IAS 12: INCOME TAX

Foundation: Assets and Liabilities

AGENDA

Accounting Literature
Objective of the lecture
Discussion
Conclusion
Homework for Wednesday
Roadmap ahead

Footnote 2
Accounting Literature
IAS 12 Income Tax
o As indicated in the module and the
lecture slides

For the purposes of IAS 12, Income Taxes

include all domestic and foreign taxes
which are based on taxable profits.

Footnote 3
Economics of Income Tax
Income Tax Act 58 of 1962 imposes the following
income taxes (as defined in IAS 12) on public
companies in South Africa:

oNormal tax (commonly referred to as income tax);

and
oWithholding taxes on dividends.

Footnote 4
Objective of the lecture

• To explain the basic principles behind calculating,

recognising and disclosing current and deferred
tax as it relates to assets and liabilities.

• The application of the principles of deferred tax to

specific types of assets and liabilities will be
discussed in more detail in a later lecture.

Footnote 5
Basics First
Accounting Taxable Permanent or
Profit Income temporary
difference
Gross Profit YES YES N/A
Cost of Sales YES YES N/A
Local dividends YES NO
Received Permanent

Depreciation YES NO
Temporary/timing
Wear and Tear NO YES

Profit on sale of YES NO

land Temporary/timing
Recoupment NO YES

Fines
Footnote
YES NO Permanent6
Basics First

• Deferred tax accounts for the timing/temporary differences

• Let me show you how in the next slides…

• Deferred tax does not account for permanent differences

• I will explain the permanent differences later

Footnote 7
Example
Timing/temporary
Asset R90 000 differences

Depreciation rate 33.3333 %

Wear & tear rate 50%

Assume a profit before tax of R100 000 p/a

Assume a tax rate of 27%

Therefore:
Depreciation 30 000 p/a
Wear & tear 45 000 p/a
Footnote
Let us now calculate the taxable income in each year 8
Current Income Tax
 Amount of income tax payable in respect of a company for the tax
period
 Taxable profit is determined in accordance with the Income Tax Act
 Taxable Income is calculated by adjusting the accounting profit for
the reporting period
 As a result the income tax expense may not be in proportion/the
same as accounting profit

Accounting Profit XXXX

Add: Depreciation
Deduct: Wear and Tear
Add: Research costs @ cost
Deduct: Research cost 150%
Add: Fines
Deduct: Dividends Received
Taxable Income XXXX

Footnote 9
Year 1
Profit before tax (PBT) 100 000

Differences: (15 000)

Depreciation 30 000
(add back accounting)
Wear & tear (bring in tax) (45 000)

Taxable income 85 000

Current tax (85 000 x 27%) 22 950

Can you see taxable income is different to PBT? Why?

Can you see current tax is calculated from taxable income

Footnote 10
This means less tax paid than PBT
Year 2

Year 2 will be treated exactly the same as Year 1:

Profit before tax 100 000

Differences: (15 000)

Depreciation 30 000
Wear & tear (45 000)

Taxable income 85 000

Current tax 22 950

Footnote 11
Less tax paid than PBT
Year 3
In Year 3 the wear & tear allowance is exhausted, but we
still have depreciation available:
Profit before tax 100 000

Differences: 30 000
Depreciation 30 000
Wear & tear -
Taxable income 130 000
Current tax @ 27% 35 100 This is
different!!
Footnote 12
Now in year 3 MORE tax paid than PBT
Year 1- Year 3
Year 1 Year 2 Year 3 Total

Profit before 100 000 100 000 100 000 300 000
Tax
Temporary (15 000) (15 000) 30 000 0
Difference
Taxable 85 000 85 000 130 000 300 000
Income
Current Tax 22 950 22 950 35 100 81 000

Less tax Less tax More tax Balances out

Is this correct?
Does it give decision-useful information?

