CH.7 Income Taxes (Deferred Tax Assets and Liabilities) Flashcards
What are the 2 Main elements Noted in IAS12 Income Taxes?
Definitions:-
Current Tax
Deferred Tax
Tax Base
Temporary Difference
IAS 12 Income Taxes notes that there are two elements to tax that an entity must deal with:
- - Current Tax – the amount payable to the tax authorities in relation to the trading activities of the current period.
- - Deferred Tax – is an accounting measure used to match the tax effects of transactions with their accounting treatment. It is not a tax that is levied by the government that needs to be paid, but simply an application of the accruals concept.
Definitions:
- Tax Base - of an asset or liability is the amount attributed to that asset or liability for tax purposes. = Tax Written down the amount
- Temporary Difference - is the difference between the carrying amount of an asset or liability in the SFP (value from an accounting perspective) and its tax base (value from a tax perspective).
How do you account for Current Tax?
and
How is it affected by over and underprovisions?
Current tax is the amount payable to the authorities for current years trading activities.
- Dr - Tax Expense - P/L
- Cr - Tax Payable - SFP.C.L
- **Current tax is usually based on estimates.
- So this means it is likely been over provided or underprovided in the financial year. (by small amounts)**
- - The following year when the final bill calculated it will likely be more or less the amount provisioned in the previous year. But the small difference is charged in the current year. So this is treated as a change in estimates which is accounted for Prospectively. i.e Charged in the year.
Note:
- Under provision in the previous year (DR in TB) = Increase next yrs expense
- Over provision in the previous year (CR in TB) = Reduce next yrs expense.
What are the main principles of Deferred Tax?
Hint
- Temporary and Non-Temporary tax differences.
- Conceptual framework -
- Definition of an asset and liability
- Accruals concept
Deferred Tax is an accounting measure, used to match the tax effects of transactions with their accounting effect. (it is how the accruals concept is applied on tax differences)
During a year a company will apply accounting principles that often do not align with local tax legislation. This difference in accounting profits and losses and taxable profits and losses, some of these differences are temporary as others are not.
e.g.
*Non-Temporary difference - entertainment or fines for late filing are none deductible expenses and must be added back to taxable profits.
Temporary difference - New Machine purchased in the current year is held for 10 years and depreciated over a Straight Line basis. But the tax rules allow (AIA) the full cost to be deductible in the current year.
This creates an issue in the financial reporting if the difference is not recognised, it will misrepresent the performance of the organisation. As in the first year, it will show a small amount of tax, and the declining performance of the organisation in the following years.
- Temporary differences may mean that profits are reported in the financial statements before they are taxable by the authorities.
- Conversely, it might mean that tax is payable to the authorities even though profits have not yet been reported in the financial statements.
Conceptual framework
- Meets the definition of asset and liability
- According to the accruals concept, the tax effect of a transaction should be reported in the same accounting period as the transaction itself. To ensure this, entities are required to account for deferred tax on temporary differences.
Give examples of when a temporary tax Difference might occur?
- Tax deductions for the cost of non-current assets that have a different pattern to the write-off of the asset in the financial statements.
- Intra-group profits in inventory that are unrealised for consolidation purposes yet taxable in the computation of the group entity that made the unrealised profit.
- Losses reported in the financial statements but the related tax relief is only available by carrying forward against future taxable profits.
- Assets are revalued upwards in the financial statements, but no adjustment is made for tax purposes.
- Development costs are capitalised and amortised to profit or loss in future periods but were deducted for tax purposes as incurred.
- The cost of granting share options to employees is recognised in profit or loss, but no tax deduction is obtained until the options are exercised. - (deferred tax asset
How are the following differences Treated?
Taxable Temporary Differences
Tax Deductible Temporary Differences
Taxable Temporary Differences —) Deferred Tax liability
- Tax Base is lower than the Carrying Amount (positive balance)
-
Tax to pay in the future
- Initially recognised as:
Cr- SFP - Deferred Tax Liability
Dr- P/L - Deferred Tax Charge
- Initially recognised as:
Tax Deductible Temporary Differences —-) Deferred Tax Asset (negative balance)
- The Tax Base is higher than the carrying amount
-
Tax saving in the future
- Initially recognised as:
Dr - SFP - Deferred Tax Asset
Cr - P/L - Deferred Tax Charge
- Initially recognised as:
What should deferred tax asset or Liability be Recognised?
- IAS 12 Income Taxes states that deferred tax should be “provided for on all taxable temporary differences”, EXCEPT FOR:-
-
Deferred tax liability arising from:
- Goodwill, for which amortisation is not tax-deductible
- Initial recognition of an item that has no effects on accounting profit or taxable profit, and does not result from a business combination.
-
Deferred tax assets should be recognised on all deductible temporary differences unless:
- The exceptions above apply
- Insufficient taxable profits are expected to be available in the future against which the deductible temporary difference can be utilised.
How is a deferred tax measured?
and
How is it presented in the accounts?
