IAS 12: Income taxes

KAPLAN Chapter 13
IAS 12 covers two types of tax:
§ Current tax
- This is the amount of tax that the company expects to pay in
respect of this year’s profits

§ Deferred tax (DT)

- DT is not payable to the tax authorities. It arises as a result
of applying the accruals (or matching) concept
- DT is the main focus of the lecture
Current tax
§ The current year’s tax expense includes 2 components:
Current year’s tax
Current year tax estimate X payable = liability in SFP
Prior year under / (over) provision X/(X)
Current year’s tax
Current year tax expense X expense in the SPL

§ This is because we want to show an estimate for the current year’s tax
balance in this year’s FSs. However, we won’t determine this until after
the FSs are published
§ Therefore if our estimate was ‘wrong’ in the prior year, we need to make
up for that this year
Example: Current tax

2010 2011
• 2010: Company started trading, and • Next year the company estimated that
based on their 1st year profits they they would need to pay £36,000 tax in
estimated that their tax bill for the year respect of 2011 profits.
would be £22,000.
Dr Tax expense (SPL) 22k Dr Tax expense (SPL) £36k
Cr Tax payable (SFP) 22k Cr Tax payable (SFP) £36k
• 2011: 9 months after the year end, the • However, they also need to make up for
final tax bill for the year 2010 was the fact that last year, they under
confirmed with HMRC at £24,000. estimated the tax payable by £2k.
Dr Tax payable 22k • This year’s tax expense is therefore
Dr Tax expense (SPL) 2k £36k + = £38k
Cr Cash 24k
Questions 1 & 2
Deferred tax: taxable profit vs accounting profit
§ The tax charge is calculated on a company’s taxable profit,
not its accounting profit
§ These two figures are rarely the same, as there will be some
expenses included in arriving at the accounting profit that
are not allowed as a deduction from taxable profit
§ In the UK, for example, entertaining customers is not an
allowable tax deduction against profit, so that amount is
added back to the accounting profit to arrive at the taxable
profit
Deferred tax: temporary differences
§ Differences that are never allowable for tax purposes are
known as permanent differences, e.g. fines, entertaining
expenses. No deferred tax implication!
§ But some differences are temporary, because they are
allowed as a deduction against taxable profit in a different
period from which they are deducted from the accounting
profit. These are called temporary differences, as they will
reverse in future and give rise to deferred tax!
Deferred tax: temporary differences
§ Depreciation is an accounting mechanism to spread the cost
of an asset over its useful economic life.
§ Capital allowances (or ‘tax depreciation’) are a
standardised tax deduction given by the tax authorities in
relation to an asset.
§ Often, relief on assets is given quicker by the tax authorities
than the speed of the deductions made for depreciation in
the SPL (=‘accelerated capital allowances’).
Example
Firm X has accounting profits of £500,000 in each of its first four years.
The figure of £500,000 has been arrived at after charging depreciation of
£25,000 a year on a non-current asset bought for £100,000 on the first
day of X’s first year.
The equivalent tax depreciation is 100%, i.e. £100,000 in year one. The
rate of income tax is 30%.

