CHAPTER ONE

IAS 12 INCOME TAXES

OBJECTIVE
The key objectives of IAS 12 are to prescribe the accounting treatment for income taxes
and the reconciliation of the legal tax liability (actual tax payable per tax regulations)
with the tax liability and expense for accounting disclosure purposes. Other issues
addressed include:
 the distinction between permanent and timing differences;
 the future recovery or settlement of the carrying amount of deferred tax assets or
liabilities in the Statement of Financial Position; and
 Recognizing and dealing with losses for income tax purposes.
SCOPE OF THE STANDARD
This standard must be applied to accounting for all income taxes, including domestic,
foreign, and withholding taxes, as well as the income tax consequences of dividend
payments.

KEY CONCEPTS
Accounting profit is net profit or loss for a period before deducting tax expense.
Taxable profit (or tax loss) is the profit (or loss) for a period, determined in accordance
with the rules established by the taxation authorities, based on which income taxes are
payable (or recoverable).
Tax expense (or tax income) is the aggregate amount included in the determination of net
profit or loss for the period in respect of current tax and deferred tax.
Current tax is the amount of income taxes payable (or recoverable) on the taxable profit
(or tax loss) for a period, in accordance with the rules established by the tax authorities.
Deferred tax liabilities are the amounts of income taxes payable in future periods for
taxable temporary differences.
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.

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Temporary differences are differences between the carrying amount of an asset or liability
in the Statement of Financial Position and its tax base. Temporary differences may be
either:
 Taxable temporary differences, which are temporary differences that will result
in taxable amounts in determining taxable profit (or tax loss) of future periods
when the carrying amount of the asset or liability is recovered or settled; or
 Deductible temporary differences, which are temporary differences that will
result in amounts that are deductible in determining taxable profit (or tax loss) of
future periods when the carrying amount of the asset or liability is recovered or
settled.
In consolidated financial statements, temporary differences are determined by comparing
the carrying amounts of the consolidated assets and liabilities to their tax bases as
determined by reference to either the consolidated tax return, or where no such return is
prepared, the individual tax returns of the consolidated entities.
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.
 The tax base of a liability is an amount taxable for tax purposes in respect of the
liability in future periods. The tax base of a liability is normally its carrying
amount less amounts that will be deductible for tax in the future.

ACCOUNTING TREATMENT
Current Taxation Assets and Liabilities
Current tax should be recognized when taxable profits are earned in the period to which it
relates in the following manner:
 A current tax expense or income item should be recognized in the income
statement.
 A current tax liability should be recognized to the extent that amounts owing are
unpaid to tax authorities.
 A current tax asset should be recognized for any amounts paid in excess of the
amounts due for the relevant period. In jurisdictions where this is relevant, the

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 benefit of a tax loss carried back to recover tax paid with respect to a prior period
should be recognized as an asset.
Current tax liabilities and assets are measured at the amount expected to be paid to or
recovered from the taxation authorities using the tax rates and laws that have been
enacted or substantively enacted (announced by the government) at the reporting date.
For current tax this is the rate that is relevant to the financial reporting period regardless
of the date on which it is announced. A change in tax rate is a change in estimate (IAS 8).

Deferred Taxation Assets and Liabilities

A deferred tax liability is recognized for all taxable temporary differences, except when
those differences arise from:
 The initial recognition of goodwill; or
 The initial recognition of an asset or liability in a transaction that is not a business
combination, and at the time of the transaction affects neither accounting nor
taxable profit or loss.
A deferred tax asset is recognized for all deductible temporary differences to the extent
that it is probable that they are recoverable from future taxable profits. A recent loss is
considered evidence that a deferred tax asset should not be recognized. A deferred tax
asset is not recognized when it arises from the initial recognition of an asset or liability in
a transaction that is not a business combination and at the time of the transaction affects
neither accounting nor taxable profit or loss.
Deferred tax balances are measured using the following:
 Tax rates and tax laws that have been substantively enacted at the reporting date;
 Tax rates that reflect how the asset will be recovered or liability will be settled
(through use, disposal, or settlement); and
 The tax rate enacted or substantively enacted that is expected to apply to the
period when the asset is realized or the liability settled.
Deferred tax assets and liabilities are not discounted. The carrying amount of any
recognized and previously unrecognized deferred tax assets should be reviewed at each
reporting date. The carrying amount should be reduced where it is no longer probable
that sufficient taxable profit will be available; conversely, an asset should be recognized
where future profits have become probable.

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Temporary differences that arise when the carrying amounts of investments in
subsidiaries, branches, associates, or joint ventures are different from their tax bases will
result in the recognition of a deferred tax liability or asset, except when both the
following occur:
 The parent, investor, or venturer can control the timing of the reversal of
temporary differences (for example, it controls the dividend policy of the investee
entity).
 It is probable that the temporary difference will not reverse (in the case of a
liability) or will reverse (in the case of an asset) in the foreseeable future. If a
deferred tax asset is recognized there must be taxable profit against which the
temporary difference can be utilized.