Measurement
Carrying Amount of asset or liability
Less: Tax Base
= Temporary Difference
X Current Tax % rate in force (or expected to be in force)
= Deferred Tax
-
- If the deferred tax is positive = Deferred Tax Asset
- Dr - SFP, Cr - P/L
-
- If the deferred tax is negative = Deferred Tax Liability
- Dr - P/L, Cr - SFP
Presentation
Income statement
- If the item is dealt with in P/L then charge deferred tax to P/L
- If the item is dealt with in OCI then charge deferred tax to OCI
SFP
Deferred tax liabilities and assets are presented as non-current on the statement of financial position.
IAS 12 notes that deferred tax can be offset as long as:
- the entity has a legally enforceable right to set off current tax assets and liabilities
- the deferred tax assets and liabilities relate to tax levied by the same tax authority.
How do you calculate the Tax base of asset or liability?
The Tax base of an asset:
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’
Simply - The Amount deductible against the taxable income.
- PPE Tax written down value = COST LESS TAX DEPRECIATION
How is deferred tax on revaluation of property treated?
Deferred tax should be recognised on the revaluation of property, plant and equipment even if:
- There is no intention to sell the asset
- Any tax due on the gain made on any sale of an asset can be deferred by being ‘rolled over’ against the cost of a replacement asset.]
Calculation
Carrying Amount = Revalued Amount
Less: Tax Base = (Cost of asset less tax allowances)
Temporary Difference
X Tax Rate
= Likely to be deferred tax Liability
Reduce current year profits in the OCI where revaluation gain will be recorded as a revaluation reserve.
How is deferred tax on share options treated?
Share option schemes require recognising an annual expense in profit or loss throughout the vesting period. Tax relief is usually given when relief is granted.
The tax relief granted is based on the Intrinsic Value (difference between market price and the exercise price)
Pro forma to calculate share options deferred tax:
Carrying amount of Share-based payment = (NIL)
Tax Base (intrinsic value on reporting date)=(F.V on reporting date less exercise price)
X %Tax Rate
= Deferred Tax Asset = Dr - SFP, Cr - P/L, Cr - Equity
How do you account for deferred tax on unused tax losses?
Unused tax losses
Tax losses usually allow for future carried forward relief, i.e losses that are deductible against future taxable profits.
Where an entity has unused tax losses, IAS 12 allows a deferred tax asset to be recognised.
Only when it is probable that future taxable profits will be available against and the amount of probable future taxable profits, which the unused tax losses can be used to deduct.
IAS 12 advises that the deferred tax asset should only be recognised after considering:
- Sufficient taxable temporary differences against which the unused tax losses can be offset.
- probable the entity will make taxable profits before the tax losses expire.
- cause of the tax losses can be identified and whether it is likely to recur (otherwise, the existence of unused tax losses is strong evidence that future taxable profits may not be available).
- whether tax planning opportunities are available.
Simply - a tax asset for % of carried forward relief on taxable profit
How is deferred tax treated on consolidation of group accounts?
Specifically:- Fair Value revaluations
When group accounts a prepared, the assets of the subsidiary are revalued to the groups accounting policies. This may create revaluations on assets acquired and the goodwill calculations.
When the asset is revalued, you must also account for the deferred tax liability on the revaluation gain.
*Simply include the deferred tax on the revaluation in the goodwill calculations
How is deferred tax treated on consolidation of group accounts?
Specifically:- Provision of unrealised Profits (P.U.R.P.S)
When one company within a group sells inventory to another group company, unrealised profits remaining within the group at the reporting date must be eliminated. I.E
- Dr - Cost of sales (P/L)
- Cr - Inventory (SFP)
This adjustment reduces the carrying amount of inventory in the consolidated statements but the tax base of the inventory remains at cost in the individual financial statements of the purchasing company.
This creates a deductible temporary difference, giving rise to a deferred tax asset in the consolidated statements.
Note: Think of this adjustment in terms of profits. The unrealised profit on the intra-group transaction is removed from the consolidated statements and therefore the tax charge on this profit must also be removed.
Simply - account for Deferred Tax Asset for an unrealised profits tax rate is based on the company making the profit
How is deferred tax treated on consolidation of group accounts?
Specifically:- Unremitted Earnings
A temporary difference arises when the carrying amount of investments in subsidiaries, associates or joint ventures is different from the tax base.
- The carrying amount in consolidated statements is usually the investor’s share of the net assets of the investee, plus purchased goodwill.
- The tax base is usually the cost of the investment.
- The difference is the unremitted earnings (i.e. undistributed profits) of the subsidiary, associate or joint venture.
- The carrying amount in consolidated statements is usually the investor’s share of the net assets of the investee, plus purchased goodwill.
IAS 12 says that deferred tax should be recognised on this temporary difference except when:
- – the investor controls the timing of the reversal of the temporary difference and
- – probable that the profits will not be distributed foreseeable future.
An investor can control the dividend policy of a subsidiary, but not always that of other types of investment. This means that deferred tax does not arise on investments in subsidiaries, but may arise on investments in
- associates
- joint ventures
Financial assets may give rise to deferred tax if they are revalued.
What are the disclosure requirements for IAS 24 income taxes?
Disclosure
An entity must disclose:
- the major components of its tax expense
- tax recognised directly in equity
- tax relating to items recognised directly in equity
- tax relating to each component of other comprehensive income
- an explanation of the relationship between tax expense and accounting profit.