Required:
Calculate Year 1 taxable profit.
aren’t permanent, because they are allowed first year. The equivalent tax depreciation is until the
as a deduction against taxable profit in a 100 per cent – ie, £100,000 given in year two to fo
different period from which they are one. The rate of income tax is 30 per cent. profits, r
Illustration of deferred tax concept
deducted from the accounting profit. These
are called temporary differences, as they will
The tax charge, based on taxable profits, is
derived in table 1. The accounting depreciation
Acco
applicati
Firm Xinhas
reverse accounting
future and give riseprofits of £500,000
to deferred tax. hasinbeen
each of itsback,
added first because
four years. The
it’s not an the tax e
The most
figure ofcommon
£500,000 example is depreciation:
has been allowable
arrived at after expense
charging for tax purposes.
depreciation Tax
of £25,000 a which it
ayear
temporary difference arises
on a non-current because
asset the for £100,000
bought depreciation onisthe
given as aday
first deduction
of X’s instead.
first year. deprecia
rate of depreciation given for accounting Based on what we’ve done so far, the taxable p
The equivalent tax depreciation
purposes is usually slower than the rate ofis 100%, i.e.
income £100,000
statementinwould
yearlook
one.likeThe rate
table 2. of deprecia
income taxgiven
depreciation is 30%.
for tax purposes. From it we can see that profit before tax is £100,00
Applying
1 Calculation of X’s tax charge looking a
has been
Year 1 (£) Year 2 (£) Year 3 (£) Year 4 (£) four, whi
Accounting profits 500,000 500,000 500,000 500,000 So the in
Add back: accounting depreciation 25,000 25,000 25,000 25,000 IAS12
calculate
Less: tax depreciation (100,000) 0 0 0
the phra
Taxable profits 425,000 525,000 525,000 525,000 you can
Income tax @ 30% 127,500 157,500 157,500 157,500 for impa
AL ACCOUNTING
Illustration of deferred tax concept
PRINCIPLES The tax expense varies, as it has been calculated on taxable profits, not
accounting profits.
The taxable profit in year one is less than the accounting profit, resulting in
rticles about accounting for taxation under IAS12,
a lower tax charge. Tax has been deferred until the future. The taxable
plains what deferred tax is and how to deal with it.
profits in years two to four are higher than the accounting profits, resulting
in a higher tax charge.
o
n impact
2 X’s initial income statement
pense Year 1 (£) Year 2 (£) Year 3 (£) Year 4 (£)
income
Profit before tax 500,000 500,000 500,000 500,000
x
three Income tax expense (127,500) (157,500) (157,500) (157,500)
eriod; Profit for the period 372,500 342,500 342,500 342,500
the
rticles about accounting for taxation under IAS12,
plains what deferred tax is and how to deal with it.
o Illustration of deferred tax concept
n impact
2 X’s initial income statement
The accounting depreciation figure in year one is £25,000, yet £100,000 of
xpense
e income
tax depreciation has been given.Year 1 (£) Year 2 (£) Year 3 (£) Year 4 (£)
Profit before
Applying thetax 500,000
tax rate to the difference, we are500,000 500,000 (£75,000
looking at £22,500 500,000x
ax
s three Income
0.3) tax expense
of tax that has been deferred (127,500) (157,500)
equally until years two(157,500) (157,500)
to four, which we
eriod; Profit for
need the period to year one. 372,500
to reallocate 342,500 342,500 342,500
the
decrease 3 X’s income statement accounting for deferred tax
us here
Year 1 (£) Year 2 (£) Year 3 (£) Year 4 (£)
t for Profit before tax 500,000 500,000 500,000 500,000
t is and Tax expense: tax charge (127,500) (157,500) (157,500) (157,500)
ated on
deferred tax (22,500) 7,500 7,500 7,500
counting
e same, Profit after tax (350,000) 350,000 350,000 0
350,500
ded in
Calculating deferred tax
Accounting depreciation is £25,000 a year on a non-current asset bought
for £100,000
Tax base: for non-current assets this would be the cost less the
accumulated tax depreciation.
The tax depreciation is 100% i.e. £100,000 in year one.
The rate of income tax is 30%.
4. Calculating deferred tax
End of Carrying amount (CA) Tax base CA - TB @ 30%
year (TB)
1 75,000 ?
2 50,000 ?
3 25,000 ?
4 0 ?
Calculating deferred tax
Accounting depreciation is £25,000 a year on a non-current asset bought
for £100,000
Tax base: for non-current assets this would be the cost less the
accumulated tax depreciation.
The tax depreciation is 100% i.e. £100,000 in year one.
The rate of income tax is 30%.
4. Calculating deferred tax
End of Carrying amount (CA) Tax base CA - TB @ 30%
year (TB) =DTL
1 75,000 0 75,000 22,500
2 50,000 0 50,000 15,000
3 25,000 0 25,000 7,500
4 0 0 0 0
Deferred tax (DT)
§ Deferred tax arises purely as a result of accruals
accounting and the matching concept
§ Its purpose is to recognise the tax effect of a transaction
in the same period as the income/ expense that gave rise
to it
§ The main reason DT is an issue is because the accounting
profit (= PBT) is not equal to the taxable profit
Deferred tax (DT)
§ DT is a fictional tax which only exists in company accounts and is never paid
§ Deferred tax does not, as such, exist J
§ But the rules of accountancy generally require that income be matched with
expenses. If an expense is recognized for tax purposes more quickly than it is for
accounting purposes (which is common with much plant and equipment, for
example) this means that the tax cost for the years when this happens is
understated
§ Conversely, when all the tax allowances have been used on these assets there might
still be accounting charges to make and the tax cost would then be overstated
§ To balance this equation a notional tax charge called deferred tax is charged to the
profit and loss account in the earlier years and put on the company’s balance sheet
as a liability. The liability is released as a credit to profit and loss account in the later
years and supposedly over the life of the asset all should balance out
Calculating deferred tax