Current and Deferred Tax Expenses or Income

Current and deferred taxation expense or income must be recognized in the same manner
in which the underlying item is recognized, that is:
 If the tax relates to an item that affects profit or loss (such as a depreciable asset)
then the related taxation is recognized in profit or loss except if the tax arises from
a business combination.
 If the tax relates to an item that affects other comprehensive income (such as an
available-for-sale asset) or directly in equity (such as the equity component of a
compound financial instrument), then the related taxation is recognized in other
comprehensive income or equity.
The income tax consequences of dividends are recognized when a liability to pay the
dividend is recognized.
Example 1: An entity has the following assets and liabilities recorded in its balance sheet
at December 31, 2021:
Asset Carrying value (in dollar)
Property 10,000,000
Plant and equipment 5,000,000
Inventory 4,000,000
Trade receivables 3,000,000
Trade payables 6,000,000
Cash 2,000,000

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The value for tax purposes of property and for plant and equipment are $7 million and $4
million respectively. The entity has made a provision for inventory obsolescence of $2
million, which is not allowable for tax purposes until the inventory is sold. Further, an
impairment charge against trade receivables of $1 million has been made. This charge
does not relate to any specific trade receivable but to the entity’s assessment of the
overall collectibility of the amount. This charge will not be allowed in the current year for
tax purposes but will be allowed in the future. Income tax paid is at 30%.
Required
Calculate the deferred tax provision at December 31, 2021.
Solution
Asset Carrying value Tax base Temporary difference
Property 10,000,000 7,000,000 3,000,000
Plant and equipment 5,000,000 4,000,000 1,000,000
Inventory 4,000,000 6,000,000 (2,000,000)
Trade receivables 3,000,000 4,000,000 (1,000,000)
Trade payables 6,000,000 6,000,000 -
Cash 2,000,000 2,000,000 -
Total 30,000,000 29,000,000 1,000,000
The deferred tax provision will be $1 million × 30% = $300,000.
Because the provision against inventory and the impairment charge are not currently
allowed, the tax base will be higher than the carrying value by the respective amounts.
Example 2
An entity acquired plant and equipment for $1 million on January 1, 2020. The asset is
depreciated at 25% a year on the straight-line basis, and local tax legislation permits the
management to depreciate the asset at 30% a year for tax purposes.
Required
Calculate any deferred tax liability that might arise on the plant and equipment at
December 31, 2020, assuming a tax rate of 30%.
Solution
The carrying value of the plant and equipment is $750,000 and the tax written down
value will be $700,000, thus giving a taxable temporary difference of $50,000. Therefore
50,000 multiplied by 30% = $15,000.

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Example 3
An entity has revalued its property and has recognized the increase in the revaluation in
its financial statements. The carrying value of the property was $8 million and the
revalued amount was $10 million. Tax base of the property was $6 million. In this
country, the tax rate applicable to profits is 35% and the tax rate applicable to profits
made on the sale of property is 30%. If the revaluation took place at the entity’s year end
of December 31, 20X4, calculate the deferred tax liability on the property as of that date.
Solution
The carrying value after revaluation is $10 million, the tax base is $6 million, and the rate
of tax applicable to the sale of property is 30%; therefore, the answer is $10 million minus
$6 million multiplied by 30%, = $1.2 million.
Example 4
An entity has acquired a subsidiary on January 1, 2014. Goodwill of $2 million has arisen
on the purchase of this subsidiary. The subsidiary has deductible temporary differences of
$1 million and it is probable that future taxable profits are going to be available for the
offset of this deductible temporary difference. The tax rate during 2014 is 30%. The
deductible temporary difference has not been taken into account in calculating goodwill.
Required
What is the figure for goodwill that should be recognized in the consolidated balance
sheet of the parent?
Solution
A deferred tax asset of $1 million × 30% = $300,000, should be recognized because it is
stated that future taxable profits will be available for offset. Thus at the time of
acquisition there is an additional deferred tax asset that has not as yet been taken into
account. The result of this will be to reduce goodwill from $2 million to $1.7 million.

PRESENTATION AND DISCLOSURE

Taxation balances should be presented as follows:
 The balances are shown separately from other assets and liabilities in the
Statement of Financial Position.
 Deferred tax balances are distinguished from current tax balances.
 Deferred tax balances are noncurrent.

