02-ias 12 income taxes

8/22/2019 02-IAS 12 Income Taxes

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C-6 Financial Accounting

IAS 12 Income Taxes

A Study For Success Scheme 2009-2010Islamabad College of Accounts and Finance

Sajid Shafiq, ACA


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Overview Objectives, Scope and Definitions

Current Tax

Deferred Tax- Introduction

Deferred Tax- Recognition and measurement

Carrying amount versus tax base Temporary differences

Determining deferred tax

Further issues

Presentation and Disclosures- Current and deferred tax

Class Practice Questions

Exam Type Questions

4-Jan-14 02- IAS 12 Income Taxes 2


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Objectives, Scope and Definitions


Objectives

IAS 12 considers both the treatment of

the current tax charge and liability

(current taxes) and deferred tax, which is

a means of accounting for the difference

between the effects of the tax and

accounting treatments of transactions.

Scope

The term income taxes is wide and covers all

domestic and foreign taxes which are based

on an entitys taxable profits.

IAS 12 concerns two different taxation issues

Current tax and Deferred tax.Whereas the

current tax is a statutory issue, the deferred

tax is entirely a financial reporting concept.

Definitions

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.

Current tax is the amount of income taxes payable (recoverable) in respect of the

taxable profit (tax loss) for a period.


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Objectives, Scope and Definitions


Definitions

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 carryforward of unused tax losses; and

c) the carryforward of unused tax credits.

Temporary differences are 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: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

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.

The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.


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Curren

tTax

IAS 12 does not set out how current tax should be calculated as it is governed by tax laws.

However, IAS 12 requires a tax liability to be recognised where an entity has unpaid current

tax, whether arising from the current or prior periods. Conversely, if an entity has overpaid

its tax liability then it should recognise a tax asset for the amount recoverable.

If it is possible for an entity that has made a loss in its current period to recover tax paid in

previous periods by carrying the loss back, an asset should be recognised in the period inwhich the loss is made. This is not applicable in Pakistan tax environment.

The tax rate to be used in determining a current tax asset or liability is the rate that is

expected to apply when the asset is expected to be recovered, or the liability to be paid.

These rates should be based upon tax laws that have already been enacted (are already

part of law) or substantively enacted (have already passed through part of the legal

process) by the end of the reporting period. Any change in tax rates subsequent to year end

is, therefore, regarded as a non-adjusting event. (IAS 10.22(h))


Normal Calculation Mechanics

Accounting Profit XXX

Add:

Accounting Depreciation xxx

Provision for expenses xxx

In admissible expenses xxx

Less:

Tax depreciation (xxx)

Provisions settled during the year (xxx)

Exempt income (xxx)

Taxable Profit XXX

@ Tax Rate = Current Tax expense XXX


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Current TaxIllustration 1

An extract from financial records of Green Limited for its first year is given below:

Rs 000

Building-Cost 35,000

Other Fixed Assets-Cost 22,000

Product research cost 15,000

Product development cost 12,000

Profit before tax 10,000

i. Depreciation is charged on buildings and other fixed assets at the rate of 15%. The rate of tax

depreciation is 30%.

ii. Half of the research and development costs are allowable for tax purposes in the first year.

The balance amount shall be permanently disallowed.

iii. The company amortizes intangible assets over a period of three years. Current year

amortization has already been accounted for.iv. The companys profit is subject to tax at the rate of 35%.

v. Interest of Rs. 1.25 million was paid on a short term loan received from directors, which is

not an allowable expense under the tax laws.

vi. Profit includes a tax exempt gain of Rs 2 million on sale of shares of a listed company.

Required: Prepare journal entry for current taxation



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Current Tax


Illustration 1 Rs 000

Profit Before Taxation (a) 10,000Add:

Accounting Depreciation- Building 5,250

Accounting Depreciation- Other Fixed Assets 3,300

Research Cost 15,000

Amortization of Development cost 4,000

Interest on loan from director 1,250(b) 28,800

Less:

Tax Depreciation- Building (10,500)

Tax Depreciation- Other Fixed Assets (6,600)

Research Cost (half) (7,500)Development Cost (half) (6,000)

Capital gain (2,000)

(c) (32,600)

Taxable Income sum (a ,b, c) 6,200

@ 35% 2,170


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Deferred Tax- Introduction The current tax liability of an entity is based on both the accounting treatment for

transactions and on a number of specific requirements set out in local taxlegislation. As a result it may not be possible to calculate the tax charge for areporting period by reference to an entitys accounting profit or loss reported forthat period.

