Corporate Reporting

Income Taxes –
IAS 12

(Chapter 13 - F7)

BSAF
Elements of Tax
IAS 12 Income Taxes states that there are two elements of tax that will need to be
accounted for:

1) Current tax (the amount of income taxes payable/recoverable in respect of the

taxable profit/loss for a period).

2) Deferred tax (an accounting adjustment aimed to match the tax effects of
transactions to the relevant accounting period).

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Income Tax on Profit – Current
The figure for income tax on profits is:
• an estimate of the amount that will be eventually paid (or received) and
• will appear in current liabilities (or assets) in the statement of financial position.

Entry -To introduce tax payable by the company:

Income tax expense (in statement of profit or loss) (Dr.)

Income tax payable (in SFP as current liability) (Cr.)

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Under/ Over Provision
• Any under or overprovision from the prior year is dealt with in the current
year's tax charge.

• This does not affect the year end tax liability, as this will already have been
paid to the tax authorities during the year.

• All we need to do is take the under or overprovided part to the statement of

profit or loss.
an under provision increases the tax charge (taxation authority demanded more than
provision made)
an over provision decreases the tax charge. (taxation authority demanded less than
provision made)

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Example # 1
Simple has estimated its income tax liability for the year ended 31 December 20X8 at
$180,000. In the previous year the income tax liability had been estimated as $150,000.

Required:
Calculate the tax charge that will be shown in the statement of profit and loss for the year
ended 31 December 20X8 if the amount that was actually agreed and settled with the tax
authorities in respect of 20X7 was:
(a) $165,000
(b) $140,000.

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Example # 1 – Solution (a) $165,000
Tax Provision – 31 December 20X7
Income tax expense (Dr.) $ 150,000
Income Tax Payable (Cr.) $ 150,000

Payment of Tax – In 20X8

Income tax Payable (Dr.) $ 150,000
Under Provision (Dr.) $ 15,000
Bank (Cr.) $ 165,000

Under Provision
Amount actually agreed for payment related to 2007 $ 165,000

Less: Provision made in 2007 ($150,000)

Under Provision $15,000 6
Example # 1 – Solution (a) $165,000
Tax Provision – 31 December 20X8
Income tax expense (Dr.) $ 180,000
Income Tax Payable (Cr.) $ 180,000

Statement of Financial Position

As at:-------
$
Current Liabilities
Income Tax Payable 180,000

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Example # 1 – Solution (a) $165,000
Statement of Profit & loss
For the period ended:-------

$
Profit before tax xxxxxx
Taxation
Current Year (180,000)
Under provision – previous year (15,000) (195,000)

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Example # 1 – Solution (b) $140,000
Tax Provision – 31 December 20X7
Income tax expense (Dr.) $ 150,000
Income Tax Payable (Cr.) $ 150,000

Payment of Tax – In 20X8

Income tax Payable (Dr.) $ 150,000
Bank (Cr.) $ 140,000
Over Provision (Cr.) $ 10,000

Over Provision
Amount actually agreed for payment related to 2007 140,000

Less: Provision made in 2007 (150,000)

Over Provision (10,000) 9
Example # 1 – Solution (b) $140,000
Statement of Profit & loss
For the period ended:-------
$
Profit before tax xxxxxx
Taxation
Current Year (180,000)
Over provision – previous year 10,000 (170,000)

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Example # 2
WS prepares its financial statements to 30 June. The following profits (before tax) were recorded from
20X1 to 20X3:
• 20X1 $100,000
• 20X2 $120,000
• 20X3 $110,000

The entity provides for tax at a rate of 30% and incorporates this figure in the yearend accounts. The
actual amounts of tax paid in respect of 20X1 and 20X2 were $28,900 and $37,200.

Required:
Prepare extracts from the statement of profit or loss and statement of financial position of WS for
each of the 3 years, showing the tax charge and tax liability.

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Example # 2 - Solution
Calculation of Under / Over Provision

2001 2002 2003

$ $ $

Profit before tax (A) 100,000 120,000 110,000

Tax Rate (B) 30% 30% 30%
Provision made (A) * (B) 30,000 36,000 33,000
Amount actually paid 28,900 37,200 ?
Under / (Over) Provision (1,100) 1,200 ?

