OVERVIEW
Objective
¾
To describe the rules for recognition and measurement of taxes.CURRENT TAX
¾ Overview ¾ Scope ¾ Definitions
CONCEPT ILLUSTRATED INTRODUCTION
INTRODUCTION WITHHOLDING
TAX
¾ Introduction ¾ Accounting
¾ Underlying problem ¾ Scenario
¾ Analysis − balance sheet approach ¾ After the company has accounted
for deferred tax the financial statements will be as follows DEFERRED
TAX
DETAILED RULES BASICS
¾ Introduction
¾ Calculation of the asset or liability
¾ Jargon
¾ Recognition of deferred tax liabilities
¾ Recognition of deferred tax assets ¾ Accounting for the movement on
the deferred tax balance COMPLICATIONS
¾ Rates
APPENDIX COMPREHENSIVE
EXAMPLE
1
INTRODUCTION
1.1
Overview
¾
In financial reporting, the financial statements need to reflect the effects of taxation on a company. Guidance is provided by the fundamental accounting concepts of accruals and prudence. Tax rules determine the cash flows; these must be matched to the revenues which gave rise to the tax and tax liabilities must be recognised as they are incurred, not merely when they are paid.¾
The consistency must be applied in the presentation of income and expenditure.1.2
Scope
¾
IAS 12 should be applied in accounting for income taxes including current tax tax on distributions deferred tax.
1.3
Definitions
¾
Accounting profit is profit or loss for a period before deducting tax expense.¾
Taxable profit (tax loss) is the profit (loss) for a period, determined inaccordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable).
¾
Tax expense (tax income) is the aggregate amount included in thedetermination of profit or loss for the period in respect of current tax and deferred tax.
¾
Current tax is the amount of income taxes payable (recoverable) in respectof the taxable profit (tax loss) for a period.
¾
Deferred tax liabilities are the amounts of income taxes payable in futureperiod in respect of taxable temporary differences.
¾
Deferred tax assets are the amounts of income taxes recoverable in futureperiods in respect of:
deductible temporary differences
the carry forward of unused tax losses, and the carry forward of unused tax credits.
¾
Temporary differences are differences between the carrying amount of an 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
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.
¾
The tax base of an asset or liability is the amount attributed to that asset orliability for tax purposes.
2
RECOGNITION OF CURRENT TAX LIABILITIES AND
CURRENT TAX ASSETS
¾
IAS 12 says that Current tax for current and prior periods should, to the extent unpaid, be
recognised as a liability. If the amount already paid in respect of current and prior periods exceeds the amounts due for those periods, the excess should be recognised as an asset.
The benefit relating to a tax loss that can be carried back to recover current tax of a previous period should be recognised as an asset.
¾
A company is a separate legal entity and is therefore liable to income tax. Income tax is based upon company’s profits for period (usually a year)Example 1
Year 1
Enid Inc starts trading with operating profits of $100,000 and an estimated tax charge of $40,000.
Required:
Solution
Year 1
Accounts Profit or loss extracts
Income tax payable
$
$ $ PBT
Tax
______ ______ ______
PAT
______ ______ ______
¾
The income tax included in profit or loss is an estimate. Any over/under provisions are cleared in the following period’s profit or loss and do not give rise to a prior period adjustment.Example 2
Year 2
Enid Inc’s tax charge for year 1 is settled at $43,000. Operating profits for the current year are $105,000 with an estimated tax charge of $44,000.
Required:
Show the relevant ledger accounts and profit or loss extracts.
Solution
Year 2
Accounts Profit or loss extracts
Income tax payable
$ $
$ $ PBT
Cash B/d 40,000 Tax
– – current year
– underprovn
______ ______ ______ ______
PAT
______ ______ ______
3
WITHHOLDING TAX
3.1
Introduction
¾
In some jurisdictions the government eases its cash flow by making companies account for tax when they make interest payments, or dividend payments.
3.2
Accounting
Payments
¾
Companies make payments net of tax, e.g. dividends. Income tax is deducted at source and paid to the tax authorities according to specified local rules.Dr Profit or loss 500
Cr Cash 350
Cr Income tax withheld 150
This records the amount that the company must pay to the authorities.