§ IAS 12 Income Taxes implements a so-called

'balance sheet method' of accounting for
income taxes

§ I.e. deferred tax is calculated by looking at the

SFP positions and determining if there are any
temporary differences
Calculating deferred tax
To calculate a deferred tax asset or liability, we follow a 3 step process.
1. Calculate the temporary difference as the difference between the
carrying amount and the tax base
2. Multiply the temporary difference by the applicable tax rate to
calculate the deferred tax asset / liability required
3. Account for the movement on the DTA/DTL

We are going to look at each of these steps one at a time.

Deferred tax calculation
Step 1.
a) Calculate the carrying amount (CA) of the asset as per the
financial statements and the equivalent tax figure, which is
called the tax base (TB)

For non-current assets this would be:

• CA: the cost less accumulated depreciation
• Tax Base: for non-current assets this would be the cost
less the accumulated tax depreciation
Step 1: Summary and decision rule
b) Compare the carrying amount and tax base. The difference
is called the temporary difference.

How do we know if we have a DT asset / liability?

§ If the carrying value is > tax base, then there are ‘taxable
temporary differences’ which means there is future tax to pay so
there is a deferred tax liability.

§ If the carrying value is < tax base, then there are ‘deductible
temporary differences’ which means future tax payments will be
reduced so there is a deferred tax asset.
The Logic Behind Recognising Deferred Tax: “Poorer-Richer-Rule”
Carrying amount Carrying amount Assessment
according to IFRS for tax purposes

Asset A 10 8 ☛ In its financial statements according to IFRS,

the entity is richer than according to the
applicable tax law (because the asset’s
carrying amount is higher under IFRS)
☛ This means that the entity recognizes a
deferred tax liability

Asset B 8 10 ☛ In its financial statements according to IFRS,

the entity is poorer than according to the
applicable tax law (because the asset’s
carrying amount is lower under IFRS)
☛ This means that the entity recognizes a
deferred tax asset
Step 2: Multiply the temporary difference by the
applicable tax rate.

Temporary difference (from Step 1)

x
Tax rate (%)
=
Deferred Tax Asset / Liability
Step 3: Account for the movement on the DTA/L

§ Since we recalculate the total DTA/L each period end, if we have a

b/f balance then we just account for the movement on the
DTA/L.
§ The DT double entry should always match the accounting
treatment of the transaction causing the deferred tax.
§ Example: If the DT adjustment arises because of dep’n and CAs,
recognise the DT difference in the SPL.
§ Example: If the DT adjustment arises because of a revaluation,
since a revaluation is recorded in the Revaluation Reserve
(through OCI) the DT will follow this treatment.
f the deferred tax calculation for X’s non-current asset
tion (£) CV (£) Cost (£) Total tax depreciation (£) TB (£) CV – TB (£) @ 30% (£)
25,000 75,000 100,000 100,000 0 75,000 22,500
50,000 50,000 100,000 100,000 0 50,000 15,000
75,000 Illustration of deferred tax concept
25,000 100,000 100,000 0 25,000 7,500
00,000 0 100,000 100,000 0 0 0

