ias 12 by rp
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IAS 12 / NAS 09 : Income Taxes
IAS 12: Income Taxes
1. Objective
The objective of IAS 12 is to prescribe the accounting treatment for income taxes. The principal issue ishow to account for the current and future tax consequences of:
(a) the future recovery (or settlement) of the carrying amount of assets (or liabilities) that are recognised
in an entity's balance sheet, and(b) transactions and other events of the current period that are recognised in an entity's financiastatements
The items below reveal more about the requirements of IAS 12.
a. Deferred tax
The carrying amount of assets and liabilities may be recovered or settled at an amount, or under a timingdifferent from that considered for tax purposes.
In such cases, IAS 12 requires an entity to recognise a deferred tax liability or a deferred tax asset (withcertain limited exceptions), so as to recognise the deferred tax effects in the current financial statementsas if those differences did not exist.
The deferred tax liability (or asset) subsequently reverses as the differences between tax and accountingtreatment reduce, and ultimately disappears.
b. Where to account for the tax
IAS 12 requires an entity to account for the tax consequences of transactions and other events in the sameway that it accounts for the transactions and other events themselves, i.e:
in the income statement
in equity, or
in calculation of goodwill
c. IAS 12 also deals with...
IAS 12 also addresses:
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
2. The scope of IAS 12
IAS 12 should be applied in accounting for income taxes.
Income taxes include:
all domestic and foreign taxes that are based on taxable profits
taxes, such as withholding taxes, payable by a subsidiary, associate or joint venture on distributions
to the reporting entity
IAS 12 does not address:
methods of accounting for government grants (see IAS 20, Accounting for Government Grants andDisclosure of Government Assistance), or
investment tax credits
However, it does address accounting for temporary differences that may arise from such grants oinvestment tax credits.
3. Key definitions
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IAS 12 / NAS 09 : Income Taxesa. Accounting profit
Accounting profit is profit or loss for a period before deducting tax expense.
b. Taxable profit (or tax loss)
Taxable profit (or tax loss) is the profit (or loss) for a period, determined in accordance with therules established by the taxation authorities, upon which it will be determined whether income
taxes are payable (or recoverable).
This is the profit or loss, as calculated by the tax authorities, at the end of a financial period basedon the income and expenses that are included or excluded for tax purposes (e.g. accountingdepreciation versus tax depreciation).
c. Tax expense (or tax income)
Tax expense (tax income) is the aggregate amount included in the determination of profit or lossfor the period in respect of current tax and deferred tax.
i.e. Tax expense (or tax income) = current tax + deferred tax
d. Current tax
Current tax is the amount of income taxes payable (or recoverable) in respect of the taxable profit(or tax loss) for a period.
i.e. Current tax = taxable profit (or tax loss) x tax rate
It is the amount of tax due to or from the tax authorities for a period.
e. Tax base
The tax base of an asset or liability is the amount attributed to that asset or liability for taxpurposes, i.e. the value of an asset or liability in terms of the tax laws.
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For example: an asset has a cost of 100, depreciation to date is 20 but tax depreciation is 25.
Therefore:Carrying amount = 80 (accounting value)
Tax base = 75 (tax value)
f. Temporary differences
Temporary differences are differences between the carrying amount of an asset or liability in thebalance sheet and its tax base, i.e. the difference between the accounting value (carrying amountand the tax authority amount (tax base) due to the differences in treatment between the relevanttax legislation and the accounting policies of the entity.
Temporary differences may be either:(a) taxable temporary differences - temporary differences that will result in taxable amounts indetermining taxable profit (or tax loss) of future periods when the carrying amount of the asset orliability is recovered or settledor(b) deductible temporary differences - temporary differences that will result in amounts that aredeductible in determining taxable profit (or tax loss) of future periods, when the carrying amount othe asset or liability is recovered or settled
g. Deferred tax liabilities
Deferred tax liabilities are the amounts of income taxes payable in future periods in respect oftaxable temporary differences.
i.e. Deferred tax liabilities = taxable temporary differences x tax rate
h. Deferred tax assets
Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:
(a) deductible temporary differences(b) the carryforward of unused tax losses, and(c) the carryforward of unused tax credits
i.e. deferred tax assets = deductible temporary differences * tax rate + unused tax losses * tax rateand tax credits
4. Tax versus accounting treatment
A key element of understanding IAS 12 is to understand the differences between accounting profit (or lossversus taxable profit (or loss) and current tax versus deferred tax.
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IAS 12 / NAS 09 : Income Taxesa. Accounting Profit (Or Loss) Versus Taxable Profit (Or Loss)
Accounting profit/loss is the profit/loss before tax in theincome statement of a business for a financial period. Howeverdue to tax legislation, certain items that are recognised foaccounting purposes are disallowed in the computation otaxable profit (or loss).Tax profit/loss = basis on which current tax is calculated.