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  Taxation expense (income) should be shown for ordinary activities on the face of
the Statement of Comprehensive Income.
 Current tax balances can be offset when: there is a legal enforceable right to offset;
and there is an intention to settle on a net basis.
 Deferred tax balances can be offset when: there is a legal enforceable right to
offset; and deferred tax assets and liabilities relate to the same tax authority on
either: the same taxable entity; or different taxable entities that intend to settle on
a net basis.
 The tax expense or income related to profit or loss from ordinary activities shall be
presented in the statement of comprehensive income.
Accounting policy disclosure: the method used for deferred tax should be disclosed.
The Statement of Comprehensive Income and notes should contain:
 Major components of tax expense (income), shown separately, including:
 Current tax expense (income);
 Deferred tax expense (income) related to the origination and reversal of
temporary differences and changes in tax rate;
 Any adjustments recognized in the current period for tax of prior periods;
 Tax benefits arising from previously unrecognized tax losses, credits, or
temporary differences of a prior period that is used to reduce the current or
deferred tax expense as relevant;
 Deferred tax arising from the write-down (or reversal of a previous write-down)
of a deferred tax asset; and
 Deferred amount relating to changes in accounting policies and fundamental
errors treated in accordance with IAS 8–allowed alternative;
 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; and the amount of tax expense related to the profit
or loss from ordinary activities of discontinued operation for the period;

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  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.
The Statement of Financial Position and notes should include:
 Aggregate amount of current and deferred tax charged or credited directly to
equity;
 Amount (and expiration date) 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;
 For each type of temporary difference, and in respect of each type of unused tax
loss and credit, the amount of the deferred tax assets and liabilities;
 Amount of a deferred tax asset and nature of the evidence supporting its
recognition, when: the utilization of the deferred tax asset is dependent on future
taxable profits; or the enterprise has suffered 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 the enterprises’ 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.

FINANCIAL ANALYSIS AND INTERPRETATION

The first step in understanding how income taxes are accounted for in IFRS financial
statements is to realize that taxable profit and accounting profit have very different
meanings. Taxable profit is computed using procedures that comply with the relevant tax
regulations of a country and is the basis upon which income taxes are paid. Accounting
profit is computed using accounting policies that comply with IFRS. When determining

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taxable profit, an entity might be allowed or required by the tax regulations to use
measurement methods that are different from those that comply with IFRS. The
resulting differences might increase or decrease profits. For example, an entity might be
allowed to use accelerated depreciation to compute taxable profit and so reduce its tax
liability, while at the same time it might be required to use straight-line depreciation in
the determination of IFRS accounting profit.

The second step is to understand the difference between current taxes, deferred tax assets
and liabilities, and income tax expense. Current taxes represent the income tax owed to
the government in accordance with tax regulations. Deferred taxes represent the future
tax consequences of the recovery of assets and settlement of liabilities resulting from the
difference between taxable profits and accounting profit. Income tax expense is an
expense reported in the Statement of Comprehensive Income, and it includes both the
current and deferred tax expense. This means that the income tax paid or payable to the
government in an accounting period usually differs significantly from the income tax
expense that is recognized in the Statement of Comprehensive Income.

Analysts sometimes question whether deferred taxes are a liability or equity. An entity’s
deferred tax liability meets the definition of a liability. However, deferred tax liabilities
are not current legal liabilities, because they do not represent taxes that are currently
owed or payable to the government. Taxes that are owed to the government but have not
been paid are called current tax liabilities. They are classified as current liabilities on the
Statement of Financial Position, whereas deferred tax liabilities are classified as
noncurrent liabilities.

If an entity is growing, new deferred tax liabilities may be created on an on-going basis
(depending on the source of potential timing differences). Thus, the deferred tax liability
balance will probably never decrease. Furthermore, changes in the tax laws or a
company’s operations could result in deferred taxes never being paid. For these reasons,
many analysts treat deferred tax liabilities as if they are part of a company’s equity
capital.

Technically, treating deferred tax liabilities as if they were part of a company’s equity
capital should be done only if the analyst is convinced that the deferred tax liabilities will

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increase or remain stable in the foreseeable future. This will be the case when a company
is expected to acquire new (or more expensive) assets on a regular basis so that the
aggregate timing differences will increase (or remain stable) over time. Under such
circumstances, which are normal for most entities, deferred tax liabilities could be viewed
as being zero interest loans from the government that will, in the aggregate, always
increase without ever being repaid. The rationale for treating perpetually stable or
growing deferred tax liabilities as equity for analytical purposes is that a perpetual loan
that requires no interest or principal payments takes on the characteristics of permanent
equity capital.

If an entity’s deferred tax liabilities are expected to decline over time, however, they
should be treated as liabilities for analytical purposes. One consideration is that the
liabilities should be discounted for the time value of money; the taxes are not paid until
future periods. An analyst should also consider the reasons that have caused deferred
taxes to arise and how likely these causes are to reverse.

In some cases, analysts ignore the deferred tax liabilities for analytical purposes when it is
difficult to determine whether they will take on the characteristics of a true liability or
equity capital over time. Ultimately, the analyst has to decide whether deferred tax
liabilities should be characterized as liabilities, equity, or neither based on the situation’s
unique circumstances.

Entities must include income tax information in their footnotes, which analysts should
use to:
 understand why the entity’s effective income tax rate is different from the
statutory tax rate;
 forecast future effective income tax rates, thereby improving earnings forecasts;
 determine the actual income taxes paid by an entity and compare them with the
reported income tax expense to better assess operating cash flow; and
 Estimate the taxable income reported to the government and compare it with the
reported pre-tax income reported in the financial statements.

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