This Under / Over Provision will be reflected in next year’s Stat. of

P&L
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Example # 2 - Solution
Income Tax Expense
2001 2002 2003
$ $ $

Current tax estimate 30,000 36,000 33,000

Under / (Over) Provision 0 (1,100) 1,200
30,000 34,900 34,200

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Example # 2 - Solution
Co.
Statement of Profit & loss
For the period ended:-------
2001 2002 2003
$ $ $
Profit before tax xxxxxx xxxxxx xxxxxx
Tax Expense (30,000) (34,900) (34,200)

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Example # 2 - Solution
Co.
Statement of Financial Position
As at --------
2001 2002 2003
$ $ $
Current Liabilities
Income Tax payable 30,000 36,000 33,000

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Deferred Tax
Deferred Tax is a basis of allocating tax charges to particular
accounting periods.

Accounting profit (or the reported profit), which is the figure of profit
before tax, reported to the shareholders in the published accounts
(Financial Statements)

Taxable profit, which is the figure of profit on which the taxation

authorities base their tax calculations.

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Example 1
A company’s financial statements show profit before tax of $1,000 in each of years 1, 2 and 3.
This profit is stated after charging depreciation of $200 per annum. This is due to the
purchase of an asset costing $600 in year 1 which is being depreciated over its 3year useful
economic life on a straight line basis.
Tax Allowance / Capital
The tax allowances granted for the related asset are: Allowance-- Means
depreciation allowed by Tax
Authorities
Year 1 $ 240
Year 2 $ 210
Year 3 $ 150

• Income tax is calculated as 30% of taxable profits.

• Apart from the above depreciation and tax allowances there are no other differences
between the accounting and taxable profits.
Required:
Ignoring deferred tax, prepare statement of profit or loss extracts for each of years 1, 217 and 3.
Example 1
Working for Tax
Year 1 Year 2 Year 3
Accounting Profit 1,000 1,000 1,000
Depreciation 200 200 200
Less: Capital allowance (240) (210) (150) given in Q
Taxable Profit 960 990 1,050
Income Tax (30%) 288 297 315

Statement of Profit & Loss (Extracts)

Year 1 Year 2 Year 3
Profit before Tax 1,000 1,000 1,000
Income Tax (288) (297) (315)
Profit After Tax 712 703 685
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Differences In Accounting & Taxable Profit
The difference between accounting profit and taxable profit is caused by:

1) Permanent differences - penalty

2) Temporary differences.

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Permanent Differences
• P.D are one-off differences
• between accounting and taxable profits caused by certain items not being
taxable/allowable……
• which only impact on the tax computation of one period.
• which have no deferred tax consequences whatever.

• An example of a permanent difference could be client entertaining

expenses or fines.

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Temporary Differences – DT (St. of FP)
Carrying amount Tax base of Asset /
of Asset /Lia. in Minus Liability
SOFP
*(Tax base = Cost – tax dep.)

Difference is Temporary Difference which eventually smoothens itself over time

Examples
Difference between the Accounting depreciation charged on a noncurrent asset
& the actual capital allowances (tax depreciation).

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Example 2
A piece of machinery cost $500. Tax depreciation to date has amounted to $220 and
depreciation charged in the financial statements to date is $100. The rate of income
tax is 30%.
Tax Depreciation-
Required: Depreciation
What is the deferred tax liability in relation to this asset? allowed/
calculated by Tax
Authorities
Temporary Difference & Deferred Tax
Carrying Amount of Asset Tax Base
Cost of Machinery $ 500 $ 500
- Depreciation (100) (220)
400 280
Deferred tax =
Temporary Difference ($400 - $280) $120 Temp. Diff * Tax rate
$ 120 * 30%
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= $ 36
Reasons of Recognizing Deferred Tax
• The accruals concept requires its recognition.
• The deferred tax is a liability (or asset) which will eventually be settled.
• The overstatement of profit caused by failing to allow for deferred tax
liabilities can lead to:
Overoptimistic dividend payments based on inflated profits
Distortion of earnings per share (EPS) and of the price/earnings (P/E) ratio, both important
indicators of a company’s performance
Shareholders being misled.
Calculate Temporary Difference & Deferred tax
Carrying amount of noncurrent asset XXX
Less: Tax base (Cost – Tax Dep) XXX
Temporary difference XX

Deductible TD Taxable TD

Deferred tax = temporary difference × tax rate.