You can calculate tax profit/loss from accounting profit bperforming the following reconciliation: Accounting profit/lossAdd: expenses not deductible under tax laws but recognised foraccounting purposes; income included under tax laws but notrecognised for accounting purposesDeduct: expenses deductible under tax laws but not recognisedfor accounting purposes; income not included under tax lawsbut recognised for accounting purposes= Tax profit/loss
b. Current Tax Versus Deferred Tax
Current tax is the tax to be paid to (or received from) the taxauthority - it relates to the tax profit/loss generated during thatfinancial period.i.e. Current tax = tax profit/loss x tax rate
The difference in timing for tax and accounting purposes (suchas different accounting depreciation versus tax depreciationrates) will give rise to a temporary difference that will reverseover time.i.e. Temporary difference = carrying amount - tax base
The temporary difference will result in deferred tax.
Deferred tax is tax that relates to differences between thecarrying amount of an asset or a liability and its tax base, andthat is payable (or recoverable) in future periods when the asseor liability is recovered or settled.i.e. Deferred tax = temporary differences x tax rate
5. Current tax liabilities and assets
Current tax liabilitiesCurrent tax for current and prior periods should, to the extent unpaid, berecognised as a liability.
For example:Dr Tax expense (Income statement)Cr Tax Authority (Balance sheet)A current tax asset is recognised when:
the excess of the amount already paid exceeds the amount due forthose periods (i.e. companies pay estimated taxes or incurunexpected losses resulting in tax assets)
it is probable that the benefit will flow to the enterprise and the benefit can be reliably measured
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Section 2
Practical Problem
2.1 Calculating current tax
The calculation of current tax can be summarised as: Current tax = Tax profit/loss x Tax rate
For a basic example on calculating tax profit or loss, refer to the image shown, and remember:Accounting profit/lossAdd: expenses not deductible under tax laws but recognised for accounting purposes (e.g. accountingdepreciation, provisions and fines)Add: income included under tax laws but not recognised for accounting purposesDeduct: expenses deductible under tax laws but not recognised for accounting purposes (e.g. taxdepreciation allowed, profit on the legal sale of an asset that cannot be recognised under IAS 18)Deduct: income not included under tax laws but recognised for accounting purposes (e.g. re-measurement of certain assets at fair value)= Tax profit/loss
2.2 Tax Base
2.2.1 The tax base of an asset
The tax base of an asset or liability is the amount attributed to thatasset or liability for tax purposes.
The tax base of an asset is equal to:the amount that will be deductible for tax purposes against anytaxable economic benefits that will flow to an entity when it recoversthe carrying amount of the asset
If those economic benefits will not be taxable, the tax base of the assetis equal to its carrying amount (and therefore there is no temporarydifference or deferred tax).
2.2.2 The tax base of a liability is:
its carrying amount, less
any amount that will be deductible for tax purposes in respectof that liability in future periods
In the case of revenue which is received in advance, the tax base ofthe resulting liability is:
its carrying amount, less
any amount of the revenue that will not be taxable in futureperiods.
2.2.3 ExceptionsThere are some additional circumstances in which tax bases may or may not be recognised under IAS 12.
a. Tax base where there is no asset or liability in the balance sheetSome items have a tax base but are not recognised as assets and liabilities in the balance sheet.
Example: Research costs of 100 are recognised as an expense in determining accounting profit for theperiod in which they are incurred but are only allowed as a deduction in determining taxable profit (ortax loss) in a later period.
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IAS 12 / NAS 09 : Income TaxesCarrying amount = 0
Tax base = 100 (the amount the taxation authorities will permit as a deduction in future periods)
b. Tax base is not immediately apparent
If the tax base of an asset or liability is not immediately apparent, consider the fundamental principle uponwhich IAS 12.10 is based:
that an entity should, with certain limited exceptions, recognise a deferred tax liability (or asset) whenever
recovery or settlement of the carrying amount of an asset or liability would make future tax payments larger
(or smaller) than they would be if such recovery or settlement were to have no tax consequences
i.e. where there is a difference in treatment between accounting policies and tax laws affecting tax payments
made, a deferred tax asset or liability is likely to exist.
c. Consolidated annual financial statements
In consolidated financial statements:
Temporary differences = carrying amounts of assets and liabilities in the consolidated financial statements -
appropriate tax base
The tax base is determined by either:
reference to a consolidated tax return in those jurisdictions in which such a return is filed, or
by reference to the tax returns of each entity in the group (in all other jurisdictions)
2.3 Taxable Vs Deducible Temporary differences
Temporary differences may be either:
(a) taxable temporary differences - temporary differences that will result in deferred tax liabilities, i.e.taxable amounts in determining taxable profit (or tax loss) of future periods
or
(b) deductible temporary differences - temporary differences that will result in deferred tax assets, i.e.
amounts that are deductible in determining taxable profit (or tax loss) of future periods
a. Temporary differences
Temporary differences arise when an income or expense item is
included in accounting profit in one period but is included in taxable
profit in a different period.
The images shown represent examples of temporary differences which
are taxable temporary differences and therefore result in deferred taxliabilities.
The table shown summarises the classification of temporary
differences.
E.g:
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i.
Interest revenue is included in accounting profit on a time proportion basis (as earned) but may, in some
jurisdictions, be included in taxable profit only when the cash is collected.
Example: Interest receivable as per balance sheet = 350.
