2. LEARNING OBJECTIVES
• After studying this chapter, you should be able to:
• Understand the fundamentals of accounting for
income taxes.
• Identify additional issues in accounting for income
taxes.
• Explain the accounting for loss carrybacks and loss
carry forwards.
• Describe the presentation of deferred income taxes
in financial statements.
3. Introduction
➢An income tax is a government tax on the taxable
profit earned by an individual or corporation.
➢Accounting for income taxes has been amended
through periods. Thus:
▪ IAS had originally been issued by the IASC in
October 1996.
▪ IAS 12 was adopted by the IASB in April 2001.
➢The objective of IAS 12 is to prescribe the
accounting treatment for income taxes.
4. Income tax terminology
• Accounting profit is profit or loss for a period
before deducting tax expense.
• Taxable profit (tax loss) is the profit (loss) for a
period, determined in accordance with the rules
established by the taxation authorities, upon which
income taxes are payable (recoverable).
• Tax expense (tax income) is the aggregate amount
included in the determination of profit or loss for the
period in respect of current tax and deferred tax.
5. CONT.D
• Current tax is the amount of income taxes payable
(recoverable) in respect of the taxable profit (tax
loss) for a period.
• Deferred tax liabilities are the amounts of income
taxes payable in future periods in respect of taxable
temporary differences.
• 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; and
➢the carryforward of unused tax credits.
6. CONT.D
• Temporary differences are differences between the
carrying amount of an asset or liability in the
statement of financial position and its tax base.
• The tax base of an asset or liability is the amount
attributed to that asset or liability for tax purposes.
7. Tax base concept
• 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.
Example 1: A machine cost 100. For tax purposes, depreciation of 30 has already
been deducted in the current and prior periods and the remaining cost
will be deductible in future periods, either as depreciation or through a
deduction on disposal. Revenue generated by using the machine is
taxable, any gain on disposal of the machine will be taxable and any loss
on disposal will be deductible for tax purposes. The tax base of the machine
is 70.
8. CONT.D
• The tax base of a liability is its carrying amount, less
any amount that will be deductible for tax purposes
in respect of that liability in future periods.
Example 2: Interest receivable has a carrying amount of 100. The related interest
revenue will be taxed on a cash basis. The tax base of the interest receivable is
nil.
Example 1: Current liabilities include accrued expenses with a carrying amount of
100. The related expense will be deducted for tax purposes on a cash
basis. The tax base of the accrued expenses is nil.
9. Recognition of deferred tax liabilities
and deferred tax assets
• A deferred tax liability shall be recognized for all
taxable temporary differences, except to the extent
that the deferred tax liability arises from:
(a) the initial recognition of goodwill; or
(b) the initial recognition of an asset or liability in a
transaction which:
(i) is not a business combination; and
(ii) at the time of the transaction, affects neither
accounting profit nor taxable profit (tax loss).
10. CONT.D
• The recognition of deferred tax is based on a
statement of financial position orientation.
• Based on this orientation, deferred tax liabilities are
recognized for taxable temporary differences and
deferred tax assets are recognized for deductible
temporary differences, the carry forward of unused
tax losses and the carry forward of unused tax
credits.
11. CONT.D
• The general principle is that a deferred tax liability
is recognized for all taxable
temporary differences.
• Deferred tax assets recognized for deductible
temporary difference, the carry forward of unused
tax losses and the carry forward of unused tax
credits are subject to a probability limitation.
12. Measurement of Deferred Tax Assets
• The computation of the amount of deferred taxes
is based on the rate expected to be in effect when
the temporary differences reverse.
13. CONT.D
• Example
An entity intends to use an asset which cost 1,000
throughout its useful life of five years and then dispose of
it for a residual value of nil. The tax rate is 40%.
Depreciation of the asset is not deductible for tax
purposes. On disposal, any capital gain would not be
taxable and any capital loss would not be deductible.
• The entity does not recognize the resulting deferred tax
liability of 400 because it results from the initial
recognition of the asset.
• In the following year, the carrying amount of the asset is
800. In earning taxable income of 800, the entity will pay
tax of 320. The entity does not recognize the deferred tax
liability of 320 because it results from the initial
recognition of the asset.
14. Calculation of deferred tax Asset or
Liability
• Process to be followed to calculate and measure
deferred tax assets and liabilities:
1. Identification of temporary differences.
2. Identification of exceptions.
3. Identification of unused tax losses or tax credits.
4. Calculation and measurement of deferred tax
assets or deferred tax liabilities.
5. Limitations on the recognition of deferred tax
assets.
15. Identification of Temporary
Differences
• Temporary differences are defined to include all
differences between the carrying amount and the tax
base of assets and liabilities.
16. Identification of Exemptions
• Two exemptions are applicable to the recognition of
deferred tax, namely goodwill and initial
recognition exception.
• Therefore, goodwill and initial recognition assets or
liabilities has no deferred tax.
17. Identification of Unused Tax Losses or
Tax Credits
• Unused tax losses or unused tax credits must be
identified to determine whether deferred tax assets
should be recognized in such transactions.
18. Calculation and Measurement of Deferred
Tax Assets and Liabilities
1. Segregate the temporary differences into those that
are taxable and those that are deductible.
2. Accumulate information about the deductible
temporary differences.
3. Measure the tax effect of aggregate taxable
temporary differences by applying the appropriate
expected tax rates
4. Similarly, measure the tax effects of deductible
temporary differences, including net operating loss
carry-forwards.
19. CONT.D
Example
• Assume that Noori Company has pretax financial
income of €250,000 in 2014, a total of €28,000 of
taxable temporary differences, and a total of €8,000
of deductible temporary differences. Noori has no
operating loss or tax credit carry-forwards. The tax
rate is a flat 40%. Also assume that there were no
deferred tax liabilities or assets in prior years.