Receipts
¾
Companies are themselves taxed on their taxable profit. If they have received interest net of a deduction then they will have already suffered taxation on this piece of income which will then be taxed again in the tax computation for the year. Therefore they need to account for the fact that they have been taxed in order to reduce the future liability.Dr Cash (net) 400
Dr Income tax asset 100
Cr Profit or loss 500
¾
If company has an income tax payable at the year end, include in payables.¾
If company has income tax recoverable, i.e. company has net income tax suffered for year deduct from income tax payable
Example 3
Rogers Inc operates in an economy where tax is withheld on payment of interest and royalties. Rogers pays a year’s interest on 10% $1 million
debentures at the year-end and on the last day of the year is paid a royalty of $1 per unit on 60,000 units sold by a customer. Income tax is at the rate of 24%.
Required:
Set out the journals to record the above and calculate the balance owed to or receivable from the tax authorities.
Solution
$ $
¾
Journal for debenture interest¾
Journal for royalties¾
Tax authority
$ $
——— ———
4
DEFERRED TAXATION — INTRODUCTION
4.1
Underlying problem
¾
In most jurisdictions accounting profit and taxable profit differ, meaning that the tax charge may bear little relation to profits in a period.¾
Differences arise due to the fact that tax authorities follow rules which differ from IFRS rules in arriving at taxable profit.¾
Transactions which are recognised in the accounts in a particular period may have their tax effect deferred until a later period.Illustration 1
Many non current assets are depreciated.
Most tax authorities will allow companies to deduct the cost of purchasing non current assets from their profit for tax purposes but only according to a set formula. If this differs from the accounting depreciation then the asset will be written down by the tax authority and by the company but at different rates. Thus the tax effect of the transaction (which is based on the tax laws) will be felt in a different period to the accounting effect.
¾
It is convenient to envisage two separate sets of accounts one set constructed following IFRS rules and a second set following the tax rules of the jurisdiction in which the company operates. (we will refer to these as the “tax comps”).
Commentary
Of course there is not really a full set of tax accounts but there could be. Tax files in reality merely note those areas of difference between the two systems
¾
The differences between the two sets of rules will result in different numbers in the financial statements and in the tax comps. These differences may be viewed from a balance sheet liability perspective, or an income statement liability perspective.
5
DEFERRED TAXATION — THE CONCEPT ILLUSTRATED
5.1
Scenario
Illustration 2
Tom Inc bought a non current asset on 1 January 2008 for $9,000. This asset is to be depreciated on a straight line basis over 3 years. Accounting depreciation is not allowed as a taxable deduction in the jurisdiction in which the company operates. Instead tax allowable depreciation (capital allowances), under the tax regime in the country of operation is available as follows.
2008 $4,000
2009 $3,000
2010 $2,000
Accounting profit for each of the years 2008 to 2010 is budgeted to be $20,000 (before accounting for depreciation) and income tax is to be charged at the rate of 30%.
Differences arising
Difference in the Carrying
amount Tax base Financial position Profit or loss Cost at 1 Jan 2008 9,000 9,000
Charge for the year (3,000) (4,000) (1,000)
Cost at 31 Dec 2008 6,000 5,000 1,000
Charge for the year (3,000) (3,000) −
Cost at 31 Dec 2009 3,000 2,000 1,000
Charge for the year (3,000) (2,000) 1,000
Cost at 31 Dec 2010 − − − −
¾
At the end of each reporting period the deferred tax liability might be identified from a balance sheet or an income statement view.¾
In this example the difference in the statement of financial position amounts is the sum of the differences that have gone through the statement of comprehensive income.¾
The balance sheet view identifies the deferred taxation balance that is required in thestatement of financial position whereas the income statement approach identifies the deferred tax that arises during the period.
