TOPIC 8 - IAS 12 Income TaxesIAS 12 – Income Taxes IAS 16 – Property, Plant and Equipment Per...

CPA P2 Advanced Corporate Reporting

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TOPIC 8 - IAS 12 Income Taxes

IAS 12 prescribes the accounting treatment for income taxes.

What is Current Tax? Current Tax is the amount of income taxes payable in respect of the taxable profit for

a period.

Income Taxes Payable – recognised as a provision (Dr Statement of Profit or Loss

(Tax Charge); Cr Tax Payable (Current Liability))

Difference Between Current Tax Charge in Statement of Profit or Loss & Tax

Liability in Statement of Financial Position

Example

Entity X – Taxable Profits - $300,000; Tax Rate – 30%

Current Tax Charge – $90,000 – DR Statement of Profit or Loss (Tax Expense); CR

Current Tax Payable (Liability)

However, if the entity has already paid some of the tax for the financial period, the

current tax liability (SOFP) will be less than the total current tax (IS) for the year

Tax Under Provided or Over Provided

The tax charge on profits for the year recognised in profit or loss is an estimate. The

actual tax charge is not agreed with the tax authorities until after the financial

statements have been issued.

Actual Tax < Tax Expense in Statement of Profit or Loss = Over Provision Tax

Charge in the following Year is reduced (CR Statement of Profit or Loss; Dr Tax in

the SOFP)


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Actual Tax > Tax Expense in the Statement of Profit or Loss = Under Provision

Tax charge in the following year is increased (DR Statement of Profit or Loss; CR

Tax in the SOFP)

DEFERRED TAX

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.

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. In the case of

revenue which is received in advance, the tax base of the resulting liability is its

carrying amount, less any amount of the revenue that will not be taxable in future

periods.

Taxable Profits can differ from accounting profits due to

1. Permanent differences

2. Temporary differences

Permanent Differences – E.g. Company reports profit of $100,000 after charging

client entertainment expenses of $20,000. But taxable profit will be $120,000 as

Accounting Base of An Asset/Liability

V.s.

Tax Base of an Asset/liability


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client entertainment expenses are disallowed. Permanent differences are therefore

ignored for accounting purposes.

Temporary differences occur when an item of expense (or income) is included in the

accounting profits for one financial year and is included in the taxable profits for a

different financial year. – e.g. Depreciation & capital allowances; interest income

receivable (i.e. where interest is not taxed until received, then the accrued income is

recorded in the FS, but tax will be paid at some point in the future hence a deferred

tax liability), development costs capitalised – Temporary differences produce

differences between accounting profits which are only temporary, over a period of

time these differences will cancel each other out.

The deferred tax charge for the year can be calculated by applying the tax rate to

changes in the total of the temporary timing differences

An increase in the deferred tax liability during the year adds to the total tax charge

and a reduction in the deferred tax liability reduces the total tax charge

DEFERRED TAX ASSET

Deferred Tax – Usually a liability

Occasionally a deferred tax asset may arise

Deferred tax assets should only be recognised if the company expects that future

profits will be sufficient to recover the deferred tax

No offsetting between deferred tax asset and deferred tax liability except in limited

circumstances if the following apply

1. The entity has a legally enforceable right to set off the recognised amounts

2. The entity intends either to settle on a net basis, or to realise the asset and

settle the liability simultaneously

– Remember - deferred tax asset/liability – classified as a non current

assets/liabilities only

Taxable Temporary Differences – Deferred Tax Liability

Deductible Temporary Differences – Deferred Tax Asset


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Accrued Pension Costs which are allowed as a taxable deduction only when paid , is a

deferred tax asset because, this expense will be claimed as a deductible expense for

tax at some stage in the future

DEFERRED TAX AND ASSET REVALUATION

On revaluation of an asset, unrealised gain is Credited to Revaluation reserve

The Unrealised gain should be net of deferred tax ( ONLY where you are instructed to

do so in a question!!!)

