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IAS 12 Income Taxes 2011

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IAS 12 Income Taxes

IFRS WORKBOOKS(1 million downloaded)

Welcome to IFRS Workbooks! These are the latest versions of the legendary workbooks in Russian and English produced by 3 TACIS projects, sponsored by the European Union (2003-2009) and led by PricewaterhouseCoopers. They have also appeared on the website of the Ministry of Finance of the Russian Federation.

The workbooks cover various concepts of IFRS based accounting. They are intended to be practical self-instruction aids that professional accountants can use to upgrade their knowledge, understanding and skills.

Each workbook is a self-standing short course designed for approximately of three hours of study. Although the workbooks are part of a series, each one is independent of the others. Each workbook is a combination of Information, Examples, Self-Test Questions and Answers. A basic knowledge of accounting is assumed, but if any additional knowledge is required this is mentioned at the beginning of the section.

Having written the first three editions, we want to update them and provide them to you to download. Please tell your friends and colleagues. Relating to the first three editions and updated texts, the copyright of the material contained in each workbook belongs to the European Union and according to its policy may be used free of charge for any non-commercial purpose. The copyright and responsibility of later books and the updates are ours. Our copyright policy is the same as that of the European Union.

We wish to especially thank Elizabeth Appraxine (European Union) who administered these TACIS projects, Richard J. Gregson (Partner, PricewaterhouseCoopers) who led the projects and all friends at Bankir.Ru for hosting the books.

TACIS project partners included Rosexpertiza (Russia), ACCA (UK), Agriconsulting (Italy), FBK (Russia), and European Savings Bank Group (Brussels). The help of Philip W. Smith (editor of the third edition) and Allan Gamborg, project managers and Ekaterina Nekrasova, Director of PricewaterhouseCoopers, who managed the production of the Russian version (2008-9) is gratefully acknowledged. Glyn R. Phillips, manager of the first two projects conceived the idea, designed the workbooks and edited the first two versions. We are proud to realise his vision. Robin Joyce Professor of the Chair of International Banking and Finance Financial University under the Government of the Russian Federation

Visiting Professor of the Siberian Academy of Finance and Banking Moscow, Russia 2011 Updated

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IAS 12 Income Taxes

CONTENTS

1 Introduction 32 IAS 12 for Banks 43 Permanent Differences 54 Definitions 65 Deferred Tax – basic idea 76 Tax Accounting – the process 157 Fair Value Adjustments 258 Deferred Tax Assets 339 Determine appropriate tax rates 3710 Determine movement in deferred tax balances 4511 Presentation 4712 Accounting for Deferred Tax - Detailed Rules. .4913 Disclosure 5414 Appendix – Some IFRS / Russian Accounting Comparisons 6015 Multiple Choice Questions 7016 Answers to multiple choice questions..............7317 NUMERICAL QUESTIONS...................................7418 ANSWERS TO NUMERICAL QUESTIONS..........77




IAS 12 Income Taxes

1. Introduction

AimThe aim of this workbook is to assist the individual in understanding the IFRS accounting treatment and disclosures of Income Taxes, as detailed in IAS 12.

Definitions of the terms used are set in section 3 on page 4.

Deferred tax is making an accrual for tax, which is then reversed when the tax is paid. The purpose is to account for tax in the same accounting period as the economic event that incurs the tax, regardless of when the tax is paid (or recovered). It links the accounting system with the systems of taxation reported in the financial statements.

In simple terms, sales generally generate a tax charge. Revaluations generate a deferred tax charge (an accrual for tax).

ObjectiveThe accounting profit may differ from the taxable profit as each is compiled according to its own set of rules and regulations.

IFRS is a common set of guidelines for compiling the financial statements but the tax law and tax code of Russia stipulates how the tax liability will be calculated, and when it will be paid.

Tax is often only collected in arrears or in advance. When this happens, there will be timing differences between when the profit is reported and when the tax on it is paid. This generates a tax liability (or tax asset).