5.2
Analysis − balance sheet approach
¾
The balance sheet approach calculates the liability (or more rarely the asset) that a company would need to set up on the face of its statement of financial position.Carrying
amount base Tax Balance sheet view of the differences (known as the temporary
difference)
Tax @ 30%
At 31 Dec 2008 6,000 5,000 1,000 300
At 31 Dec 2009 3,000 2,000 1,000 300
At 31 Dec 2010 − − − −
¾
Application of the tax rate to the difference will give the deferred tax balance that should be recognised in the statement of financial position.¾
In 2008 the company will recognise a deferred tax liability of $300 in its statement of financial position. This will be released to the profit or loss in later years.¾
The $300 is a liability that exists at the end of the reporting period and which will be paid in the future.Commentary
In years to come (i.e. looking forward from the end of 2008) the company will earn profits against which it will charge $6,000 depreciation but will only be allowed $5,000 capital allowances. Therefore taxable profit will be $1,000 bigger than accounting profit in the future. This means that the current tax charge in the future will be $300 (30% × $1,000) bigger than would be expected from looking at the financial statements. This is because of events that have occurred and been recognised at the end of the reporting period. This satisfies the definition and recognition criteria for a liability as at the reporting date.
¾
The charge to profit or loss is found by looking at the movement on the liabilityLiability required Profit or loss entry
2008 300 Dr 300
2009 300 NIL
2010 NIL Cr 300
5.3
After the company has accounted for deferred tax the financial
statements will be as follows
¾
Statement of financial position – extracts2008 2009 2010
$ $ $
Deferred taxation liability 300 300 −
¾
Profit or loss2008 2009 2010
$ $ $
Profit before tax 17,000 17,000 17,000
Income tax @ 30% W1 4,800 5,100 5,400
Deferred tax 300 − (300)
(5,100) (5,100) (5,100)
Profit after tax 11,900 11,900 11,900
¾
Accounting for the tax on the differences through profit or loss restores the relationship that should exist between the accounting profit and the tax charge. It does this by taking a debit or a credit to the statement of comprehensive income. This then interacts with the current tax expense to give an overall figure that is the accounting profit multiplied by the tax rate.¾
As can be seen from this example, the effect of creating a liability in 2008 and then releasing it in 2010 is that profit after tax ($11,900 for all three years) is not distorted by temporary timing differences. As such, a user of the financial statements now has better information about the relationship between profit before tax and profit after tax.¾
Accruals and provisions for taxation will impact on earnings per share, net assets per share and gearing.W1 Calculations of tax for the periods
2008 2009 2010
$ $ $
Accounting profit (after
depreciation) 17,000 17,000 17,000
Add back depreciation 3,000 3,000 3,000 Deduct capital
allowances (4,000) (3,000) (2,000)
(1,000) 1,000
Taxable profit 16,000 17,000 18,000
6
ACCOUNTING FOR DEFERRED TAXATION
−
BASICS
6.1
Introduction
¾
IAS 12 takes a balance sheet perspective. Accounting for deferred taxation involves the recognition of a liability (or more rarely an asset) in the statement of financial position. The difference between the liability at each year end is taken to the statement ofcomprehensive income.
Illustration 3
$ Deferred taxation balance at the start of the year 1,000 Transfer to the profit and loss (as a balancing figure) ______ 500 Deferred taxation balance at the end of the year 1,500 ______ Most of the effort in accounting for deferred taxation goes into the calculation of this year-end balance figure.
We will look at the accounting for the movement in more detail later in the session
6.2
Calculation of the liability/asset
¾
The calculation of the balance to be put onto the statement of financial position is, in essence, very simple. It involves the comparison of the carrying values of items in the accounts to the tax authority’s view of the amount (known as the tax base of the item). The difference generated in each case is called a temporary difference.¾
The basic rule in IAS 12 is that deferred taxation should be provided on all taxable temporary differences. (Note that this is a simplification. Complications will be covered later).Illustration 4
Carrying Tax Temporary Deferred tax
value in base differences balance
financial required
statements at 30%
$ $ $ $
Non current assets 20,000 14,000 6,000 1,800
Other transactions
A (accrued income) 1,000 – 1,000 300
B (an accrued expense) (2,000) – (2,000) (600) ______ ______
6.3
Jargon
6.3.1
Definitions
¾
Temporary differences are differences between the carrying amount of an asset or liabilityand its tax base.
¾
Temporary differences may be either debit balances in the financial statements compared to the tax
computations. These will lead to deferred tax credit balances. These are known as taxable temporary differences, or
credit balances in the financial statements compared to the tax
computations. These will lead to deferred tax debit balances. These are known as deductible temporary differences.
¾
The tax base of an asset or liability is the amount attributed to that asset or liability for taxpurposes.