Footnote 13
Year 1- Year 3
Year 1 Year 2 Year 3 Total

Profit before 100 000 100 000 100 000 300 000
Tax
Temporary (15 000) (15 000) 30 000 0
Difference
Taxable 85 000 85 000 130 000 300 000
Income
Current Tax 22 950 22 950 35 100 81 000

Less tax Less tax More tax Balances out

Deferred Tax 4 050 4 050 (8 100) 0

We need this deferred tax make this correction

Footnote 14
 Year 1

• We want the following result:

Taxation expense 27 000

Current tax 22 950
Deferred tax 4 050

Journal: Increase the tax expense to

Dr Taxation expense (P/L) 4 050 equal 27 000

Cr Deferred tax-liability (SFP) 4 050 Increase the deferred tax to

show we will pay more tax in
future (liability)

How did we calculate the R4 050

Temporary differences of R15 000 x 27% = R4 050
Footnote How do we determine the direction of the R15 000? 15
• Why increase the tax expense?
• Shouldn’t we just be happy that we got away with paying
R4 050 less tax?
• This is a temporary situation, somewhere in the future
the situation will reverse itself (have to pay more tax).
By providing deferred tax now, we are making provision
for the reversal (additional tax) of the situation in future.
• Remember, deferred tax is only a book entry, it is not
physically payable to SARS! NO CASHFLOW
IMPLICATIONS
Footnote 16
 Year 1

• Income Tax Expense Note:

Taxation expense 27 000

Current tax 22 950
Deferred tax 4 050

Journal:
Increase the tax expense to
Dr Taxation expense (P/L) 4 050 equal 27 000

Cr Deferred tax-Liability (SFP) 4 050 Increase the deferred tax to

show we will pay more tax in
future (a liability)

Footnote 17
Year 1- Year 3
Year 1 Year 2 Year 3 Total

Profit before 100 000 100 000 100 000 300 000
Tax
Temporary (15 000) (15 000) 30 000 0
Difference
Taxable 85 000 85 000 130 000 300 000
Income
Current Tax 22 950 22 950 35 100 81 000

Less tax Less tax More tax Balances out

Deferred Tax 4 050 4 050 (8 100) 0

We need this deferred tax make this correction

Footnote 18
 Year 2

• Result:

Taxation expense 27 000

Current tax 22 950
Deferred tax 4 050

Journal: Increase the tax expense to

equal 27 000
Dr Taxation expense (P/L) 4 050
Increase the deferred tax to
Cr Deferred tax-Liability (SFP) 4 050 show we will pay more tax in
future (a Liability)

Footnote 19
Year 1- Year 3
Year 1 Year 2 Year 3 Total

Profit before 100 000 100 000 100 000 300 000
Tax
Temporary (15 000) (15 000) 30 000 0
Difference
Taxable 85 000 85 000 130 000 300 000
Income
Current Tax 22 950 22 950 35 100 81 000

Less tax Less tax More tax Balances out

Deferred Tax 4 050 4 050 (8 100) 0

We need this deferred tax make this correction

Footnote 20
 Year 3

• Result:

Taxation expense 27 000

Current tax 35 100
Deferred tax (8 100)

Journal: Decrease the deferred tax to show that the

liability is reversing
Dr Deferred tax –liability (SFP) 8 100
Cr Income tax expense (P/L) 8 100 Decrease the tax expense to
equal 27 000

Footnote 21
Year 1- Year 3
Year 1 Year 2 Year 3 Total

Profit before 100 000 100 000 100 000 300 000
Tax
Temporary (15 000) (15 000) 30 000 0
Difference
Taxable 85 000 85 000 130 000 300 000
Income
Current Tax 22 950 22 950 35 100 81 000

Deferred Tax 4 050 4 050 (8 100) 0

Tax expense 27 000 27 000 27 000 81 000

Effective tax 27% 27% 27%

rate 27 000
/100 000
27 000
/100 000
27 000
/100 000
Footnote 22
Basics first!

• With a profit before tax of R100 000, can you see that the users
expectation of the tax expense has been met

• Example one:
Profit before tax 100 000
Taxation expense (@ 27%) (27 000)
Profit after tax 73 000

• Do you agree?