problems,
principle. 5 The fourth and fifth steps of the calculation
provision is Journals Dr (£) Cr (£)
ed. In all
Tax expense (income statement) 22,500
vision is
ts to think Deferred tax account (balance sheet) 22,500
the Creating the deferred tax at end of Y1 (note that the full amount is posted)
e account Deferred tax account (balance sheet) 7,500
st also be Tax expense (income statement) 7,500
ost. There
The decrease in the provision at end of Y2 (only the movement is posted: £22,500 - £15,000)

) of the Deferred tax account (balance sheet) 7,500

ments and Tax expense (income statement) 7,500
s called The decrease in the provision at end of Y3 (£15,000 - £7,500)
nt assets Deferred tax account (balance sheet) 7,500
umulated
Tax expense (income statement) 7,500
he
The decrease in the provision at end of Y4 (£7,500 - £0)
espectively.
and TB.
e
Accounting entries for deferred tax

§ It is the movement on deferred tax that will need to be

accounted for.
§ Increase in deferred tax provision:
Dr Income tax expense /OCI
Cr Deferred tax (SFP)
§ Reduction in deferred tax provision:
Dr Deferred tax (SFP)
Cr Income tax expense/OCI
The Logic Behind Recognising Deferred Tax
Example:
Assume that the carrying amount of a piece of land is £10mln according to IFRS and
£8mln for tax purposes.
Carrying amount Tax base Temp. difference
£10mln £8mln £2mln

A fictitious sale of the land for £10mln (i.e. at the carrying amount according to IFRS)
would result in a gain of £2mln under the applicable tax law.
Hence, the entity’s taxable profit would increase by £2mln and (assuming that the tax
rate is 25%) current tax payable would increase by £0.5mln.
This means that a sale in a future period would result in a tax disadvantage of
£0.5mln for the entity. Consequently, the entity recognizes this disadvantage of
£0.5mln as a deferred tax liability.
The Logic Behind Recognising Deferred Tax: “Poorer-Richer-Rule”
Carrying amount Carrying amount Assessment
according to IFRS for tax purposes

Asset A 10 8 ☛ In its financial statements according to IFRS,

the entity is richer than according to the
applicable tax law (because the asset’s
carrying amount is higher under IFRS)
☛ This means that the entity recognizes a
deferred tax liability

Asset B 8 10 ☛ In its financial statements according to IFRS,

the entity is poorer than according to the
applicable tax law (because the asset’s
carrying amount is lower under IFRS)
☛ This means that the entity recognizes a
deferred tax asset
 FOR THE YEAR ENDED 30 SEPTEMBER 2018

GROUP INCOME STATEMENT

Year ended 30 September 2017
Year ended 30 September 2018 Restated*
Separately Separately
Underlying disclosed items Underlying disclosed items
results (Note 7) Total results (Note 7) Total
Notes £m £m £m £m £m £m

Revenue 4 9,584 – 9,584 9,006 – 9,006

Cost of providing tourism services (7,629) (22) (7,651) (7,014) (2) (7,016)
Gross profit 1,955 (22) 1,933 1,992 (2) 1,990
Personnel expenses 5 (1,015) (56) (1,071) (975) (28) (1,003)
Depreciation and amortisation 12/13 (219) – (219) (222) – (222)
Net operating expenses 6 (473) (116) (589) (468) (52) (520)
Profit/(loss) on disposal of subsidiaries and fixed assets 13/32 – 41 41 – (9) (9)
Amortisation of business combination intangibles 7 – (8) (8) – (8) (8)
Share of results of joint venture and associates 14 2 8 10 (1) – (1)
Profit from operations 250 (153) 97 326 (99) 227