IFRS 12 sets out to overcome this problem in terms of presentation so that financial statements prepared under different tax regimes include the effect of taxes at the appropriate time.

IAS 12 prescribes the accounting treatment for income taxes, and the tax consequences of:

(1) Transactions of the current period that are recorded the financial statements; and

(2) The future liquidation of assets and liabilities that are recorded only the balance sheet.

If liquidation of those assets and liabilities will make future tax payments larger or smaller, IAS 12 generally requires an undertaking to record a deferred tax liability (or deferred tax asset).

IAS 12 requires an undertaking to account for the tax consequences of transactions, in the same manner that it accounts for the transactions:

For transactions recorded in the income statement, any related tax consequences are also recorded in the income statement.

For transactions recorded directly in equity, any related tax consequences are also recorded directly in equity (for example, property revaluations under IAS 16).




IAS 12 Income Taxes

The recognition of deferred tax assets, and liabilities, in a business combination affects the amount of goodwill arising in that combination.

IAS 12 also covers:1. Recognition of deferred tax assets arising from

unused tax losses, or unused tax credits,2. Presentation of income taxes, and3. Disclosure of information relating to income taxes.

ScopeIAS 12 should be applied in accounting for income taxes including:

1. All domestic, and foreign, taxes based on taxable profits.

2. Taxes, such as withholding taxes payable by a subsidiary, associate, trade investment or joint venture on distributions to the reporting undertaking.

IAS 12 does not deal with the methods of accounting for government grants, or investment tax credits (see IAS 20).

However, IAS 12 does deal with the accounting for temporary differences that may arise from such grants, or investment tax credits each of which alter the timing of when the tax is payable.

2 IAS 12 for Banks

Accounting for income tax is firmly based on the national tax system.

As bank accounting for income tax is based on the national tax system, banks have little more than to follow the presentation requirements of IAS 12, using the figures already compiled. Differences may occur in the treatment of carried forward tax losses and tax credits.

The major additional work is the deferred tax computations, effectively accruing for future tax on revaluations. In Russia, there is a requirement to account for tax (PBU 18), but banks have, so far, been exempt from this requirement.

In simple terms, sales generally generate a tax charge. Revaluations generate a deferred tax charge (an accrual for tax). The revaluations gains will be effectively shown as 80% of the total gain, having accrued deferred tax at 20%.

Banks already revalue their currency positions daily in Russia, but generally have not revalued their financial instruments to reflect the latest market prices.

Deferred tax will need to be accrued for all revaluations of financial instruments, where this is required by IFRS 9 Financial Instruments, unless the profits will not be liable for tax.

Deferred tax will need to be accrued for the fair values of assets computed in accounting for acquisitions and revaluations of property.

Where transformation from Russian accounting to IFRS moves profit from one period to another and the tax payment does not move, deferred tax will need to be accrued. This will especially apply to finance leases (IAS 17 Leases) which are




IAS 12 Income Taxes

not recognised for tax purposes as any different from operating leases.

When reviewing financial statements of clients and correspondent banks, banks will need to ensure that deferred tax has been fully accrued.

3 Permanent DifferencesPermanent differences between the financial profit and taxable profit arise when income is not taxable or expenses are not allowed for tax.

A government grant may be a gift that is not taxed. Government bonds often provide tax-free interest income, or may be taxed at a lower rate than the standard income tax rate for companies. Fines paid by an undertaking may not be tax-deductible.

The tax computation for the period will calculate the impact of these transactions.

No further accounting is needed and no deferred asset or liability will be recorded.

Definitions Accounting profit (‘net profit before tax’)Accounting profit is net profit for a period, before deducting tax.TAXABLE PROFIT (OR TAX LOSS)Taxable profit (tax loss) is the profit (loss) for a period, calculated according to the rules of the tax authorities, upon which income taxes are payable (recoverable).


EXAMPLE-Permanent DifferencesYour firm receives a tax- free $4million grant to employ more staff.