Differences may arise because the tax liability occurs in a period different to that inwhich the underlying transaction is reported. To ensure that the financialstatements are internally consistent, an adjustment may be required to the currenttax expense, so that the total tax charge is based on an entitys financial reportingprofit for the period. This adjustment is referred to as deferred tax.

It is important to appreciate that deferred tax does not alter the tax to be paid,only the means by which it is reflected in the financial statements.

IAS 12 requires that deferred tax is calculated using what is commonly referred toas the balance sheet liability method. This method is based on an assessment oftemporary differences.

A temporary difference is the difference between the carrying amount of an asset

or liability in the statement of financial position and the amount of that item fortax purposes, which is called its tax base.

The concept of deferred tax is best described through the use of a simple example.



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Deferred Tax- IntroductionIllustration 2

An entity acquires a new computer for CU1,200 in the year. The entity depreciates computer

equipment over 3 years in accordance with IAS 16. Local government provides a tax incentive to

businesses for investments in new computer equipment and therefore the full cost of the

equipment is allowable for tax purposes in the year that it is purchased.

At the end of the year, the computer equipment has the following carrying amount and tax base:

Balance sheet carrying amount:

CU1,200 less depreciation of (CU1,200 x 1/3) CU400 = CU800Tax base:

CU1,200 less amount deductible for tax purposes of CU1,200 = nil

A temporary difference arises of CU800, being the difference between the carrying amount in the

balance sheet and the value for tax purposes.

The temporary difference reflects the fact that the entity has reduced its actual tax liability by

CU1,200 multiplied by the tax rate although only CU400 is shown an expense in profit or loss for

the period. This means that the current tax expense is less than what a user would expect to see

based on the results reported in the entitys statement of comprehensive income.



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Deferred Tax- Introduction

The reason that an entity is required to recognisedeferred tax is because:

A deferred tax liability will ultimately translate itselfinto an actual liability by, for example, resulting in alarger tax liability in future periods;

The matching of items recognised in an entitysfinancial statements is consistent with therequirements of IAS 1 on the preparation of an entitysfinancial statements; and

Ignoring deferred tax may lead to the reported profit ina period being misinterpreted. This is explained indetail in next Illustration.



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Illustration 3 Deferred Tax- Introduction


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Deferred Tax- Recognition and Measurement


Deferred Tax Liability

An entity is required to recognise a deferredtax liability where it has identified a taxabletemporary difference between an assets orliabilitys carrying amount for accountingpurposes and its value for tax purposes.

A deferred tax liability arises where thecarrying amount of an asset (liability) for

accounting purposes is greater (less) thanits tax value.

There are two exceptions to thisrequirement to recognise a deferred taxliability:

ofirstly, where it arises from the initialrecognition of goodwill (i.e. the excess

paid for a business above the value of itsnet assets) and

osecondly, where the initial recognition ofan item, that is not part of a businesscombination, does not affect accountingor tax profit.

Deferred Tax Asset

An entity recognises a deferred tax asset as aresult of a deductible temporary differencearising on the assessment of an assets orliabilitys value for accounting and tax purposes.

A potential deferred tax asset arises where thecarrying amount of an asset (liability) foraccounting purposes is less (greater) than its tax

value.As with a deferred tax liability, an entity should

not recognise a deferred tax asset where itarises from a transaction that is neither abusiness combination nor affects accounting ortax profit at the time of recognition.

A deferred tax asset can also be recognised in

respect of C/f of tax losses and unused taxcredits.

For a deferred tax asset to be recognised theentity should assess its recoverability as beingprobable.


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Carrying amount versus tax base

An entity should determine an assets or liabilitys carrying amount in its SFP and its value for tax

purposes, i.e. its tax base. Where there is a difference between the two amounts the entity may

need to recognise a deferred tax asset or liability.

The tax base of an asset is the amount that will be deductible for tax purposes against future profits

generated by the asset.

Illustration 4

An entity has an asset in its SFP representing interest receivable of CU500. Although the interest will

not be received until after the end of the reporting period, it has been earned in the current period

and therefore has been recorded as income. Thecarrying amount of the asset at the end of the

reporting period date is therefore CU500.

The interest will be chargeable to tax when the cash is received, i.e. in the following period.

The interest asset has no value for tax purposes in the current period, so its tax base is nil.

The tax base of a liability is its carrying amount less any amount that will be deductible for tax

purposes in future periods.