Net unrealised gain should be reported as “other comprehensive income”

DEFERRED TAX AND ASSET REVALUATION

Example – A company revalues an asset from $8m to $10m – tax rate – 30%

– Dr Asset Cost 2,000,000

– Cr Revaluation Reserve 1,400,000

– Cr Deferred Tax Liability 600,000

– Report the gain as “other comprehensive income” as $1.4m

Further examples of taxable temporary differences

Transactions that affect profit or loss

1 Interest revenue is received in arrears and is included in accounting profit on a time

apportionment basis but is included in taxable profit on a cash basis.

2 Revenue from the sale of goods is included in accounting profit when goods are delivered

but is included in taxable profit when cash is collected. (note: as explained in B3 below,

there is also a deductible temporary difference associated with any related inventory).

3 Depreciation of an asset is accelerated for tax purposes.

4 Development costs have been capitalised and will be amortised to the statement of

comprehensive income but were deducted in determining taxable profit in the period in

which they were incurred.

5 Prepaid expenses have already been deducted on a cash basis in determining the taxable

profit of the current or previous periods.


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Transactions that affect the statement of financial position

6 Depreciation of an asset is not deductible for tax purposes and no deduction will be

available for tax purposes when the asset is sold or scrapped. (note: paragraph 15(b)of

the Standard prohibits recognition of the resulting deferred tax liability unless the asset

was acquired in a business combination, see also paragraph 22 of the Standard).

7 A borrower records a loan at the proceeds received (which equal the amount due at

maturity), less transaction costs. Subsequently, the carrying amount of the loan is

increased by amortisation of the transaction costs to accounting profit. The transaction

costs were deducted for tax purposes in the period when the loan was first

recognised. (notes: (1) the taxable temporary difference is the amount of transaction

costs already deducted in determining the taxable profit of current or prior periods, less

the cumulative amount amortised to accounting profit; and (2) as the initial recognition

of the loan affects taxable profit, the exception in paragraph 15(b) of the Standard does

not apply. Therefore, the borrower recognises the deferred tax liability).

8 A loan payable was measured on initial recognition at the amount of the net proceeds,

net of transaction costs. The transaction costs are amortised to accounting profit over the

life of the loan. Those transaction costs are not deductible in determining the taxable

profit of future, current or prior periods. (notes: (1) the taxable temporary difference is

the amount of unamortised transaction costs; and (2) paragraph 15(b) of the Standard

prohibits recognition of the resulting deferred tax liability).

9 The liability component of a compound financial instrument (for example a convertible

bond) is measured at a discount to the amount repayable on maturity (see IAS

32Financial Instruments: Presentation). The discount is not deductible in determining

taxable profit (tax loss).

Fair value adjustments and revaluations

10 Financial assets or investment property are carried at fair value which exceeds cost but

no equivalent adjustment is made for tax purposes.

11 An entity revalues property, plant and equipment (under the revaluation model

treatment in IAS 16 Property, Plant and Equipment) but no equivalent adjustment is

made for tax purposes. (note: paragraph 61A of the Standard requires the related

deferred tax to be recognised in other comprehensive income).

http://www.charteredaccountants.ie/chariotindex/text/ias12/8.html#ias12_pr15




http://www.charteredaccountants.ie/chariotindex/text/ias12/22.html#ias12_pr61a


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TAX IN THE STATEMENT OF PROFIT OR LOSS – 3 COMPONENTS

1. Tax on Current Year Profits (Estimate)

2. Plus Under Provision or Minus Over Provision of tax in the Previous Year

3. Plus /minus deferred tax differences

Deferred Tax and Non Current Asset Revaluations

IAS 12 – Income Taxes

IAS 16 – Property, Plant and Equipment

Per IAS 12, when an asset is revalued to fair value, a difference then arises between

(a) The Carrying Amount of the Asset (i.e. its fair value)

AND

(b) The TWDV of the asset

It is this difference that gives rise to a deferred tax liability/asset on revaluation.

When an asset is revalued upwards, the carrying amount of the asset increases and is greater

than the TWDV of the Asset and hence gives rise to deferred tax liability.