YES!!!

Footnote 23
 Summary of Deferred tax
t-account

Deferred tax liability (SFP)

Year 3 Income tax (P&L)(Yr3) 8 100 Balance B/D 0
Income tax (P&L) (Yr1) 4 050
Income tax (P&L) (Yr2) 4 050
Balance C/F ___0__ _____
8 100 8 100

Zero balance @ end of useful life – Correct!

This is why it’s a temporary difference

Footnote 24
Up next – Assets and Liabilities method

Footnote 25
 Basics first!

Principle:

Deferred tax is a “tool” to

make sure that matching
occurs between profit before
tax and the taxation expense.

Footnote 26
Taxable Temporary differences (Yr 1 & Yr 2)
Example:
Profit before tax 100 000
Temporary differences: (15 000)
Depreciation 30 000
Wear & tear (45 000)
Taxable income 85 000

What is your expectation of tax due?

• Tax actually due: 85 000 x 27% = R22 950

• Timing differences work in our favour, we are paying
R4 050 less than expected.
• Temporary situation – will reverse itself in the future

• Action: Create a provision now for future “extra” tax payable

Footnote 27
Taxable Temporary differences (Yr 1 & Yr 2)
Profit before tax 100 000
Temporary differences: (15 000)
Depreciation 30 000
Wear & tear (45 000)
Taxable income 85 000

Taxable temporary differences

Journal:
Dr Income tax (P/L) 4 050
Cr Deferred tax-Liability (SFP) 4 050

Taxation expense: 27 000

Current tax 22 950
Deferred tax 4 050
Footnote
We are paying less tax now, but we will pay more tax in the future 28
hence a liability
Deductible Temporary differences - Yr 3
• Example:
Profit before tax 100 000
Temporary differences: 30 000
Depreciation 30 000
Wear & tear
Taxable income 130 000

What is your expectation of tax due?

• Tax actually due: 130 000 x 27% = R35 100

• Timing differences work to our disadvantage, we are paying
R8 100 more than expected.
• Temporary situation – will reverse itself in the future
• Action: Create an asset now for future benefits (i.e. less tax
payable)
Footnote 29
Deductible Temporary differences – Yr 3
Profit before tax 100 000
Temporary differences: 30 000
Depreciation 30 000
Wear & tear
Taxable income 130 000

Deductible temporary differences

Journal:
Dr Deferred tax-Asset (SFP) 8 100
Cr Taxation expense (P/L) 8 100

Taxation expense: 27 000

Current tax 35 100
Deferred tax (8 100)
Footnote
We are paying MORE tax now, but we will pay LESS tax in the 30
future hence a ASSET
•Two types of differences between
accounting and tax

•Timing differences

•Permanent Differences

Footnote 31
Asset and Liability Method

• Asset and liability method = FORMULA

Carrying Amount – Tax Base = Temporary Difference

• Three Steps Approach
1. Determine the CA, TB and the TD
2. Apply the appropriate rate
3. Determine the Deferred tax asset or liability

Footnote 32
Carrying Amount

• The carrying Amount of the Asset as determined in terms of IFRS

• The amount recognised on the Statement of Financial Position

Footnote 33
Tax base

What is a tax base?

The tax base of an asset or liability is the amount attributed to that asset or liability
for tax purposes.

Thus, it can be compared to the concept of a carrying value, its just a “carrying
value” for tax purposes.