¾
The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefit that will flow to an entity when it recovers the carrying amount of the asset.6.3.2
Accounting issues
Illustration 5
(Revisiting illustration 2)
2008 $
Carrying value 6,000
Tax base of the asset (5,000)
______
Temporary difference 1,000
______
Deferred tax balance required (@30%) 300
______
¾
The difference between the carrying value of the asset and the tax authority’s value is described as a temporary difference because it is temporary in nature − it will disappear in time.¾
Temporary differences may lead to deferred tax credits or debits, though the standard imposes a tougher recognition criteria in respect of debit balances.¾
Deferred tax accounting is about accounting for items where the tax effect of items is deferred to a later period. Circumstances under which temporary differences arise include When income or expense is included in accounting profit in one period but included in the taxable profit in a different period. E.g.
−
items which are taxed on a cash basis but which will be accounted for on an accruals basis.Illustration 6
The accounts of Bill Inc show interest receivable of $10,000. No cash has yet been received and interest is taxed on a cash basis. The interest receivable has a tax base of nil. Deferred tax will be provided on the temporary difference of $10,000.
−
situations where the accounting depreciation does not equal tax allowable depreciation.Illustration 7
Bill Inc has non current assets at the year end with a cost of $4,000,000.
Aggregate depreciation for accounting purposes is $750,000. For tax purposes, depreciation of $1,000,000 has been deducted to date. The non current assets have a tax base of $3,000,000. The provision for deferred tax will be provided on the taxable temporary difference of $250,000.
−
finance leases recognised in accordance with the provisions of IAS 17 but which fall to be treated as operating leases under local tax legislation. Revaluation of assets where the tax authorities do not amend the tax base when the asset is revalued.
¾
Unfortunately the definition of temporary difference captures other items which should not result in deferred taxation accounting, e.g. accruals for items which are not taxed or do not attract tax relief.¾
The standard includes provisions to exclude such items. The wording of one such provision is as followsIllustration 8
Bill Inc provided a loan of $250,000 to John Inc. At the year end Bill Inc’s accounts show a loan payable of $200,000. The repayment of the loan has no tax consequences. Therefore the loan payable has a tax base of $200,000. No temporary taxable difference arises.
Example 4
The following information relates to Boniek Sp. z.o.o. as at 31 December 2007.
Note Carrying Tax
value base
Non current assets $ $
Plant and machinery 200,000 175,000
Receivables:
Trade receivables 1 50,000
Interest receivable 1,000
Payables
Fine 10,000
Interest payable 2,000
Note 1
The trade receivables balance in the accounts is made up of the following amounts.
$
Balances 55,000
Doubtful debt allowance (5,000)
______ 50,000 ______ Further information:
1. The deferred tax liability balance as at 1 January 2007 was $1,200. 2. Interest is taxed on a cash basis.
3. Allowances for doubtful debts are not deductible for tax purposes. Amounts in respect of receivables are only deductible on application of a court order to a specific amount.
4. Fines are not tax deductible. 5. Deferred tax is charged at 30%.
Required:
Solution
Carrying
value base Tax Temporary difference
Non current assets $ $ $
Plant and machinery
Receivables:
Trade receivables Interest receivable
Payables
Fine
Interest payable
Temporary
differences Deferred tax @ 30% Deferred tax liabilities
Deferred tax assets
Deferred tax @
30% $
Deferred tax as at 1 January 2007 1,200
7
ACCOUNTING FOR DEFERRED TAX
−
DETAILED RULES
7.1
Recognition of deferred tax liabilities
7.1.1
The rule
¾
A deferred tax liability should be recognised for all taxable temporary differences, unless the deferred tax liability arises from 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.¾
If the economic benefits are not taxable the tax base of the asset is equal to its carrying amount.7.1.2
Accounting issues
¾
“all taxable temporary differences”The definition of temporary differences includes all differences between accounting rules and tax rules, not just the temporary ones! The standard contains other provisions to correct this anomaly and excludes items where the tax effect is not deferred, but rather, is permanent in nature.
¾
“initial recognition ---- not a business combination”If the initial recognition is a business combination deferred tax may arise.
¾
“effects neither accounting profit nor loss”The rule here is an application of the idea that if an item is not taxable it should be excluded from the calculations.
¾
Taxable temporary differences also arise in the following situations: Certain IFRSs permit assets to be carried at a fair value or to be revalued.