Deferred Tax Asset Deferred Tax Liabilities

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Deferred tax Asset / Liability
Rules -Assets
Temporary Deferred Interpretation
Difference * tax Asset
(Taxable / / Liability
Deductible)
Carrying amount of Asset Taxable DT Less tax is being paid TODAY & this deficit will have to be
> Tax Base of Asset Liabilities paid in future.

i.e. Tax depreciation is Income taxes payable in future.

more than Accounting
* Temporary Difference
depreciation = Carrying amount of Asset –Profit
Accounting Tax >Base
Taxable Profit
Carrying amount of Asset Deductible DT Asset Paid too much tax TODAY, so we will get a break next year.
< Tax Base of Asset
Income taxes recoverable in future
Taxable Profit > Accounting Profit

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Entries – Deferred tax
First Time – Record Deferred tax
Deferred tax Liability Deferred Tax Asset
Deferred tax Expense (Dr.) (SP&L) Deferred tax Asset (Dr.) (SOFP)
Deferred tax Liability (Cr.) (SOFP) Deferred tax Expense (Cr.) (SP&L)

Subsequent- Calculate the movement in Deferred tax provision

i.e. Closing DT position Opening DT position

Increase in Deferred tax Liability Increase in Deferred tax Asset

Deferred tax Expense (Dr.) (SP&L) Deferred tax Asset (Dr.) (SOFP)
Deferred tax Liability (Cr.) (SOFP) Deferred tax Expense (Cr.) (SP&L)

Decrease in Deferred tax Liability Decrease in Deferred tax Asset

Deferred tax Liability (Dr.) (SOFP) Deferred tax Expense (Dr.) (SP&L)
Deferred tax Expense (Cr.) (SP&L) Deferred tax Asset (Cr.) (SOFP) 26
Example 1 – Continued…….
A company’s financial statements show profit before tax of $1,000 in each of years 1, 2 and 3.
This profit is stated after charging depreciation of $200 per annum. This is due to the
purchase of an asset costing $600 in year 1 which is being depreciated over its 3year useful
economic life on a straight line basis.
Tax Allowance / Capital
The tax allowances granted for the related asset are: Allowance-- Means
depreciation allowed by Tax
Authorities
Year 1 $ 240
Year 2 $ 210
Year 3 $ 150

• Income tax is calculated as 30% of taxable profits.

• Apart from the above depreciation and tax allowances there are no other differences
between the accounting and taxable profits.
Required:
Accounting for deferred tax, prepare statement of profit or loss and statement of financial position extracts for each of years
1, 2 and 3. 27
Example 1 – Continued…….
Temporary differences and deferred tax
1 2 3
Carrying amount (A) 400 200 0
(600-200) (600-200-200) (600-200-200-200)
Tax Base (B) 360 150 0
(600-240) (600-240-210) (600-240-210-150)
Temporary Difference 40 50 0
(taxable) (A-B) (400-360) (200-150)
Deferred tax provision/ 12 15 0
Liability – Closing (40*30%) (50*30%)
(30%)
Increase / (Decrease) 12 3 (15)
Movement (SP&L) (Closing DT15- (Closing Dt 0 –
Opening DT12) Opening Dt 15)

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Example 1 – Continued…….
Working for Tax
Year 1 Year 2 Year 3
Accounting Profit 1,000 1,000 1,000
Depreciation 200 200 200
Less: Capital allowance (240) (210) (150) given in Q
Taxable Profit 960 990 1,050
Income Tax (30%) 288 297 315 Income Tax is
increasing each
Tax Expense year and profit is
decreasing --
1 2 3 Despite same
Performance
Income Tax 288 297 315
Deferred tax(From 12 3 (15)
previous slide)
So with Deferred tax – Tax
Tax Expense 300 300 300 Expense is same in all29years
Example 1 – Continued…….
Statement of Profit & Loss (Extracts)
Year 1 Year 2 Year 3
Profit before Tax 1,000 1,000 1,000
Tax Expense (300) (300) (300)
Profit After Tax 700 700 700