Finance income 8 5 – 5 4 – 4
Finance costs 8 (129) (26) (155) (147) (41) (188)
(Loss)/Profit before tax 126 (179) (53) 183 (140) 43
Tax Note 9 (110) (34)
(Loss)/Profit for the year (163) 9
9 TAX
2018 2017
£m £m

Analysis of tax charge

Current tax
UK corporation tax charge for the year – –
adjustments in respect of prior periods – (4)
– (4)
Overseas corporation tax charge for the year 45 45
adjustments in respect of prior periods 1 1
46 46
Total current tax 46 42
Deferred tax
tax charge/(credit) 64 (8)
Total deferred tax 64 (8)

Total tax charge 110 34

The tax on the Group’s profit/(loss) before tax differs from the theoretical amount that would arise using the UK standard corporation tax rate
ACCA “Financial Reporting” DT Scenarios

Scenario 1. Depreciation and capital allowances

Scenario 2. Revaluations
Scenario 1: Depreciation and Capital Allowances
Example:
A company invests in a new photocopier for £10,000. It expects the
photocopier to last 10 years and have nil residual value.
Tax relief on the asset is given at 20% per annum (= tax depreciation)
The company pays tax at 22%.

Calculate the deferred tax implication of the photocopier at the end of

Year 1 (assuming the asset was purchased on the first day of the year).
Scenario 1: Depreciation and Capital Allowances (continued)

Solution

Step 1: Calculate the temporary difference

At the end of year 1:
Carrying amount (10,000 – 1,000) = £9,000
Tax base (10,000 – 2,000) = £8,000
Temporary difference = £1,000

Since the CA > TB then we have a DTL.

Scenario 1: Depreciation and Capital Allowances (continued)

Step 2: Calculate the DTL

DTL = £1,000 x 22% = £220

Step 3: Account for the the DTL

Record a DTL at y/e @ £220

Cr Tax expense (SoPL) £220

Dr Deferred tax liab. (SoFP) £220
Scenario 2: Revaluations
Example
On 31 December, a company performs a revaluation on an asset up to its
fair value of £1,800k.
Immediately before this its carrying amount had been correctly
determined at £1,200k.
The tax base of the asset currently stands at £800k.
The company pays tax at 20% and currently has no DTA/Ls.
Calculate the DT implication of the revaluation at 31 December.
Scenario 2: Revaluations (continued)

Solution

Step 1: Calculate the temporary difference

At the end of Year 1:
Carrying amount (= FV) = £1,800k
Tax base = £800k
Temporary difference = £1,000k

Since the CV > TB then we have a DTL.

Scenario 2: Revaluations (continued)
Solution (continued)

Step 2: Calculate the DTL

DTL = £1,000k x 20% = £200k

Step 3: Account for the movement on the DTL

Have a DTL b/f £0
Record a DTL at y/e £200k

BUT THE TREATMENT FOLLOWS THE ITEM CAUSING THE DIFFERENCE.

Scenario 2: Revaluations (continued)
What is the £200k difference made up of?
§ Some of it is caused by the revaluation (→ OCI).
§ The rest is caused by the difference between depreciation
and capital allowances (→ SPL).

Difference caused by the revaluation

§ The revaluation was from a CA of £1.2m up to FV of £1.8m,
hence £600k recognised in the Revaluation Reserve.
§ Therefore DT on this £600k should also be recognised in the
RR (= £600k x 20% = £120k)
Scenario 2: Revaluations (continued)

Difference caused by depreciation and capital allowances

§ If the revaluation hadn’t occurred, there would still have
been a temporary difference:
‣ Carrying amount = £1,200k
‣ Tax base = £800k
‣ Difference = £400k
§ DT on this difference (£400k x 20% = £80k) is recognised in
the SPL (where dep’n is recorded).
Scenario 2: Revaluations (continued)
In summary we have:
DT caused by the revaluation = £120k
DT caused by dep’n & CAs = £80k
£200k

Step 3: Account for the movement

Dr Revaluation reserve 120k
Dr SPL Tax expense 80k
Cr DTL 200k
Questions 3-7
Homework
Read Chapters 16