−
if the revaluation of the asset is also reflected in the tax base then no temporary difference arises.−
if the revaluation does not affect the tax base then a temporary difference does arise and deferred tax must be provided.Commentary
This is basically the same rule as above applied to a group accounting situation
Example 5
The following information relates Lato Sp z.o.o.
Carrying Tax
value base
$ $
At 1 January 2007 1,000 800
Depreciation (100) (150)
At 31 December 2007 900 650
At the year end the company decided to revalue the asset to $1,250. The tax base is not affected by this revaluation.
Required:
Calculate the deferred tax provision required in respect of this asset as at 31 December 2007.
Solution
Carryingvalue Tax base Temporary difference
$ $
7.2
Recognition of deferred tax assets
7.2.1
The rule
¾
A deferred tax asset should be recognised for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which thedeductible temporary difference can be utilised, unless the deferred tax asset arises from
the initial recognition of an asset or liability in a transaction which:
−
is not a business combination and−
at the time of transaction, affects neither accounting profit nor taxable profit (tax loss).¾
The carrying amount of a deferred tax asset should be reviewed at the end of every reporting period. The carrying value of a deferred tax asset should be reduced to the extent that it is no longer probable that sufficient taxable profit will be available to utilise the asset.7.2.2
Commentary
¾
Most of the comments made in respect of deferred tax liabilities also apply to deferred tax assets.¾
Major difference between the recognition of deferred tax assets and liabilities is in the use of the phrase “to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised”.Commentary
This means that IAS 12 brings a different standard to the recognition of deferred tax assets than it does to deferred tax liabilities. In short liabilities will always be provided in full (subject to the specified exemptions) but assets may not be provided in full or, in some cases at all.
This is an application of the concept of prudence
Illustration 9
Situation 1 Situation 2 $ $
Deferred tax liability 10,000 5,000
Deferred tax asset (8,000) (8,000)
Net position 2,000 (3,000)
¾
In situation 1 the existence of the liability ensures the recoverability of the asset and the asset should be provided.¾
In situation 2 the company would provide for $5,000 of the asset but would need to consider carefully the recoverability of the $3,000 net debit balance.¾
In short debit balances which are covered by credit balances will be provided (as long as the tax is payable/recoverable to/from the same jurisdiction), but net debit balances will be subject to close scrutiny.7.3
Accounting for the movement on the deferred tax balance
¾
Deferred tax should be recognised as income or an expense and included in profit or loss for the period, except to the extent that the tax arises from a transaction or event which is recognised, in the same or a different period, outside of profit or loss or
a business combination that is an acquisition.
¾
Deferred tax should be recognised outside of profit or loss if the tax relates to items that are themselves recognised outside profit or lossCommentary
Example 6
Following on from example 5
Carrying Tax
value base
$ $
At 1 January 2007 1,000 800
Depreciation (100) (150)
At 31 December 2007 900 650
At the year end the company revalued the asset to $1,250. The tax base is not affected by this revaluation.
Carrying Tax Temporary
value base difference
$ $
1,250 650 600
Deferred tax at 30% 180
Required:
Assuming that the only temporary difference that the company has relates to this asset construct a note showing the movement on the deferred taxation and identify the charge to profit or loss in respect of deferred taxation for the year ended 31 December 2007.
Solution
Deferredtax @ 30%
$ Deferred tax as at 1 January 2007
To other comprehensive income Profit or loss
8
COMPLICATIONS
8.1
Rates
The tax rate that should be used is the rate that is expected to apply to the period when the asset is realised or the liability is settled, based on tax rates that have been enacted by the end of the reporting period.
Illustration 10
The following information relates to Tomaszewski Sp. Z.o.o. at 31 December 2007:
Carrying
value Tax base
$ $
Non-current assets 460,000 320,000
Tax losses 90,000
Further information:
1. Tax rates (enacted by the 2006 year end)
2007 2008 2009 2010
36% 34% 32% 31%
2. The loss above is the tax loss incurred in 2007. The company is very confident about the trading prospects in 2008.
3. The temporary difference in respect of non-current assets is expected to grow each year until beyond 2010.
4. Losses may be carried forward for offset, one third into each of the next three years
Required:
Calculate the deferred tax provision that is required at 31 December 2007.