Statement of Financial Position (Extracts)

Year 1 Year 2 Year 3
Non Current Liabilities
Deferred tax Liability 12 15 0

Current Liabilities
Provision for tax 288 297 315
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Revaluation of noncurrent assets
As per IAS 16, if the entity decides to follow “the revaluation model” for its PPE:
• The carrying amount of the asset changes
Temporary Difference
• The tax base remains same PPE (Dr.) XX
Revaluation Surplus (OCI) (Cr). XX

• Calculate the deferred tax provision (SFP)

• Deferred tax asset OR deferred tax liability?
• Calculate the deferred tax movement (Closing – Opening DT)
DT movement is taken
Increase in DT liability => Dr D. Tax expense/OCI X to the revaluation
Cr Deferred tax Liability (SFP) X surplus (and OCI),
Reduction in DT liability => Dr Deferred tax Liability (SFP) X rather than the
statement of profit or
Cr Income tax expense/OCI X loss.
Revaluation of noncurrent assets
On 1 January 20X8 Simone Ltd decided to revalue its land for the first time. A qualified
property valuer reported that the market value of the land on that date was $80,000. The
land was originally purchased 6 years ago for $65,000.

The required provision for income tax for the year ended 31 December 20X8 is $19,400.
The difference between the carrying amounts of the net assets of Simone (including the
revaluation of the land in note (above) and their (lower) tax base at 31 December 20X8 is
$27,000. The opening balance on the deferred tax account was $2,600. Simone’s rate of
income tax is 25%.
Carrying amount – tax base = $ 27,000 (Taxable Temporary difference) $ 15,000 Rev.
Surplus of Land
Required:
Prepare extracts of the financial statements to show the effect of the above transactions.

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Revaluation of noncurrent assets
01 Jan 20x8 – Revaluation of Land On 1 January 20X8 Simone Ltd revalues its land &
Land (Dr.) (SOFP) $15,000 the market value of the land on that date was
Revaluation Surplus (Cr.) (OCI) $15,000 $80,000. The land was originally purchased 6
years ago for $65,000.
31 Dec 20X8 – Provision for Income Tax
Income Tax Expense (Dr.) (SP&L) $19,400 The required provision for income tax for the year
ended 31 December 20X8 is $19,400.
Provision for Income Tax (Cr.) (SOFP) $19,400

Calculate Deferred tax – Closing amount (SOFP)

The difference between the carrying amounts of
Carry amount of Asset – Taxable Temporary $27,000
the net assets of Simone (including the
Tax base Difference
revaluation of the land in note (above) and their
Deferred Tax Liability $27,000*25% $6,750 (lower) tax base at 31 December 20X8 is $27,000.

Calculate Movement (Closing - Opening)

Deferred Tax Liability Closing $6,750 The opening balance on the deferred tax account
Deferred Tax Liability Opening $2,600 was $2,600. Simone’s rate of income tax is 25%.
Increase in Deferred tax lia (Closing – Opening) 4,150 33
Revaluation of noncurrent assets
Increase in Deferred tax liability due to Revaluation Revaluation Surplus is $ 15,000 & Deferred tax
Deferred tax Expense (Dr.) (SP&L) $400 because of revaluation is $15,000 *25% = $3,750
Revaluation Surplus (Dr.) (OCI) $3,750 So, Out of $4,150 (Increase in Deferred tax
Deferred tax liability (Cr.) (SOFP) $4,150 liability) $3,750 relates to Revaluation of Land
(OCI).