Tax base = 0 (interest revenues do not affect taxable profit until cash is collected)
Carrying amount = 350Taxable temporary difference = 350 (350 - 0)
Deferred tax liability (30%) = 105 (350 x 30%)
ii.
Depreciation used in determining taxable profit (or tax loss) may differ from that used in determiningaccounting profit.
Example: Asset cost = 500, accounting depreciation = 200, tax depreciation = 250.
Carrying amount = 300
Tax base = 250
Taxable temporary difference = 50 (300 - 250)Deferred tax liability (30%) = 15 (50 x 30%)
iii.
Development costs may form part of the cost of an internally generated intangible asset that is amortised
over future periods in determining accounting profit but deducted in determining taxable profit in the periodin which they are incurred.
Example: Original cost of development costs = 4,500, with a carrying amount of = 3,500.
Carrying amount = 3,500
Tax base = 0Taxable temporary difference = 3,500 (3,500 - 0)
Deferred tax liability (30%) = 1,050 (3,500 x 30%)
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2.4 Other causes of temporary differences
Temporary differences also arise when...
i. the cost of a business combination that is an acquisition is allocated to the identifiable assets and liabilities
acquired by reference to their fair values but no equivalent adjustment is made for tax purposes.
Example: Plant originally costs 500, tax base = 500. Due to acquisition in a business combination the plants
carrying amount is now 700.
Carrying amount = 700
Tax base = 500
Taxable temporary difference = 200
ii. there is a revaluation of assets
When assets are revalued and no equivalent adjustment is made for tax purposes, this gives rise to a
temporary difference.
Example: A building originally cost 500, tax base = 500. Due to the implementation of IAS 40: Investment
Property the building is revalued to 800.
Carrying amount = 800
Tax base = 500Taxable temporary difference = 300
iii. there is goodwill
When goodwill arises on consolidation, due to tax authorities not allowing reductions (e.g. impairments) in
the carrying amount of goodwill as a deductible expense, a taxable temporary difference may arise -
however:
IAS 12.21 does not permit the recognition of the resulting deferred tax liability because goodwill is a
residual and the recognition of the deferred tax liability would increase the carrying amount of goodwill.
iv. the tax base of an asset or liability differs from its carrying amount on initial recognition
If the tax base of an asset or liability differs from its carrying amount on initial recognition, the entity does
not recognise the resulting deferred tax under IAS 12.15(b)(ii) and IAS 12.24(b).
v. the carrying amount of investments in subsidiaries, branches, associates and joint ventures differ from
their tax baseIf the carrying amount of investments in subsidiaries, branches and associates or interests in joint ventures
becomes different from the tax base of the investment or interest, a temporary difference will arise.
This is covered in another Coach me session: Investments in subsidiaries, branches and associates or
interests in joint ventures.
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Example
1 Calculating Current Tax
Jones Inc
Jones Inc. has an accounting profit of 10,000 for the year ended 31 December 2005.
During the year the company paid fines of 300, and 1,200 dividends were received (both are disallowed bythe tax laws of the jurisdiction in which Jones Inc. operates). The company recognised a depreciation
expense of 450 for the year whereas the tax allowance was 600. Jones Inc. recognised a provision for a
bonus of 775 in 2005 (2004: 625) - these amounts are tax deductible when they are paid. The 2004 bonus of
625 was paid during the 2005 financial year. There are no other items in the accounts with a tax effect.
The tax rate is 30%.
Accounting profit/loss: 10,000
Add - Expenses not deductible under tax laws but recognised for accounting purposes:
Fines: 300Depreciation: 450
Provision 2005: 775
Deduct - expenses allowed under tax laws but not recognised for accounting purposes:Tax allowance on assets: (600)
Provision 2004: (625)
Deduct - Income not recognised under tax laws but recognised for accounting purposes:
Dividends: (1,200)= Tax profit/loss: 9,100
Current Tax @ 30%: 2,730
2. Taxable temporary differences
On 1 January 2005, Pyramids Ltd purchases an item of plant for 120,000. This plant has an expected usefullife of four years with a zero residual value. The company depreciates on a straight-line basis. The tax
authorities allow a three- year amortisation period as shown in the diagram. The tax rate is 30%.
Recovery of an asset: the underlying principle behind the recovery of an asset is that:
its carrying amount will be recovered in the form of future benefits that flow into the entity (either throughuse (by generating income from using the asset) or through sale).
at least the carrying amount will be recovered (120,000)
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This point is made to illustrate that even through use the asset will have an effect on accounting current andfuture profits. When the carrying amount is greater than tax base (e.g. in 2005), this means that the amount
available to offset against future accounting profit (90,000) is greater than the amount to be offset againstfuture taxable profit (80,000).
This means that in the future there will be taxes payable in excess of what one would normally project from
the carrying amount of the asset (90,000). These excess taxes payable in the future (10,000) (taxable
temporary differences) need to be recognised as a liability (i.e. a deferred tax liability 3,000).
3. Deductible temporary differences
On 1 January 2005, Osiris Ltd purchases an item of plant for 120,000. This plant has an expected useful life
of four years with a zero residual value. The company depreciates on a straight-line basis. The tax
authorities allow a five year amortisation period. The tax rate is 30%.