The Unrealised gain taken to Revaluation Reserve should be net of deferred tax (wherever

such information is provided).

Exam Note: The examiner will instruct as to whether or not the gain/loss taken to revaluation

reserve should be net of deferred tax

When an asset like Land ( which is not depreciated) is revalued upwards, the value of the

revalued asset will be recovered by generating future economic benefits (i.e. taxable

income) through use – Therefore even if the asset is not planned to be sold, the gain on

revaluation will lead a deferred tax liability based on the future economic benefits (i.e.

taxable income) which will arise through use which will be subject to tax at some stage in

the future


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Example

Deft ltd has the following accounting profits after charging depreciation

Statement

of Profit or

Loss

Year 1 Year 2 Year 3 Year 4

Accounting

Profit

300 400 500 600

Deft ltd bought a machine at the start of year 1 for 200 and charges depreciation of 50 each

year

For tax purposes capital allowances are given at 50% in year 1 and 50% in year 2. Assume a

tax rate of 30%.

Tax Computation


Accounting

Profit

300 400 500 600

Addback :

Depreciation

50 50 50 50

Less: Captial

Allowances

100 100

Taxable Profit 250 350 550 650

Tax Payable @

30%

75 105 165 195

The accounting profits and taxable profits are different, the reason for this is that depreciation

and capital allowances are calculated differently

Calculate Deferred Tax Provision

Compare the carrying amount of asset in statement of financial position with its

corresponding TWDV and then multiply the resultant difference by the tax rate. This

approach gives the deferred tax provision balance at the end of the year; to compute the

deferred tax charge or credit for the year it is necessary to compare the opening and closing

deferred tax provision.


Carrying

Amount

150 100 50 0

TWDV 100 0 0 0

Cumulative

Timing

Differences

50 100 50 0

Deferred Tax

Provision (30%

Income Tax

Rate)

15 30 15 0

Deferred Tax

Charge/Credit

15 Charge 15 Charge 15 Credit 15 Credit


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Example

Example – Revaluation of Tangible Non Current Assets

Tangible non current assets with a carrying amount of 100 are revalued upwards to 190. The

TWDV of the assets are 60. The tax rate is 30%

Deferred Tax Provision

Carrying

Amount

TWDV Cumulative

Timing

Difference

Income

Tax Rate –

Deferred

Tax

Provision

At Year

End -

Without

Revaluation

100 60 40 30% 12

AT Year

End – With

Revaluation

190 60 130 30% 39

Increase in

Provision

27

An unrealised gain of 90 arises on revaluation of the asset, however if deferred tax is

accounted for, the net unrealised gain will be 63, with a credit to deferred tax provision of 27

Dr Non Current Asset 90

Cr Deferred Tax Provision 27

Cr Revaluation Reserve 63


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The Unrealised gain taken to Revaluation Reserve should be net of deferred tax (wherever

such information is provided).

Exam Note: The examiner will instruct as to whether or not the gain/loss taken to revaluation

reserve should be net of deferred tax

Example -Impairment Loss

Tangible non current asset with a carrying amount of 100 and a TWDV of 60 is impaired by

20. The tax rate is 30%

Carrying

Amount

TWDV Cumulative

Timing

Difference

Income Tax

Rate

Deferred Tax

Provision

At Year End

– Without

Impairment

100 60 40 30% 12

At Year End

– With

Impairment

80 60 20 30% 6

Cr Tangible Non Current Asset 20

Dr Statement of Profit or Loss 20

Dr Deferred Tax Provision 6

Cr Income Tax (Inc. Statement) 6

Assuming no revaluation reserve existed for the impaired asset

Example - Development Expenditure

If development costs are capitalised in the SOFP, this situation can give rise to deferred tax

implications

Assume a company has capitalised €200,000 of development expenditure in its SOFP. The

tax rate is 30%

The tax treatment is to deduct the expenditure incurred in arriving at the taxable profit thus

giving rise to a timing difference of 200,000. The timing difference of €200,000 is multiplied

by the tax rate of 30% to give a deferred tax provision of €60,000.