Illustration 5An entity has recognised a current liability for expenses that it has incurred but not yet paid at the

end of its reporting period of CU1,000. The expenses will be fully allowable for tax purposes when

they are paid in the following period.

The carrying amount of the liability at the end of the reporting period is therefore CU1,000.

The tax base is nil, being the carrying amount of CU1,000 less the amount that will be deductible for

tax purposes in future periods i.e. CU1,000.


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Tax Base of Asset

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, eitheras 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.

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.

3. Trade receivables have a carrying amount of 100. The related revenue has already beenincluded in taxable profit (tax loss). The tax base of the trade receivables is 100.

4. Dividends receivable from a subsidiary have a carrying amount of 100. The dividends are not

taxable. In substance, the entire carrying amount of the asset is deductible against the

economic benefits. Consequently, the tax base of the dividends receivable is 100.(a)

5. A loan receivable has a carrying amount of 100. The repayment of the loan will have no tax

consequences. The tax base of the loan is 100.

a) Under this analysis, there is no taxable temporary difference. An alternative analysis is that the

accrued dividends receivable have a tax base of nil and that a tax rate of nil is applied to the

resulting taxable temporary difference of 100. Under both analyses, there is no deferred tax

liability.



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Tax Base of Liability

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.

2. Current liabilities include interest revenue received in advance, with a carrying amount of 100.

The related interest revenue was taxed on a cash basis. The tax base of the interest received in

advance is nil.

3. Current liabilities include accrued expenses with a carrying amount of 100. The related expense

has already been deducted for tax purposes. The tax base of the accrued expenses is 100.

4. Current liabilities include accrued fines and penalties with a carrying amount of 100. Fines andpenalties are not deductible for tax purposes. The tax base of the accrued fines and penalties is

100.(a)

5. A loan payable has a carrying amount of 100. The repayment of the loan will have no tax

consequences. The tax base of the loan is 100.

a)Under this analysis, there is no deductible temporary difference. An alternative analysis is thatthe accrued fines and penalties payable have a tax base of nil and that a tax rate of nil is applied

to the resulting deductible temporary difference of 100. Under both analyses, there is no

deferred tax asset.



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Temporary difference

Temporary differences are 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 temporary differences, which result in taxable amounts arising in future accounting

periods, as the carrying amount of the asset or liability is recovered or settled, or

deductible temporary differences, which result in amounts that are deductible in future

periods as the carrying amount of the asset or liability is recovered or settled.

Illustration 6

The temporary differences in illustrations 4 and 5 are:

Illustration 4: Carrying amount of the interest receivable is CU500 less its tax base of nil

temporary difference is CU500.

Illustration 5: Carrying amount of the liability is CU1,000 less its tax base of niltemporary

difference is CU1,000.

The temporary differences in Illustration 4 is a taxable temporary difference and in Illustration

5 is a deductible temporary difference.



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DeferredTax-Recognitio

nandMeasurement

Determining deferred tax

A deferred tax asset or liability is calculated by multiplying the temporary difference by the relevant tax rate.

The tax rate to be used in the calculation for determining a deferred tax asset or liability is the rate that is

expected to apply when the asset is realised, or the liability is settled. These rates should be based on tax

laws that have already been enacted or substantively enacted by the end of the reporting period.


Illustration 7

An entity operates in Muldovia, and enters into a long-

term contract to build a motorway. During the year ended

31 December 2007, the entity recognises CU4million of

income on this contract in profit or loss for the period,

cash is expected to be received in 2009. Under the tax

rules of Muldovia tax is charged on a cash receipts basis.

The tax rate for businesses in Muldovia was 30% in the

year to 31 December 2007, but the government has voted

in favour of a reduction to 29% for 2008. There is currently

a rumour that the rate will drop to 28% in 2009, but no

announcement has been made.

The rate of tax that should be used to determine the

deferred tax balance is 29%. This is the rate is that

expected to apply when the asset is realised. The rate of

30% in 2007, when the temporary difference originated, is

not relevant. The 28% would be used if it had been

enacted, but currently it is only under discussion. The best

estimate of the rate applying in 2009, based upon laws

already enacted or substantively enacted, is the rate for

2008 of 29%.

Illustration 8

A machine cost CU50,000. For tax purposes,

allowances of CU30,000 have already been

deducted in the current and previous periods

with the remaining CU20,000 deductible in future

periods. The carrying amount of the machine for

accounting purposes is CU35,000.