21. Limitation on the Recognition of Deferred
Tax Assets
• It can be argued that deferred tax assets should be
included in the statement of financial position only
if they are, in fact, very likely to be realized in future
periods.
• Under IAS 12, deferred tax assets resulting from
temporary differences and from tax loss carry-
forwards are to be given recognition only if
realization is deemed to be probable.
22. CONT.D
Example
➢An asset which cost 150 has a carrying amount of
100. Cumulative depreciation for tax purposes is 90
and the tax rate is 25%.
• The tax base of the asset is 60 (150 - 90).
• Taxable temporary difference = 40 (Carrying
amount-tax base (100-60)
• Therefore, the entity recognizes a deferred tax
liability of 10 (40 at 25%).
23. CONT.D
Exercise
• A company purchased an asset costing $1,500. At
the end of 20X8 the carrying amount is $1,000. The
cumulative depreciation for tax purposes is $900 and
the current tax rate is 25%.
Required
Calculate the deferred tax liability for the asset.
24. CONT.D
• Example
An entity recognizes a liability of 100 for accrued
product warranty costs. For tax purposes, the product
warranty costs will not be deductible until the entity
pays claims. The tax rate is 25%.
• In settling the liability for its carrying amount, the entity
will reduce its future taxable profit by an amount of 100
and, consequently, reduce its future tax payments by 25
(100 at 25%).
• Therefore, the entity recognizes a deferred tax asset of
25 (100 at 25%), provided that it is probable that the
entity will earn sufficient taxable profit in future periods
to benefit from a reduction in tax payments.
25. CONT.D
Example:- Richcard Co has an asset with a carrying
amount of $10,000 and a tax base of $6,000. If the
asset were sold, a tax rate of 20% would apply. A tax
rate of 30% would apply to other income.
Required
State the deferred tax consequences if the entity:
(a) Sells the asset without further use.
(b) Expects to return the asset and recover its carrying
amount through use.
Solution
(a)deferred tax liability (10,000 – 6,000) *20%= $800.
(b)deferred tax liability(10,000 –6,000) *30%=$1,200.
26. Recognition of current and deferred tax
• Current tax is the amount payable to the tax
authorities in relation to the trading activities of the
period.
• It is generally straightforward.
• Any unpaid tax in respect of the current or prior
periods to be recognized as a liability.
• Any excess tax paid in respect of current or prior
periods over what is due should be recognized as an
asset.
27. CONT.D
• The benefit of a tax loss that can be carried back to
recover current tax of previous periods must also be
recognized as an asset.
• Current and deferred tax should both be recognized
as income or expense and included in the net profit
or loss for the period.
• Current tax assets and current tax liabilities should
be offset in the balance sheet only if the enterprise
has the legal right and the intention to settle these on
a net basis and they are levied by the same taxation
authority.
28. CONT.D
• Jonquil Co buys equipment for $50,000 and depreciates
it on a straight line basis over its expected useful life of
five years. For tax purposes, the equipment is
depreciated at 25% per annum on a straight line basis.
Tax losses may be carried back against taxable profit of
the previous five years. In year 20X0, the entity's
taxable profit was $25,000. The tax rate is 40%.
• Required
Assuming nil profits/losses after depreciation in years
20X1 to 20X5, show the current and deferred tax
impact in years 20X1 to 20X5 of the acquisition of the
equipment.
29. CONT.D
• Jonquil Co will recover the carrying amount of the
equipment by using it to manufacture goods for
resale. Therefore, the entity's current tax
computation is as follows.
30. Measurement of Current Tax
• Measurement of Current Tax Current tax liabilities
are measured at the amount expected to be paid to
the taxation authorities, using the tax rates (and tax
laws) that have been enacted or substantially
enacted by the end of the reporting period.
• Current tax assets are similarly measured at the
amount expected to be recovered from the taxation
authorities.
31. Accounting for net operating losses
• A net operating loss (NOL) occurs for tax purposes
in a year when tax-deductible
expenses exceed taxable revenues.
• Loss carrybacks. Deductions or credits that cannot
be utilized on the tax return during a year and that
may be carried back to reduce taxable income or
taxes paid in a prior year.
• Loss carry-forwards. Deductions or credits that
cannot be utilized on the tax return during a year and
that may be carried forward to reduce taxable
income or taxes payable in a future year.
32. CONT.D
• In 20X7 Eramu Co paid $50,000 in tax on its profits.
In 20X8 the company made tax losses of $24,000.
The local tax authority rules allow losses to be
carried back to offset against current tax of prior
years. The tax rate is 30%.
Required:Show the tax charge and tax liability for
20X8.
• Solution :Tax repayment due on tax losses
= 30%*$24,000 = $7,200.
The double entry will be:
Tax receivable…………….$7,200
Tax repayment ………………$7,200
33. Presentation of tax assets and liabilities
• Tax assets and liabilities presented separately from
other assets and liabilities in the statement of
financial position.
• Current tax assets and liabilities can be offset, but
this should happen only when certain conditions
apply.
1. The entity has a legally enforceable right to set off
the recognized amounts.
2. The entity intends to settle the amounts on a net
basis, or to realize the asset and settle the liability
at the same time.
34. CONT.D
• Deferred tax assets and liabilities should be
distinguished from current tax assets and liabilities.
• All deferred tax balances are always classified as
noncurrent.
• The tax expense (income) related to the profit or loss
for the year should be shown in the profit or loss
section of the statement of profit or loss and other
comprehensive income.