It is later also fined $1m for environmental misuse, after illegally discharging chemicals into a river. The fine cannot be deducted for tax.

The financial statements will reflect these items, but your tax computation will exclude them, or record that no tax is payable nor receivable. Your tax computation will reconcile these adjustments to the accounting profit.

No deferred tax needs to be calculated for permanent differences. This is because deferred tax is an accrual of tax, and there will be no further tax to be accrued.

Assuming that both items are taken into profit in full in the same period, the tax computation could reflect:

In the following examples, I/B refer to Income Statement and Balance Sheet (SFP).

$mAccounting Profit 486Less grant -4Plus fine +1=Taxable profit 483

Tax charge = 483 * 20% = 96,600

I/B DR CRTax expense I 96,600Accrual for income tax B 96,600Tax expense for the period

6



IAS 12 Income Taxes

TAX EXPENSE (OR TAX INCOME)Tax expense (tax income) is the total amount included in the net profit (or loss) for the period, in respect of current tax, and deferred tax.

Tax expense (tax income) comprises both current tax expense (income) and deferred tax expense (income).

Current taxCurrent tax is the total of income taxes payable (recoverable) in respect of the taxable profit (loss) for a period.

Deferred tax liabilitiesDeferred tax liabilities are the amounts of taxes payable, in future periods, in respect of taxable temporary differences.

DEFERRED TAX ASSETS

Deferred tax assets are the taxes recoverable, in future periods, in respect of:

(1) deductible temporary differences (accruals of tax receivable);

(2) unused tax losses; and

(3) unused tax credits.

Temporary differencesTemporary 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) taxable temporary differences that will increase taxable profit of future periods, when the carrying amount of the asset (or liability), is liquidated; or

(2) deductible temporary differences that will reduce taxable profit (tax loss) of future periods, when the carrying amount of the asset (or liability) is liquidated.

Tax baseThe tax base of an asset (or liability) is the value of that asset (or liability), for tax purposes. This may be the written down value of a fixed asset for tax basis. Others are described below.

The tax base is the amount that will be deductible for tax purposes over the life of the asset.

EXAMPLE - Determine the tax base of assets and liabilities

Issue An asset’s tax base 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 asset’s carrying amount. If those economic benefits will not be taxable, the asset’s tax base is equal to its carrying amount.

How should management calculate the tax base of a dividend receivable balance?

BackgroundEntity G’s management has recognised, in G’s single-entity financial statements, a dividend receivable of 100,000 from a wholly-owned subsidiary. The dividend is not taxable.




IAS 12 Income Taxes

SolutionManagement should calculate the tax base of the dividend receivable as follows:

Carrying amount 100,000

Future taxable amounts

- (the dividend is not taxable)

Future deductible amounts

-

Tax base 100,000

5 Deferred Tax – basic ideaDeferred tax is an accrual for tax, receipt or payment, created when the economic activity and the tax impact are either in different periods, or do not completely match in amounts or time period.

Accounting for tax is simpler when the transaction is booked for both accounting and tax purposes in the same year. In such a case income tax is recorded and no deferred tax needs to be accrued.

If a transaction takes place in year 1 and tax is paid in year 2, year 1 will show a transaction without a tax charge, and year 2 will show a tax charge without a transaction:

In this example, a financial asset (at fair value through profit and loss) is purchased for 1.000 in Year 1 and revalued at 1.100 at the period end, recording a profit of 100. The financial asset is then sold in Year 2 for 1.100, its revalued amount.

Year 1 Year 2Income 100 0Tax expense @ 20% 0 -20Net profit 100 -20

The tax expense is a direct result of the income in period 1. Readers of financial statements should be made aware that a tax charge will be levied in the following year.

Deferred tax is used to identify future tax payments generated by transactions in the current year – it is an accrual for tax, and like all accruals, will be reversed when the tax is actually paid.