Tax Expense – (SP&L)

Income Tax – Provision $19,400
Deferred Tax Expense $400
Tax Expense $19,800
Deferred Tax Liability (SOFP)
Deferred Tax Liability Opening $2,600
Increase in Deferred tax lia movement $4,150
Deferred Tax Liability Closing $6,750
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Revaluation of noncurrent assets
Statement of Profit & Loss (Extracts)
Statement of Profit & Loss $
Profit before Tax XXX
Tax Expense (19,800)
Profit After Tax XXX

Statement of OCI $ $
Revaluation Surplus 15,000
- Deferred Tax Expense (3,750) 11,250
- (15,000*25%)

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Revaluation of noncurrent assets
Statement of Financial Position (Extracts)
$
Non Current Liabilities
Deferred tax Liability 6,750

Current Liabilities
Provision for tax 19,400

Non Current Asset

PPE – Land 80,000

Equity
Revaluation Surplus 11,250

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Test Your Understanding # 4
Kaplan F7 Study Text

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Tax-Base of Asset / Liability
The tax base of an asset is the amount that will be deductible for tax
purposes against any taxable economic benefits that will flow to an
entity when it recovers the carrying amount of the asset.

If those economic benefits will not be taxable, the tax base of the
asset is equal to its carrying amount.

The tax base of a liability is its carrying amount, less any amount that
will be deductible for tax purposes in future periods.

In the case of revenue which is received in advance, the tax base of

the liability is its carrying amount, less any amount of the revenue
that will not be taxable in future periods. 38
Deferred tax Asset / Liability
Rules – Continued Liabilities
Temporary Deferred Interpretation
Difference * tax Asset
(Taxable / / Liability
Deductible)
Carrying amount of Lia. > Deductible DT Asset The tax base of a liability is its carrying amount, less any
Tax Base of Lia amount that will be deductible for tax purposes in future
periods.
Carrying amount of Taxable DT Liability
Liability < Tax Base of In the case of revenue which is received in advance, the
* Temporary Difference = Carrying amount of
Liability taxAsset
base of–the
Taxliability
Baseis its carrying amount, less any
amount of the revenue that will not be taxable in future
periods.

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Example – How to calculate Deferred Tax
Assets Carrying Tax Base Temporary Taxable Deductible
Amount $ Difference T.D T.D
$ $ $ $
A machine cost $100,000. Depreciation of 82,000 70,000 12,000 12,000 -
$18,000 has been charged to date. Tax
allowances of $30,000 have been claimed. (100,000- (100,000-
18,000) 30,000)
Interest receivable in the statement of 1,000 0 1,000 1,000 -
financial position is $1,000. The interest
will be taxed when received.
Trade receivables have a carrying amount 10,000 10,000 0 - -
of $10,000. The revenue has already been
included in taxable profit.
Inventory has been written down by $500 4,500 5,000 (500) - (500)
to $4,500 in the financial statements. The
reduction is ignored for tax purposes until
the inventory is sold. 40
Deferred tax Asset / Liability
Liabilities* Carrying Tax Base Temporary Taxable Deductible
Amount $ $ Difference T.D T.D
$ $ $
Current liabilities include accrued (1,000) 0 (1,000) - (1,000)
expenses of $1,000. This is
deductible for tax on a cash paid
basis.
Accrued expenses have a carrying (5,000) (5,000) - - -
amount of $5,000. The related
expense has been deducted for tax
purposes.
Total 13,000 (1,500)
Net – Taxable Temporary Difference (13,000 - 1,500) = $ 11,500 * Tax Rate (30%)
Deferred Tax Liability = ($11,500*30%) = $3,450
* Tax-Base of Liability
(Carrying amount- amount that will be deductible for tax purposes in future periods) 41
Deferred tax Asset / Liability

Deferred tax Expense (Dr.) (SP&L) $ 3,450

Deferred tax liability (Cr.) (SOFP) $ 3,450

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Deferred Tax Calculation Example

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Deferred Tax Calculation- (Shep) Question # 1

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Deferred Tax Calculation- (Shep) Question # 1

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Deferred Tax Calculation (Shep) Question # 2

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Deferred Tax Calculation (Shep) Question # 2

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Deferred Tax Calculation (Shep) Question # 2

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Deferred Tax Calculation (Shep) Question # 2

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Deferred Tax Calculation (Shep) Question # 2

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