The tax rate is currently 30% and is not expected

to change in the foreseeable future.

The tax base of the machine is CU20,000

(CU50,000 less CU30,000).

There is a taxable temporary difference of

CU15,000 (i.e. accounting carrying amount

CU35,000 tax base CU20,000). This generates a

deferred tax liability of CU4,500 (i.e. CU15,000 x

30%).


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DeferredTax-Recognitio

nandMea

surement



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DT Recognition and Measurement- Further IssuesRevaluations

The act of revaluing an asset will not generally result in a taxable event. However, the future recovery of theasset (through continuing use or through disposal), will lead to taxable amounts being generated by the entity.

The amount that will be deductible for tax purposes, based on cost, will differ from that for accounting

purposes, based on the revalued amount.Consequently, the difference between the CA of a revalued asset and its tax base is a temporary difference.

An upward revaluation of an asset will therefore give rise to a deferred tax liability.

Most transactions creating TD relate to transactions recognised in PL, so the related deferred tax is alsorecognised in PL. However, where the underlying transaction, such as a revaluation, is recognised in OCI, thedeferred tax impact is also recognised in OCI.

The expected manner of recovery of an asset orsettlement of liability

The measurement of deferred tax liabilities (and assets)should reflect the tax consequences of how an entityintends to settle (and recover) the carrying amount of itsliabilities (or assets).

For example, different tax rates may apply, dependingon whether the entity intends to use an asset togenerate future benefits for the entity on an ongoingbasis or to sell it. The DT amount will therefore becalculated using the tax rate relevant to the entitys

expected use.

Annual review

The carrying amount of a deferred tax asset shouldbe reviewed at the end of each reporting period toensure that it continues to be probable that it willbe recovered against future taxable profits.

If it is no longer probable that sufficient taxableprofit will be available to utilise the benefit of the

deferred tax asset, then its carrying amount shouldbe written down accordingly. If sufficient profitslater become available, then the amount writtendown should be reversed.

Discounting

IAS 12 does not permit deferred tax assets and liabilities to be discounted


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Presentationa

nd

Disclosures-

Currentandde

ferred

tax

1. Current and deferred tax movements should be recognised directly in the PL for the period, except where

the tax arises from: [IAS 12.58]

a transaction that is accounted for directly in OCI (such as a revaluation); or

a business combination. ( in that case it adjusts the value of goodwill)

2. The tax expense or income in respect of the PL should be presented in the SCI.

3. The main components of the tax expense, or income, should be disclosed separately in the FS. The main

components of the tax expense or income may include, for example:

i. current tax expense (income);

ii. adjustments recognised in the period for current tax of prior periods;

iii. deferred tax expense (income) relating to temporary differences;

iv. an adjustment to the deferred tax expense (income) relating to changes in tax rates; and

4. Further disclosures requirements include: [IAS 12.81]

i. the amount of income tax relating to each component of OCI;ii. a reconciliation of the tax expense (income) to the amount calculated as the accounting profit multiplied

by the tax rate. (or with percentages);

iii. the amount of any potential deferred tax asset which has not been recognised because of uncertainties

over its recoverability;

5. Deferred tax assets and liabilities should not be disclosed as part of current assets and liabilities.

Offsetting

A CT asset and a CT liability should only be offset by an entity where it has a legally enforceable right to set off

the amounts and it intends to settle them on a net basis or to be settled simultaneously. [IAS 12.71]

DT assets and liabilities should similarly only be offset where the entity has a legally enforceable right to set off

CT assets against CT liabilities and the DT assets and liabilities have arisen on income taxes levied by the same

taxation authority. In addition, the amounts should be in relation to the same taxable entity or, where they

have arisen in respect of different taxable entities, there should be the right to settle the amounts on a net

basis or simultaneously. [IAS 12.74]



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Comprehensive IllustrationXYZ Limited submits following details to you for calculation of Current and Deferred Tax.

Accounting Profit before Tax 4,000,000

The profit has been calculated after incorporating following items

Accounting Depreciation for the year 1,000,000

Accumulated Accounting Depreciation at year end 2,000,000

Provision for warranty expenses 800,000

Following information is relevant for tax law purposes

Tax Depreciation 2,000,000

Accumulated Tax Depreciation at year end 4,000,000

Inadmissible expenses 900,000

Exempt income 200,000

Warranty cost is deductible only on paid basis

Other Information

The company first time created provision for warranty expense out of which no payment is made as yet.

The applicable tax rate for current year is 40% and was 30% last year.

