Chapter 20

Question 1

Why is determining the amount of tax charged important?

Answer 1

The amount of tax charged against the profit in any period is an important determinant of the amount attributable to the owners of a company (reflected in net profit and earnings per share).

Question 2

What is the first thing tax authorities do?

Answer 2

The first thing that such tax authorities do to the profit figure as calculated and published in the income statement, is to remove all the depreciation entries put in by the accountant. In other words, the depreciation figure, which will have been deducted in arriving at the profit figure, is simply added back again.

Question 3

What is the difference between the depreciation charge in any year and the tax allowance for that year?

Answer 3

Referred to as a timing difference or temporary difference.

Question 4

What is timing differences?

Answer 4

Timing differences are a potential source of differences between accounting profit and taxable profit. The measurement and recognition of the revenues and expenses for the period is determined by the accounting principles.

Question 5

How is taxable profit defined by IAS 12?

Answer 5

as ‘the profit or loss for the period, determined in accordance with the rules established by the taxation authorities’. An important point in accounting for income taxes is the identification of these differences between accounting profit or income and taxable income

Question 6

How do these difference arise?

Answer 6

These differences arise from a different treatment of the same transaction by the accounting principles in comparison to the tax principles. Some of these differences are permanent while others are temporary in nature.

Question 7

What is a permanent difference?

Answer 7

A permanent difference between accounting profit and taxable profit arises when the treatment of a transaction by taxation legislation and accounting standards is such that amounts recognized as part of the accounting profit are never recognized as part of the taxable profit or vice versa.

Question 8

How can the amount to be transferred to the credit go the deferred tax account be formally calculated?

Answer 8

Amount = Tax rate * (tax allowances given - depreciation disallowed)

Question 9

How can the transfer to the deferred tax account be seen?

Answer 9

The transfer to the deferred tax account can be seen to be the result of an amalgam of positive originating timing differences relating to depreciation.

Question 10

What can we suggest in the long-term, regarding deferred tax account?

Answer 10

1. If the entity reaches the state where it has a constant volume of fixed assets, merely replacing its existing assets as they wear out and also the price it has to pay for replacement fixed assets does not rise over time, then the balance of liability on the deferred tax account will remain a more or less constant figure.
2. If the entity finds that it is effectively in the position of paying gradually more and more money for fixed assets each year, then the balance of the liability on the deferred tax account will gradually rise, apparently without limit.
3. Only if the monetary amount of reinvestment in fixed assets actually falls will the balance of liability on the deferred tax account start to fall.

Question 11

How likely are these three suggestions to be an outcome, when?

Answer 11

1 Entities have a tendency to expand.
2 Entities have a tendency to become more capital intensive.
3 Inflationary pressures tend to cause the amount of money paid for assets to increase over time.

Question 12

What are the four distinguished approaches?

Answer 12

1 The flow through approach, which accounts only for that tax payable in respect of the period in question, i.e. timing differences are ignored.
2 Full deferral, which accounts for the full tax effects of timing differences, i.e. tax is shown in the published accounts based on the full accounting profit and the element not immediately payable is recorded as a liability until reversal.
3 Partial deferral, which accounts only for those timing differences where reversal is likely to occur in aggregate terms (because, for example, replacement of assets and expansion is expected to exceed depreciation).
4 Present value, where the expected future cash flows are discounted; these cash flows might be postponed to the far future when replacements are assumed, which could result in a deferred tax account close to zero.

Question 13

On what does the tax amount depend on?

Answer 13

The deferred tax amount is dependent on the tax rate used.

Question 14

What can you use when calculating the tax amount?

Answer 14

• the tax rate applying when the temporary difference originated – deferral method
• the tax rate (or the best estimate of it) ruling when the tax will become payable – liability method.

Question 15

On which difference lies the focus when viewing the income statement of deferred tax?

Answer 15

The accounting profit and taxable profit.

Question 16

How are temporary differences defined?

Answer 16

Temporary differences are defined as 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 or deductible.

Question 17

What are the first definitions given by IAS 12?

Answer 17

• Accounting profit is net 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 net profit or loss for the period in respect of current tax and deferred tax.
• Current tax is the amount of income taxes payable (recoverable) in respect of 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:
  (a) deductible temporary differences
  (b) the carry forward of unused tax losses (c) the carry forward of unused tax credits.

Question 18

What are the last definitions given by IAS 12?

Answer 18

• Temporary differences are differences between the carrying amount of an asset or liability in the balance sheet and its tax base. Temporary differences may be either:
  1. (a) taxable temporary differences, which are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled or
  2. (b) deductible temporary differences, which are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. These lead to deferred tax assets.
• The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.