The image shows the deferred tax calculation for Osiris Ltd.
Where the carrying amount is less than the tax base, the amounts available for offset against accountingprofit are less than amounts to be offset against taxable profit. Therefore in the future there will be less tax
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payable (as tax authorities owe a future deduction equal to what has been deducted for accounting purposes)
than what one would normally project from the carrying amount of the asset.
This tax benefit in the future (deductible temporary difference) needs to be recognised as an asset (i.e. a
deferred tax asset), provided that it is probable that the entity will have sufficient taxable profit against
which the deductible temporary difference can be utilised.
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Section 3
3.1 Calculation of Deferred Tax
Step 1: Determine the tax base
Step 2: Calculate the temporary difference (if any)Step 3: Identify if the temporary difference is deductible (i.e. will lead to a deferred tax asset) or taxable (i.e.
will lead to a deferred tax liability)Step 4: Are any exemptions to the recognition of deferred tax applicable?Step 5: Calculate the deferred tax by applying the correct tax rate
Step 6: Is the movement recognised in the income statement, equity or goodwill?
3.2 Step 1: Determine the tax base
Tax base of an asset = future deductible amounts
Therefore for Property, Plant and Equipment these amounts are the original cost less tax depreciation (Note 1 -
Management Accounts) as the balance will be deductible in the future.
Land (200,000 - 0) = 200,000Building 1 (363,636 -109,091) = 254,545
Building 2 (437,383 - 87,477) = 349,906
Plant (333,433 - 66,687) = 266,746Machinery (250,000 - 100,000) = 150,000
Trademarks tax base is also the original cost less tax depreciation (Note 2.2 - Management Accounts):(2,000,000 - 1,600,000) = 400,000
Product development costs were deducted when the expense was incurred and therefore none are deductible inthe future = 0
Inventories writedowns (Note 5 Management Accounts) are not deductible for tax purposes, so the full
inventory balance plus the writedown is deductible in the future (as cost of sales): (250,000 + 31,021) = 281,021
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Receivables impairment (Note 6 Management Accounts) are only 25% deductible for tax purposes and
therefore the entire receivables plus 75% of the impairment, is deductible in the future: (435,078+(75% x
44,922) = 468,770
Prepayments (Note7 Management Accounts), 300,000 is deductible in the current year and the balance is
deductible in the future = 477,115
The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes inrespect of that liability in future periods. In the case of revenue which is received in advance, the tax base of theresulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future
periods.
Trade and other payables, no amounts are deductible for tax purposes in respect of that liability in future periodstherefore tax base equals carrying amount = 3,935,396
Provision (Note 8 Management Accounts), carrying amount (207,973), less any amount that will bedeductible for tax purposes in respect of that liability in future periods (137,973) = 70,000
Step 2: Calculate the temporary difference
This step is straightforward, provided you have
completed Step 1 correctly:
Temporary Difference for an asset = Tax Base -
Carrying Amount
Temporary Difference for a liability = Carrying Amount
- Tax Base
Step 3: Is it deductible or taxable?
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Youre applying the following rules correctly:
when an assets carrying amount is greater than its tax base, a taxable temporary difference arises
when an assets carrying amount is less than its tax base, a deductible temporary difference arises
when a liability's carrying amount is greater than its tax base, a deductible temporary difference arises
when a liability's carrying amount is less than its tax base, a taxable temporary difference arises
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Section 4
Exceptions
1. Taxable temporary differences and exceptions
Introduction
A deferred tax liability should be recognized for all taxabletemporary differences, including those arising from:
business combinations
assets carried at fair value
split accounting of financial instruments
unless the deferred tax liability arises from the initial recognition of
goodwill or the initial recognition of an asset or liability in atransaction which:
is not a business combination, and
at the time of the transaction, affects neither accounting profitnor taxable profit (or tax loss)
This Coach me explores the situations where a deferred tax liability
is or is not recognised on taxable temporary differences.
a. Business combinations
The cost of a business combination is allocated to the identifiable assets and liabilities acquired by reference to
their fair values at the date of the exchange transaction.
Temporary differences arise when the tax bases of the identifiable assets and liabilities acquired are not affected
by the business combination or are affected differently.
The image shows an example.
Buckley Inc. acquires Sugar Ltd. The cost of the plant of Sugar
Ltd is 800, and its fair value is 1,000. Buckley Inc. recognises theasset at fair value.
Carrying amount = 1,000Tax base = 800
Taxable temporary difference = 200
Deferred tax liability (@30%) = 60
The resulting deferred tax liability affects goodwill (also covered in
this Coach me) i.e. the journal entry is:
Dr Goodwill
Cr Deferred tax liability
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b. Assets carried at fair value
IFRS permit certain assets to be carried at fair value or to be revalued. For example refer to:IAS 16: Property, Plant and Equipment
IAS 38: Intangible Assets
IAS 39: Financial Instruments: Recognition and MeasurementIAS 40: Investment Property
IAS 41: Agriculture
If the tax authorities recognize the revaluation or fair value adjustment for tax purposes (i.e. adjust the tax base),
there will be no difference between the carrying amount and tax base, and hence no temporary difference.