Temporary difference
$
Non-current assets (460,000 − 320,000) 140,000
Losses (90,000)
Deferred tax liability (31% × 140,000) 43,400
Deferred tax asset
Reversal in 2008 (30,000 × 34%) (10,200)
Reversal in 2009 (30,000 × 32%) (9,600)
Reversal in 2010 (30,000 × 31%) (9,300)
¾
The tax rate used should reflect the tax consequences of the manner in which the entity expects to recover or settle the carrying amount of its assets and liabilities.Illustration 11
Tom Inc has an asset with a carrying amount of $5000 and a tax base of $3000. A tax rate of 25% would apply if the asset were sold and a tax rate of 33% would apply to other income.
The entity would recognise a deferred tax liability of $500 ($2000 @ 25%) if it expects to sell the asset without further use and a deferred tax liability of $660 ($2000 @33%) if it expects to retain the asset and recover its carrying value through use.
9
COMPREHENSIVE EXAMPLE
Gorgon Inc operates in country where the tax regime is as follows
¾
Transactions are only deductible for tax purposes when they are “booked”, ie, double entered into statutory accounting records. This means that there is often little difference between accounting profit under local GAAP and the taxable profit. However, it is common practice for large companies to maintain a parallel set of records and accounts for reporting according to IFRS rules. These are notably different to the rules in the domestic tax code and as a result the accounting profit under IFRS can be very different from the taxable profit.¾
The tax code allows for the general application of the accounting principles of prudence and accruals, but it does state the following tax allowable depreciation is computed according to rules set out in the tax code allowance for doubtful debts are only deductible under very strict and limited
circumstances
interest is taxable/allowable on a cash basis.
¾
The government operates a system of incentive through the tax system known as “Investment Relief”. Under this system a company is able to claim a proportion of the costs of qualifying non current assets, as being deductible, in excess of the normal depreciation rates which would result from adoption of IFRSs.Example 7
The following balances and information are relevant as at 31 December 2007.
Carrying Tax Notes
Value base
Non-current assets $ $
Assets subject to investment relief 63,000 1
Land 200,000 2
Plant and machinery 100,000 90,000 3
Receivables
Trade receivables 73,000 4
Interest receivable 1,000
Payables
Fine 10,000
Interest payable 3,300
Note 1
This asset cost the company $70,000 at the start of the year. It is being depreciated on a 10% straight line basis for accounting purposes. The company’s tax advisers have said that the company can claim $42,000 as a taxable expense in this years tax computation.
Note 2
The land has been revalued during the year in accordance with IAS 16. It originally cost $150,000. Land is not subject to depreciation under IFRS nor under local tax rules.
Note 3
The balances in respect of plant and machinery are after providing for accounting depreciation of $12,000 and tax allowable depreciation of $10,000 respectively.
Note 4
The trade receivables balance in the accounts is made up of the following amounts
$
Balances 80,000
Doubtful debt allowance (7,000)
______ 73,000 ______
Note 5
The balance on the deferred taxation account on 1 January 2007 was $3,600.
Note 6
The applicable tax rate is 30%.
Required:
1. Identify the tax base of each item listed and then identify the temporary difference.
Solution
Carrying
value base Tax Temporary difference
Non current assets $ $
Assets subject to investment relief Land
Plant and machinery
Receivables:
Trade receivables Interest receivable
Payables
Fine
Interest payable
Temporary
differences Deferred tax @ 30% Deferred tax liabilities
Deferred tax assets
Deferred tax @
30% $
Deferred tax as at 1 January 2007 3,600
To other comprehensive income Profit or loss
10 APPENDIX
10.1 Deferred taxation calculations
(a) Debits in the financial statements compared to the taxman’s view give rise to deferred
tax credits.
Credits in the financial statements compared to the taxman’s view give rise to deferred
tax debits.
(b) Full provision accounting is easy!
DT = TAX RATE × TEMPORARY DIFFERENCE = DEFERRED TAX ASSET/LIABILITY (c) Steps
Step 1: Summarise the accounting carrying amounts and the tax base for every asset and liability.
Step 2: Calculate the temporary difference by deducting the tax base from the carrying amount – see proforma below.
