for this period. No tax planning
opportunities are available to create taxable profits.
The company's tax rate is 30%. Assume that the company has the right to offset deferred tax assets
and liabilities.
What is the amount of deferred tax asset and deferred tax liability before netting, and what amount
should be included in the company’s balance sheet at 31 December 20X4?
Answer 5 – Recognition of deferred tax asset
In a first step, we need to determine if there are sufficient taxable temporary differences available
against which the deductible temporary differences can be utilised. The amount of available taxable
temporary differences that will be reversed in the same period as the deductible temporary
differences is Shs 40,000. Management can recognise the related deferred tax asset of Shs 12,000
(40,000 at 30%).
The company has a history of recent losses, which is strong evidence that future taxable profit may
not be available. There is no business plan available that may support management’s expectation
that the company will have a taxable gain in 20X8. Therefore, it is not probable that sufficient
taxable profits are available in 20X8, the time when the taxable temporary difference will be
reversed and against which the deductible temporary could be utilised. Therefore, the company
should only include deductible temporary differences of Shs 40,000 in its calculation of the deferred
tax asset.
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IAS 12
Handout 4
Essentials Deferred Tax
With this information, we can calculate the amount of deferred taxes. Management should not
include a deferred tax asset or liability in its balance sheet at 31 December 20X4. Deferred tax
assets and deferred tax liabilities should be offset. This is illustrated below:
Taxable temporary differences
Deductible temporary differences
Amount of
temporary differences
Shs
(40,000)
Amount of
deferred tax
Shs
(12,000)
40,000
12,000
Deferred tax asset / (liability) in
balance sheet at 31 December 20X4
Nil
BUT even if the offsetting of deferred tax assets and liabilities results in a net amount of nil and no
deferred tax asset or liability is included in the face of the balance sheet, the information about
deferred tax assets and liabilities still needs to be disclosed in the notes to the financial statements.
Question 6 – proof of tax
C Ltd’s tax computation for the year ended 31 December 2004 is as follows:
Shs
Accounting profit
Add back:
Depreciation of office building
Depreciation of industrial building
Depreciation of plant and machinery
Depreciation of saloon car*
Unrealised exchange losses (trading items)
Donations
Fines
2,000,000
3,000,000
2,500,000
1,500,000
300,000
1,000,000
700,000
Less:
Industrial building allowance
Wear & Tear allowances
Dividend from subsidiary
2,000,000
2,100,000
5,000,000
Shs
56,783,000
11,000,000
67,783,000
9,100,000
Taxable profit
58,683,000
Tax at 30%
17,604,900
*The saloon car cost Shs 6,000,000, which was restricted to Shs 1,000,000 for tax purposes.
None of the assets have been revalued.
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IAS 12
Handout 4
Essentials Deferred Tax
Based on the above information, what would you expect the tax expense to be after adjusting for the
deferred tax movement?
Answer 6 – proof of tax
Shs
Accounting profit
Add back – permanent differences:
Depreciation of office building
Depreciation of saloon car*
Donations
Fines
2,000,000
1,250,000
1,000,000
700,000
Less – permanent differences:
Dividend from subsidiary
5,000,000
Shs
56,783,000
4,950,000
61,733,000
5,000,000
Taxable profit
56,733,000
Expected tax expense at 30%
17,019,900
* 1,500,000 x 5/6
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