In the next year €50,000 of the development expenditure deferred is amortised to profit or

loss. In this year there is a reversing timing which results in a reduction in the deferred tax

provision of €50,000 multiplied by 30% which amounts to €15,000.


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Losses

Losses in so far as they will reduce future taxable profits have deferred tax implications

Year 1 Year 2

Profit/(Loss) Before

Tax

(200,000) 500,000

Income Tax (90,000)

Deferred Tax 60,000 (60,000)

Profit/(Loss) After

Tax

(140,000) 350,000

Tax Computation

Without Loss 500,000 * 30% =

150,000

With Loss (500,000 – 200,000)

* 30% = 90,000

The loss in Year 1 gives rise to a reduction in the tax payable by €200,000 multiplied by 30%

which amounts to €60,000. In this case a deferred tax asset of €60,000 arises. The key

assumption here is that there will be future profits to utilise this loss against.


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Tutorial Question: Based on P2 ACR Q1 April 2010 Note 10

Greenville - Accounts for the Year Ended 31 December 2009

The taxation rate applicable for all taxes is 25%. The figure shown for taxation in Greenville

draft trial balance as at 31 December 2009 is €1,200,000 in the Credit Column.

This figure represents the balance on the deferred tax account as at 31 December 2008.

A figure of €1,800,000 should be provided in the company's financial statements for the year

ended 31 December 2009 in respect of taxation.

This figure takes account of all items, including adjustments, with the exception of the

following:

1) Greenville was fortunate to be able to generate large cash surpluses at certain times

during 2009 which it was able to put on deposit.

Interest receivable at 31st December 2009 included in other receivables amounts to

€1,200,000. Interest is taxed on a receipts basis.

2) The net book value of plant & equipment at 31st December 2009 after providing for

depreciation is €4,032,000. The tax written down value is €1,032,000

3) Other payables at 31st December 2009 include an accrual for pension contributions of

€1,400,000. Pension costs are deductible for tax purposes when paid.


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Past Exam

Questions – P1 –

IAS 12

Past Exam

Questions – P2 –

IAS 12

Q3 (3) April 15 Q1 April 2010 Note

10

Q2 Aug 13 Q1 Apr 09 Note 12

Q3 Aug 12

Q3 April 2012

Q2,Q3 April 2011

Q2 Apr 2010

IAS 12 – Income Taxes – Homework Question

The deferred tax balance at 31 December 2012 is an asset of €1,100,000. The adjustments for

2012 have not yet been considered. All temporary differences are to be taxed at 12.5% in

2012.

At 31 December 2012, the following were relevant:

1) The tax written down value of the group’s non current assets exceeded its book value by

€2.8 million. This difference is due entirely to the different rates of depreciation and capital

allowances on the company’s tangible assets

2) At 31 December 2012 the defined benefit pension obligation was €1.006 million. The

equivalent tax base was €300,000. You may assume that, for tax purposes, the pension

expense is allowed only when it is paid.

3) Included in “trade and other payables” is an accrual for interest charges. The accrual

relates to interest on a €10 million 5% bank loan that was issued on 1 January 2012. Interest

is charged semi annually on the loan and is paid , in arrears, in August and February of each

year. A payment for the first 6 months of the year was duly made on 1st August 2012. The

capital sum is due to be repaid in one lump sum in 2019.

4) One of the group’s 100% subsidiaries, OMIY Ltd, made a tax adjusted loss of €2.54

million during the year. The only relief for this tax loss is to carry forward for offset against

future taxable profits of the company. OMIY Ltd is expected to be profitable in future years.

5) The remaining temporary taxable timing differences affecting the statement of

comprehensive income in 2012 amount to €2,970,000

Required: The deferred tax impact of the above 5 items represent the closing balance for

deferred tax at 31.12.12. Prepare workings for each item and the overall adjustment required

for deferred tax at 31.12.12

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