Asset/Liability Carrying Tax Temporary Amount Base Difference
$ $ $
Step 3: Calculate the deferred tax liability and asset. To calculate the deferred tax liabilities we sum all positive temporary differences and apply the tax rate. To calculate the deferred tax asset we sum all negative temporary
differences and apply the tax rate.
Step 4: Calculate the net deferred tax liability or asset by summing the two amounts in Step 3. THIS WILL BE THE ASSET OR LIABILITY CARRIED IN THE STATEMENT OF FINANCIAL POSITION.
Step 5: Deduct the opening deferred tax liability or asset. THE DIFFERENCE WILL BE THIS YEARS CHARGE/CREDIT TO PROFIT OR LOSS/OTHER COMPREHENSIVE INCOME/DIRECT TO EQUITY.
(d) Where there has been a change in the tax rate it is necessary to calculate the effect of this change on the opening deferred tax provision. Follow steps 1 to 5 above, calculating the required closing deferred tax liability or asset and the charge/credit to the relevant statement. The charge/credit is then analysed into the amount that relates to the change in the tax rate and the amount that relates to the temporary differences.
FOCUS
You should now be able to:
¾
account for current taxation in accordance with relevant accounting standards;¾
record entries relating to income tax in the accounting records;¾
explain the effect of both taxable and deductible temporary differences on accounting and taxable profits;EXAMPLE SOLUTIONS
Solution 1 — Year 1
Accounts Profit or loss extracts
Income tax payable
$
$ $ PBT 100,000
C/d 40,000 PorL 40,000 Tax (40,000)
______ ______ ______
40,000 40,000 PAT 60,000
______ ______ ______
Solution 2 — Year 2
Accounts Profit or loss extracts
Income tax payable
$ $
$ $ PBT 105,000
Cash 43,000 B/d 40,000 Tax
PorL 3,000 – current year 44,000
underprovn – underprovn 3,000 (47,000)
______ ______ ______ ______
43,000 43,000 PAT 58,000
______ ______ ______
Income tax payable
$ $
C/d 44,000 PorL 44,000
Solution 3
$ $
Journal for debenture interest
Dr P&L (interest) 100,000
Cr Bank 76,000
Cr Tax authority 24,000
Journal for royalties
Dr Bank 45,600
Dr Tax authority 14,400
Cr P&L (other operating income) 60,000
¾
Tax authority
$ $
Royalties 14,400 Debenture Interest 24,000
Bal c/d 9,600
______ ______
24,000 24,000
______ ______
Solution 4
Carrying
value base Tax Temporary difference
Non current assets $ $
Plant and
machinery 200,000 175,000 25,000
Receivables:
Trade receivables 50,000 55,000 (5,000)
Interest receivable 1,000 − 1,000
Payables
Fine 10,000 10,000 −
Interest payable 2,000 − (2,000)
Temporary
differences Deferred tax @ 30%
Deferred tax liabilities 26,000 7,800
Deferred tax assets (7,000) (2,100)
Deferred tax @ 30%
$
Deferred tax as at 1 January 2007 1,200
Profit or loss (balancing figure) 4,500
Deferred tax as at 31 December 2007 5,700
Solution 5
Carryingvalue Tax base Temporary difference
$ $
1,250 650 600
Deferred tax at 30% 180
Solution 6
Deferredtax @ 30% $ Deferred tax as at 1 January 2007 (1,000 − 800) × 30% 60 To other comprehensive income 30% × (1,250 − 900) 105 Profit or loss Balancing figure (or as (150 − 100) × 30%) 15
Deferred tax as at 31 December 2007 180
Solution 7
Carrying
value base Tax Temporary difference
Non current assets $ $
Assets subject to investment relief 63,000 28,000 35,000
Land 200,000 150,000 50,000
Plant and machinery 100,000 90,000 10,000
Receivables:
Trade receivables 73,000 80,000 (7,000)
Interest receivable 1,000 − 1,000
Payables
Fine (10,000) (10,000) −
Interest payable (3,300) − (3,300)
Temporary
differences Deferred tax @ 30%
Deferred tax liabilities 96,000 28,800
Deferred tax assets (10,300) (3,090)
25,710
Deferred tax @
30% $
Deferred tax as at 1 January 2007 3,600
To other comprehensive income 30% × 50,000 15,000
Profit or loss Balancing figure 7,110