The only depreciable asset of the company was acquired at a cost of Rs 5,000,000

214-Jan-14 02- IAS 12 Income Taxes


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Current Tax Calculation--Accounting Profit Before

Tax

4,000,000

Add:

Less:

Taxable Income

Current Tax @ 40%


Comprehensive Illustration


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Deferred Tax CalculationYear End Balances

Description Carrying

Amount

Tax Base Temporary

Difference

Type

Depreciable Asset 3,000,000

Provision forwarranty expense

800,000

Net Temporary Difference

Deferred Tax @ 40%

Opening Deferred Tax

1,000,000 @ 30% 300,000 Liability

Deferred Tax expense for the year




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Analysis of Deferred Tax Expense for the year

EFFECT OF CHANGE IN RATES Rs.

Opening Temporary Difference 1,000,000

X X

Change in Tax Rate (40% -30%)=10% 100,000

EFFECT OF CHANGE IN TEMPORARY DIFFERENCE

Closing Tax Rate 40%

X x

Change in Temporary Differences

Deferred Tax Expense for the year




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Reconciliation of Expected and Actual Tax ExpenseExpected Tax Expense 1,600,000

-- Accounting PBT x Tax Rate

In admissible expenseseffect

Exempt income effect

Effect of change in tax rate

Actual Tax Expense

(Current + Deferred Tax)




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Note Carrying value Tax base

$ $

Non current assets Plant and machinery 200,000 175,000

Receivables Trade receivables 50,000

Interest receivables 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 provision (5,000)

50,000

Further information:1. The deferred tax balance as at 1 January 2004 was $ 1,200.

2. Interest is taxed on a cash basis.

3. Provisions 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: Calculate the deferred tax provision which is required at 31 December 2004

ClassP

ractice

Questions


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Exam Type Questions (M-08)Waqar Limited has provided you the following information for determining its tax and deferred taxexpense for the year 2006 and 2007:

i. During the year ended December 31, 2007, the companys accounting profit before tax amountedto Rs. 40 million (2006: Rs. 30 million). The profit includes capital gains amounting to Rs. 10 million(2006: Rs. 8 million) which are exempt from tax.

ii. The accounting written down values of the fixed assets, as at December 31, 2005 were as follows:

Cost Accumulated Depreciation Written down value

-------------- Rupees in millions --------------

Machinery 200 25 175

Furniture and fittings 50 10 40

No additions or disposals of fixed assets were made in the years 2006 and 2007.

iii. Machinery was acquired on January 1, 2005 and is being depreciated on straightline basis over itsestimated useful life of 8 years. The tax base of machinery as at December 31, 2005 was Rs. 90million.

iv. Furniture and fittings are also depreciated on the straight line basis at the rate of 10% per annum.The tax base of furniture and fittings as at December 31, 2005 was Rs. 40.5 million.

v. Normal rate of tax depreciation on both types of assets is 10% on written down value.vi. As on December 31, 2005, Waqar Limited had unused tax losses of Rs. 75 million.

vii. The tax rates for 2005, 2006 and 2007 were 35%, 35% and 30% respectively.

Required:

Determine the tax and deferred tax expense for the year 2006 and 2007. Ignore minimum turnover tax.



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i ( )


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Exam Type Questions (M-09)

Given below is the statement of comprehensive income of Shakir Industries for the year ended December 31, 2008:

Following information is available:i. Operating expenses include an amount of Rs. 0.7 million paid as penalty to SECP on non compliance of certain requirements of the

Companies Ordinance, 1984.

ii. During the year, the company made a provision of Rs. 2.4 million for gratuity. The actual payment on account of gratuity to outgoingmembers was Rs. 1.6 million.

iii. Lease payments mad during the year amounted to Rs. 0.65 million which include financial charges of Rs. 0.15 million. As at December

31, 2008, obligations against assets subject to finance lease stood at Rs. 1.2 million. The movement in assets held under finance lease is

as follows:

2008

Rupees in million

Sales 143.000

Cost of goods sold (96.60)

Gross profit 46.40

Operating expenses (28.70)

Operating profit 17.70

Other income 3.40

Profit before interest and tax 21.10

Financial charges (5.30)

Profit before tax 15.80

Rupees in million

Opening balance01/01/2008 2.50

Depreciation for the year (0.7)

Closing balance31/12/2008 1.8033C-6 Financial Accounting


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Exam Type Questions (M-09)



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02-ias 12 income taxes

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