However if the revaluation or restatement of an asset does not affect taxable profit in the period of the
revaluation or restatement, then the tax base of the asset is not adjusted.Due to the future recovery of the carrying amount resulting in a taxable flow of economic benefits to the entity,
the amount that will be deductible for tax purposes will differ from the amount of those economic benefits. This
is true even if:
(a) the entity doesn't intend to dispose of the asset (recovery will be through use and this will generate taxable
income which exceeds the depreciation that will be allowable for tax purposes in future periods), or
(b) tax on capital gains is deferred (as permitted by many tax authorities) if the proceeds of the disposal of the
asset are invested in similar assets. In such cases, the tax will ultimately become payable on sale or use of thesimilar assets.
c. Initial recognition of an asset or liability
A temporary difference may arise on initial recognition of an asset or liability, for example if part or all of the
cost of an asset will not be deductible for tax purposes. The method of accounting for such a temporary
difference depends on the nature of the transaction which led to the initial recognition of the asset or liability:
(a) in a business combination, an entity recognises any deferred tax liability or asset from temporary differences
and this affects the amount of goodwill
(b) if the transaction affects either accounting profit or taxable profit, an entity recognises any deferred tax
liability or asset and recognises the resulting deferred tax expense or income in the income statement.
Business combinations
If the transaction is not a business combination, and affects neither accounting profit nor taxable profit,
then an entity would, in theory, need to recognise the resulting deferred tax liability or asset and adjust
the carrying amount of the asset or liability by the same amount.
However, such adjustments would make the financial statements complex and less transparent.
Therefore, IAS 12 does not permit an entity to recognise a deferred tax liability or asset arising on initial
recognition of an asset or liability acquired other than in a business combination, where the transaction
affects neither accounting profit nor taxable profit (loss).
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In accordance with IAS 32: Financial Instruments: Disclosure and Presentation, the issuer of a
compound financial instrument classifies the instrument in two parts:
the liability component as a liability, and
the equity component as equity.
In some jurisdictions, the tax base of the liability component on initial recognition is equal to the initialcarrying amount of the sum of the liability and equity components.
The resulting taxable temporary difference arises from the initial recognition of the equity component
separately from the liability component (and not the initial recognition of an asset or liability). Therefore
the exemption does not apply and any resulting deferred tax liability should be recognised.
The deferred tax is charged directly to the carrying amount of the equity component. Subsequent
changes in the deferred tax liability are recognised in the income statement as deferred tax expense (or
income).
Business combinations
d. Goodwill
Many taxation authorities do not allow the amortisation of goodwill as
a deductible expense in determining taxable profit or the cost ofgoodwill to be deducted when a subsidiary disposes of its underlying
business. These tax rules lead to taxable temporary differences.
However, IAS 12 does not permit the recognition of the resultingdeferred tax liability because goodwill is a residual and the recognition
of the deferred tax liability would increase the carrying amount of
goodwill.
Note further:a) 12.21A - Subsequent reductions in deferred tax liability that is
unrecognised because it arises from the initial recognition of goodwill
are also not recognised (this is in line with the treatment of initialrecognition).
b) 12.21B - Deferred tax liabilities for taxable temporary differences
relating to goodwill are however recognised to the extent that they do not arise from the initial recognition ofgoodwill (eg. tax laws allow write-off of the balance).
Summary
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2. Deductible temporary differences and exceptions
Deductible temporary differencesA deferred tax asset should be recognised for all deductible
temporary differences to the extent that:
it is probable that taxable profit will be available against which thedeductible temporary difference can be utilised
unless the deferred tax asset arises from the initial recognition of an
asset or liability in a transaction which:is not a business combination, and
at the time of the transaction, affects neither accounting profit nor
taxable profit (or tax loss)
2.1 Deductible temporary differences resulting in deferred tax
assets
Retirement benefit costs may be recognised in determining accounting profit as service isprovided by the employee, but only deducted in determining taxable profit either when
contributions are paid to a fund by the entity or when retirement benefits are paid by the
entity. A deductible temporary difference exists between the carrying amount of theliability and its tax base because the tax base is usually nil (calculated as the carrying
amount of the liability less the amount that will be deductible in the future). A deferred
tax asset therefore exists.
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Example: Retirement benefit costs (4,500)
Carrying amount Liability = 4,500
Tax base = 0 (4,500 less amount that will be deductible in the future i.e. 4,500)Deductible temporary difference = 4,500
Deferred tax asset (@30%) = 1,350 (4,500 x 30%)
Research costs are recognised as an expense in determining accounting profit in theperiod in which they are incurred but may not be permitted as a deduction in determiningtaxable profit (or tax loss) until a later period.
Example: Research costs (6,000)
Carrying amount asset = 0 (as was expensed immediately)Tax base = 6,000
Deductible temporary difference = 6,000
Deferred tax asset (@30%) = 1,800
The cost of a business combination is allocated to the assets and liabilities recognised, byreference to their fair values at the date of the transaction.