Question 19

What is the tax base of an asset?

Answer 19

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.

Question 20

What are the requirements of IAS 12?

Answer 20

Unpaid current tax in relation to current or earlier periods is shown as a liability and if the amount paid exceeds the amount due, then the excess is recognized as an asset. In addition, where the benefit from a tax loss can be carried back to recover the current tax of a previous period, this should also be recognized as an asset.

Question 21

When should deferred tax liability not be recognised?

Answer 21

• the initial recognition of goodwill or
• the initial recognition of an asset or liability in a transaction which is not a business combination and at the time of the transaction affects neither accounting profit nor taxable profit.

Question 22

What are temporary differences?

Answer 22

Temporary differences are differences between the carrying amount of an asset or a liability in the statement of financial position and its tax base.

Question 23

What can arise deferred tax?

Answer 23

1. Business combinations
2. Investment in subsidiaries, branches, associates and joint ventures

Question 24

What are business combinations?

Answer 24

When a combination occurs under the acquisition method, the acquired assets and liabilities are revalued to fair value. A temporary difference therefore arises on which a deferred tax liability is recognized.

Question 25

What are investments in subsidiaries, branches, associates and joint ventures?

Answer 25

The tax base of the investment is generally cost. The carrying amount of the investment, however, changes over time as undistributed profits are built up in the subsidiary, associate and so on, or due to foreign currency translation or when the investment is reduced to its recoverable amount.

Question 26

When does IAS 12 require deferred tax to not be recognised?

Answer 26

• the parent, investor or venturer is able to control the timing of the reversal of the difference and
• it is probable that the difference will not reverse in the foreseeable future.

Question 27

How does IAS 12 define deferred tax assets?

Answer 27

Defines a deferred tax asset as the amount of income taxes recoverable in future periods in respect of: (1) deductible temporary differences, (2) the carry forward of unused tax losses and (3) the carry forward of unused tax credits.

Question 28

Which circumstances arise the reason when deferred tax asset should no be recognised?

Answer 28

Arises from the initial recognition of an asset or liability in a transaction that:
* is not a business combination
* (at the time of the transaction) affects neither accounting profit nor taxable profit (loss).

Question 30

What does IAS 12 state?

Answer 30

States that the existence of unused tax losses is strong evidence that future taxable profits may not be available.

Question 31

What does IAS 12 require when measuring deferred tax?

Answer 31

IAS 12 requires that deferred tax is measured by reference to tax rates and laws, as enacted or substantively enacted by the balance sheet date, that is expected to apply in the periods in which the assets and liabilities to which the deferred tax relates are realized or settled.

Question 32

What does IAS 12 require from an entity?

Answer 32

IAS 12 requires an entity to measure deferred tax relating to an asset depending on whether the entity expects to recover the carrying amount of the asset through use or sale.

Question 33

What does IAS 12 provide?

Answer 33

IAS 12 provides a practical solution to the problem by introducing a presumption that recovery of the carrying amount will normally be through sale.

Question 34

What does IAS 12 not permit?

Answer 34

IAS 12 does not permit the discounting of deferred tax balances, so measuring the liability of the asset at present value is not allowed. There is one exception. IAS 12 allows discounting of deferred tax where it relates to a pre-tax amount that is itself discounted.

Question 35

Why does the board not permit the discounting of deferred tax balances?

Answer 35

• Reliable calculation is complex and dependent on several factors, not least of which is choice of discount rate, and therefore, if discounting were required, ‘reliability’ would be questionable.
• If discounting is permitted, some entities would discount and others would not, leading to a lack of comparability.

Question 36

When is this difference recognized in arriving at the net profit or loss for the period, except for tax arising from?

Answer 36

• a transaction or event which is recognized in any accounting period directly in equity, in which case the movement in deferred tax should be accounted for directly in equity or
• a business combination that is accounted for as an acquisition, in which case the movement in deferred tax is included in the resulting goodwill figure.

Question 37

With which two models does the tax uncertainty need to be reflected?

Answer 37

• • the most likely amount – the single most likely amount in a range of possible outcomes
• • the expected value – the sum of the probability-weighted amounts in a range of possible outcomes.

Question 38

What should an entity always assume when determining the probability of acceptance?

Answer 38

In determining the probability of acceptance of the uncertain tax treatment, an entity should always assume that a taxation authority will examine amounts it has a right to examine and has full knowledge of all related information when making those examinations.