Footnote 34
Tax base – Asset (.07)

• Thus the amount that can still be deducted for tax purposes in
future

Footnote 35
Example This is the same
example as was
used on the
Profit/Loss method.
Asset R90 000
Depreciation rate 33.3 %
Wear & tear rate 50% %

At the Acquisition Date

Carrying Amount 90 000

Tax Base 90 000

Footnote 36
Asset and Liability Method

• Asset and liability method = FORMULA

Carrying Amount – Tax Base = Temporary Difference

Future Economic Benefits Future Deductions Future Taxable

Income

Temporary Difference x Tax Rate (%) = Deferred Tax

Footnote 37
 Asset and Liability method

Carrying Tax Temporary Deferred A/L

Value Base Difference Tax
Year 0
90 000 90 000 - - -
Year 1
60 000 45 000 15 000 4 200 L

Journal (Year 1):

Dr Income tax expense (P/L) 4 050
Cr Deferred tax-liability (SFP) 4 050
Footnote 38
NB - Be careful!!
• Profit and Loss method calculates a deferred tax MOVEMENT

• Asset and Liability method calculates deferred tax BALANCES

To get the movement you should

subtract two balances from each
other!

Footnote 39
Asset and Liability method

Carrying Tax Temporary Deferred A/L

Value Base Difference Tax
Year 1
60 000 45 000 15 000 4 050 L
Year 2
30 000 0 30 000 8 100 L

Journal (Year 2):

Dr Income tax expense (P/L) 4 050
Cr Deferred tax -liability(SFP) 4 050

Footnote 40
Asset and Liability Method
Carrying Tax Temporary Deferred A/L
Value Base Difference Tax
Year 2
30 000 - 30 000 8 100 L
Year 3
- - - - -
Journal (Year 3):
Dr Deferred tax-liability (SFP) 8 100
Cr Taxation expense (P/L) 8 100

Footnote 41
 Summary of Deferred tax
t-account

Deferred tax liability

Year 3 Income tax (P&L)(Yr3) 8 100 Balance B/D 0
Income tax (P&L) (Yr1) 4 050
Income tax (P&L) (Yr2) 4 050
Balance C/F ___0__ _____
8 100 8 100

Zero balance @ end of useful life – Correct!

This is why it’s a temporary difference

Footnote 42
 Asset and Liability method versus Profit and
Loss method
• Difference?
• None in answer, both methods will give you exactly the same answer!
• Principles for asset and liability method:

Assets: CV > TB = taxable temporary difference=DT Liability IAS12.16

CV < TB = deductible temporary difference=DT Asset

Footnote 43
Tax base examples

See good examples of tax base scenarios in par .07 of IAS 12.

Footnote 44
Up next…. Exceptions

Footnote 45
Exceptions

Sometimes the pure application of the tax base rules lead to results that
do not make sense.

In order to correct these situations, exceptions to the tax base rules exist.

Make sure you understand all of them, the application thereof is important!

Footnote 46
Exception 1 (.07)

Example:
A company has a gross debtor of R10 000.

The gross debtor will not be taxable when the cash is

received (it was taxed at time of sale). Thus the tax base is
equal to the carrying amount.

Footnote 47
Asset and Liability method
Carrying Tax Temporary Deferred A/L
Value Base Difference Tax

Exception 1
10 000 10 000 0 0

Footnote 48
Exception 2 (.15)

Goodwill acquired in a business combination has no

deferred tax implications (permanent difference)

• Tax base of goodwill will always be zero (not deductible in

future).
• Thus a “temporary difference” arises between carrying value
and tax base.
• IAS 12 does not permit a deferred tax liability to be recognised
since goodwill is a residual and the deferred tax liability will
increase the amount of goodwill.
Footnote 49
Exception 3 (.15 and.22)

Sometimes a temporary difference arises on initial recognition of an

asset/liability (for example part/all of the cost of the asset will not be
deductible for tax purposes).
• If this transaction is not a business combination, and affects neither acc profit
not taxable profit, then no deferred tax is created initially or subsequently.
• Thus, treat as permanent difference
• Example – Land
• Purchased for R15 000, and SARS does not grant a wear and tear allowance
for the land.

Footnote 50
 Asset and Liability method

Carrying Tax Temporary Deferred A/L

Value Base Difference Tax
Exception 3

15 000 0 15 000 IRE

Footnote 51
Roadmap ahead

What you need to do after the lecture?

1. Work through the slides ONLY
2. Ask if you do not understand anything. This is still the basics

Footnote 52