Example: A liability of 4,000 was recognised on the acquisition but the related costs were
not deducted in determining taxable profits until a later period.
Carrying amount liability = 4,000
Tax base = 0 (4,000 less amount that will be deductible in the future i.e. 4,000)
Deductible temporary difference = 4,000Deferred tax asset (@30%) = 1,200
The resulting deferred tax asset affects goodwill. Therefore the journal entry is:
Dr Deferred tax asset, Cr Goodwill
Certain assets may be carried at fair value, or may be revalued at amounts lower than the
amount attributed to them for tax purposes
Example: Plant with a tax base and previous carrying amount of 55,000 was impaired to
its recoverable amount of 35,000.
Carrying amount of asset = 35,000
Tax base = 55,000
Deductible temporary difference = 20,000 (55,000 - 35,000)
Deferred tax asset (@30%) = 6,000 (20,000 x 30%)
Initial recognition of an asset or liability - example
A non-taxable government grant (200) related to a harvester (600) was given to Hilly Farms Ltd. For tax
purposes, the grant is not taxable. The tax rate is 35%. Deferred tax calculation:
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Carrying amount of harvester = 400 (600 less 200 grant that was offset against cost of the asset according to one
of the alternatives under IAS 20)
Tax base = 600Deductible temporary difference = 200
However the entity does not recognise the resulting deferred tax asset, because the initial recognition of an assetor liability in a transaction was not a business combination, and at the time of the transaction, affected neither
accounting profit nor taxable profit. As the temporary difference in the above case is somewhat permanent,we can identify that the IAS 12 exemption on initial recognition applies.
Government grants may also be recognised as deferred income under the other alternative in IAS 20, in which
case the difference between the deferred income and its tax base of nil is a deductible temporary difference.
However the entity does not recognise the resulting deferred tax asset, because the initial recognition of an asset
or liability in a transaction was not a business combination, and at the time of the transaction, affected neither
accounting profit nor taxable profit.
As the temporary difference in the above case is somewhat permanent, we can identify that the IAS 12
exemption on initial recognition applies.
3. Calculating deferred tax
Deferred tax
Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable
temporary differences.
Deferred tax liability = taxable temporary difference x tax rate
Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of:deductible temporary differences
the carryforward of unused tax losses, andthe carryforward of unused tax credits
Deferred tax asset = (deductible temporary difference and carryforward of unused tax losses) x tax rate and
unused tax credits
Example
Muggins Health Shop had the following balances at the end of 2005 (tax rate = 30%):
Taxable temporary difference = 56,000Assessed Loss carried forward = 30,000
Deferred tax calculation:
Deferred tax liability = 16,800 (56,000 x 30%)Deferred tax asset = 9,000 (30,000 x 30%)
TOTAL deferred tax liability for 2005 = 7,800 (16,800 9,000)
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4. Recognition of deferred tax assets limitations
The reversal of deductible temporary differences means that there will be deductions in determining taxable
profits of future periods. However, these deductions are allowable only if it is probable that taxable profits will
be available against which the deductible temporary differences can be utilised (i.e. when the entity earnssufficient taxable profits against which the deductions can be offset). There are criteria that help to assess
whether the recognition of deferred tax assets is probable.
Probability
It is probable that taxable profit will be available against which a deductible temporary difference can be
utilised when there are sufficient taxable temporary differences relating to the same taxation authority and thesame taxable entity which are expected to reverse:
in the same period as the expected reversal of the deductible temporary difference, or
in periods into which a tax loss arising from the deferred tax asset can be carried back or forward
If these criteria are met, the deferred tax asset is recognised in the period in which the deductible temporary
differences arise.
Insufficient taxable temporary differences
When there are insufficient taxable temporary differences relating to the same taxation authority and the same
taxable entity, the deferred tax asset is recognised to the extent that:
1) it is probable that the entity will have sufficient taxable profit relating to the same taxation authority and thesame taxable entity in the same period as the reversal of the deductible temporary difference or in the periods in
which the tax loss arising from the deferred tax asset can be carried back or forward. (Note: in assessing this,
the taxable amounts arising from other deductible temporary differences that are expected to originate in future
periods are ignored) and2) tax planning opportunities are available to the entity that will create taxable profit in appropriate periods
Tax planning opportunities
Tax planning opportunities are actions that the entity could take in order to create or increase taxable income in
a particular period before the expiry of a tax loss or tax credit carryforward.
For example, taxable profit may be created or increased by:
electing to have interest income taxed on either a received or receivable basisdeferring the claim for certain deductions from taxable profit
Unused tax losses and unused tax credits
A deferred tax asset should be recognised for:
the carryforward of unused tax losses, andthe carryforward of unused tax credits
to the extent that it is probable that future taxable profit will be available against which the unused tax losses
and unused tax credits can be utilised.
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The criteria for recognising deferred tax assets arising from thecarryforward of unused tax losses and unused tax credits are the same as the criteria for recognising deferred tax
assets arising from deductible temporary differences. However, the existence of unused tax losses is strong
evidence that future taxable profit may not be available. So, the entity recognises a deferred tax asset arisingfrom unused tax losses or tax credits only to the extent that the entity has sufficient taxable temporary
differences, or there is convincing other evidence that sufficient taxable temporary differences will be available
against which the unused tax losses or tax credits can be utilised
Disclosure of the amount of the deferred tax asset and the nature of the evidence supporting its recognition isrequired by IAS 12.
Consider these criteria in assessing the probability that taxable profit willbe available. Whether:
1) the entity has sufficient taxable temporary differences relating to the same taxation authority and the same
taxable entity which will result in taxable amounts against which the unused tax losses/credits can be utilisedbefore they expire
2) it is probable that the entity will have taxable profits before the unused tax losses/credits expire
3) the unused tax losses result from identifiable causes which are unlikely to recur, and
4) tax planning opportunities are available to the entity that will create taxable profit in the period in which theunused tax losses/credits can be utilised.
To the extent that it is not probable that taxable profit will be available against which the unused tax
losses/credits can be utilised, the deferred tax asset is not recognised.
At each balance sheet date, an entity re-assesses unrecognised deferredtax assets. The entity recognises a previously unrecognised deferred tax asset to the extent that it has become
probable that future taxable profit will allow the deferred tax asset to be recovered.
For example:
an improvement in trading conditions oran entity re-assesses deferred tax assets at the date of a business combination or subsequently
and it becomes probable that the entity will be able to generate sufficient taxable profit in the future for thedeferred tax asset to meet the recognition criteria.
5. Subsidiaries, branches and associates, and joint ventures
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5.1 When do temporary differences arise?
Temporary differences arise when the carrying amount of investments in subsidiaries, branches and associatesor interests in joint ventures (i.e. the net assets including the carrying amount of goodwill) becomes different
from the tax base (which is often cost). Such differences may arise in a number of different circumstances, for
example:the existence of undistributed profits of subsidiaries, branches and associates or joint ventures
changes in foreign exchange rates when a parent and its subsidiary are based in different countries having
different currenciesa reduction in the carrying amount of an investment in an associate to its recoverable amount (due to
impairment)
5.2 Recognition of deferred tax liabilities
Recognise all deferred tax liabilities associated with investments in subsidiaries, branches and associates, and
interests in joint ventures, except to the extent that both of the following conditions are satisfied: 1) the parent,investor or venturer is able to control the timing of the reversal of the temporary difference, 2) it is probable that
the temporary difference will not reverse in the foreseeable future. Further issues:
Control of timing
Foreign operations
Investments in associates
Joint ventures
Control of timing
As a parent controls the dividend policy of its subsidiary (and branch operations) it therefore controls the timing
of the reversal of temporary differences associated with that investment, including:
the temporary differences arising from undistributed profits, and
any foreign exchange translation differences
Also, it would often be impracticable to determine the amount of income taxes that would be payable when the
temporary difference reverses. Therefore, when the parent has determined that those profits will not bedistributed in the foreseeable future the parent does not recognise a deferred tax liability.
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Foreign operations
The non-monetary assets and liabilities of an entity are measured in its functional currency (see IAS 21:TheEffects of Changes in Foreign Exchange Rates). If the entitys taxable profit or tax loss (and, hence, the tax base
of its non-monetary assets and liabilities) is determined in a different currency, changes in the exchange rate
give rise to temporary differences that result in a recognised deferred tax liability or asset. The resultingdeferred tax is charged or credited to profit or loss. Because such temporary differences relate to the foreign
operation's own assets and liabilities, rather than to the reporting entity's investment in that foreign operation,the reporting entity recognises the resulting deferred tax liability or deferred tax asset
Investments in associates
An investor in an associate:1. does not control that entity, and
2. is usually not in a position to determine its dividend policy
Therefore, in the absence of an agreement requiring that the profits of the associate will not be distributed in the
foreseeable future, an investor recognises a deferred tax liability arising from taxable temporary differences
associated with its investment in the associate. In some cases, an investor may not be able to determine theamount of tax that would be payable if it recovers the cost of its investment in an associate, but can determine
that it will equal or exceed a minimum amount. In such cases, the deferred tax liability is measured at this
minimum amount
Joint ventures
The arrangement between the parties to a joint venture usually deals with the sharing of the profits.
When:
the venturer can control the sharing of profits, and
it is probable that the profits will not be distributed in the foreseeable future
a deferred tax liability is not recognised.
5.3 Recognition of deferred tax assets
An entity should recognise a deferred tax asset for all deductible temporary differences arising frominvestments in subsidiaries, branches and associates, and interests in joint ventures only to the extent that it is
probable that:
the temporary difference will reverse in the foreseeable future, andtaxable profit will be available against which the temporary difference can be utilised
You should use the same criteria on 'Limitations in recognition of deferred tax assets'. for determining adeferred tax asset.
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Recognition & Measurement
1. Recognition: income statement, equity or goodwill?
1.1. Accounting for current and deferred tax effects
Accounting for the current and deferred tax effects of a transaction should be the same as the accounting for thetransaction or event itself.
I.e. If the accounting transaction affects the income statement (e.g. temporary difference between depreciation
for accounting and for tax purposes), so will the tax transaction. For example:
Dr Tax expense - Income statement
Cr Deferred tax liability
1.2. Recognition in Income Statement;
When to recognise
Current and deferred tax should be recognised as income or an expense and included in the profit or loss for the
period, except to the extent that the tax arises from:
a transaction or event which is recognised directly in equity, or
a business combination
Changes;
The carrying amount of deferred tax may change even though there is no change in the amount of the related
temporary differences. For example, when there is a:
change in tax rates or tax lawsre-assessment of the recoverability of deferred tax assets, or
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change in the expected manner of recovery of an asset
the resulting deferred tax is recognised in the income statement, except to the extent that it relates to itemspreviously charged or credited to equity.
1.3. Equity recognition
Current tax and deferred tax should be charged or credited directly to equity if the tax relates to items that arecredited or charged, in the same or a different period, directly to equity.
Detailed below are circumstances where the charge is to be taken to equity.
Items to be charged directly to equity
IFRS require or permit certain items to be credited or charged directly to equity. For example:a change in carrying amount arising from the revaluation of property, plant and equipment (see IAS 16)
an adjustment to the opening balance of retained earnings resulting from either a change in accounting
policy that is applied retrospectively or the correction of an error (see IAS 8: Accounting Policies, Change
in Accounting Estimates and Errors)exchange differences arising on the translation of the financial statements of a foreign operation (see IAS
21), and
amounts arising on initial recognition of the equity component of a compound financial instrument (see IAS32)
Revaluation of an asset - example 1
Here's an example of where the impact on the tax is recognised where an entity may recognise a revaluation
of an asset in accordance with IAS 16 (revaluation recognised in equity). Tax rate 30%.
Accounting entry:Dr Asset 1,000
Cr Revaluation reserve (Equity) 1,000...to recognise the revaluation of an asset under IAS 16
Deferred tax:Dr Revaluation reserve (Equity) 300 (30% x 1,000)
Cr Deferred tax liability 300
...to recognise the tax effect associated with the revaluation
Note: The recognition of deferred tax follows accounting for the initial transaction.
Revaluation of an asset - example 2
Here's an example of where the impact on the tax is recognised where an entity may recognise a revaluation
of an asset in accordance with IAS 40 (fair value movement recognised in the income statement). Tax rate30%.
Accounting entry:Dr Asset 1,000
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Cr Fair value adjustment - (Income statement) 1,000
...to recognise the revaluation under IAS 40
Deferred tax:
Dr Tax expense - (Income statement) 300 (30% x 1,000)
Cr Deferred tax liability 300...to recognise the associated tax effect
Note: The recognition of deferred tax follows the accounting for the initial transaction.
2. Deferred tax arising from a business combination
Business combinations
Temporary differences may arise in a business combination. In accordance with IFRS 3: Business
Combinations an entity recognises any resulting deferred tax assets (to the extent that they meet the recognitioncriteria) or deferred tax liabilities as identifiable assets and liabilities at the date of the acquisition.
Consequently, those deferred tax assets and liabilities affect goodwill. However, an entity does not recognisedeferred tax liabilities arising from the initial recognition of goodwill.
Recognition of a deferred tax asset
As a result of a business combination, an acquirer may consider it probable that it will recover its own
deferred tax asset that was not recognised before the business combination.
For example, the acquirer may be able to utilise the benefit of its unused tax losses against the future taxable
profit of the acquiree. In such cases, the acquirer recognises a deferred tax asset, but does not include it as part of the accounting for the business combination, and therefore does not take it into account in
determining the goodwill or the amount of any excess of the acquirers interest in the net fair value of theacquirees identifiable assets, liabilities and contingent liabilities over the cost of the combination.
Initial non-recognition of a deferred tax asset
An acquirer may consider it improbable at the date of acquisition that it will recover the acquirees potentialbenefit arising from tax loss carry-forwards or other deferred tax assets but at a later date the possibility may
become probable.
3. Presentation
3.1 Current tax
Current tax assets and liabilities can be offset only if there is:
a legally enforceable right to set off the recognised amounts, and
an intention either to settle on a net basis, or to realise the asset and settle the liability simultaneously
Criteria for legally enforceable rights
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There will normally be a legally enforceable right to set off when current taxes relate to income tax
levied by the same taxation authority, and the taxation authority permits the entity to make or receive a
single net payment.
Therefore although current tax assets and liabilities are separately recognised and measured, they can
usually be offset in the balance sheet of a single entity.
Consolidated annual financial statements
In consolidated financial statements, a current tax asset of one entity in a group is offset against a current tax
liability of another entity in the group only if the entities concerned have a legally enforceable right to make
or receive a single net payment, and the entities intend to make or receive such a net payment or to recoverthe asset and settle the liability simultaneously.
Therefore the offset of current tax assets and liabilities in a group is more difficult.
3.2 Deferred tax
Deferred tax should be offset only when the same criteria as for current tax are met in each future period inwhich significant amounts of deferred tax liabilities or assets are expected to be settled or recovered.
In certain circumstances, detailed scheduling may be required.