Year 1 Year 2Income 100 0Tax expense @ 20% 0 -20Deferred tax @ 20% -20 20Net profit 80 0

The deferred tax reverses over time (and will thus disappear). This provides a more comprehensive picture to readers. Without the deferred tax accrual, profits in Year 1 would be overstated, with the risk that dividends might be higher than the undertaking could afford.

In this case, it creates an accrual of the tax charge in year 1 to link with the timing of the transaction.




IAS 12 Income Taxes

It is reversed in year 2 to reflect that tax has been accrued in year 1, even though it was charged in year 2.

On the balance sheet, this deferred tax would be shown as a liability (accrual) at the end of period 1. It will disappear at the end of period 2.

EXAMPLE - tax is paid on receipt of the money in period 1, but only treated as income in period 2.

Year 1 Year 2Income 0 100Tax expense @ 20%

-20 0

Net profit -20 100In year 1 there is a tax charge without a transaction. In year 2 there is a transaction without a tax charge.Again, we use deferred tax to link the transaction

to the tax charge.Year 1 Year 2

Income 0 100Tax expense @ 20%

-20 0

Deferred tax @ 20%

+20 -24

Net profit 0 80

In this case, deferred tax accrues a tax credit in year 1 to carry forward the tax paid to period 2 to link with the timing of the transaction. The accrual is reversed in year 2. On the balance sheet, this deferred tax would be shown as an asset (or prepayment of tax) at the end of period 1. It will disappear by being reversed at the end of period 2.

EXAMPLE - the cash is received and taxed in year 1, but the income is split between years 1, 2 and 3. This might occur when an advance payment is received for a long-

term contract. Year 1 Year 2 Year 3

Income 200 200 200Tax expense @ 20%

-120 0 0

Net profit 80 200 200The income is the same for each year, but the net profit changes due to the tax payment. The income in years 2 & 3 is taxed in the first year.

Deferred tax is used to apportion the tax charge to match the income:

Year 1 Year 2 Year 3Income 200 200 200Tax expense @ 20%

-120 0 0

Deferred tax @ 20%

+80 -40 -40

Net profit 160 160 160http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng 9



IAS 12 Income Taxes

The total tax charge for year 1 will be 40 (120 minus 80), so the Income Statement for each year will be the same. The deferred tax reduces the tax charge in year 1, but

increases it in years 2 & 3.

EXAMPLE -expenses attract tax credits (‘tax income’).

If a transaction takes place in year 1 and tax is credited in year 2, year 1 will show a transaction without a tax credit, and year 2 will show a tax credit without a transaction:

Year 1 Year 2Expense -100 0Tax income @ 20%

0 +20

Net profit -100 +20The tax income, or benefit of paying less tax due to the expense, is a direct result of the expense in period 1. Readers of financial statements should be made aware that tax will be credited in the following year.

Deferred tax is used to accrue future tax credits generated by transactions in the current year.


0 +20

Deferred tax @ 20%

+20 -20

Net profit -80 0

On the balance sheet, this deferred tax would be shown as an asset at the end of period 1. It will disappear at the end of period 2 by being reversed.

EXAMPLE- tax is credited on payment of the money in period 1, but only treated as an expense

in period 2.Year 1 Year 2

Expense 0 -100Tax income @ 20%

+20 0

Net profit +20 -100In year 1 there is a tax credit without a transaction. In year 2 there is a transaction without a tax credit. The tax will be shown as a prepayment.

Again, we use deferred tax to link the transaction to the tax credit.

Year 1 Year 2Expense 0 -100Tax income @ 20%

+20 0

Deferred tax @ 20%

-20 +20

Net profit 0 -80In this case, it accrues a tax credit in year 1 to carry forward the tax paid to period 2 to link with the timing of the transaction. It is reversed in year 2.




IAS 12 Income Taxes

EXAMPLE- an advance payment on a construction contract.

The cash is paid and credited for tax in year 1, but the expense is split between years 1, 2 and 3.

Year 1 Year 2 Year 3Expense -200 -200 -200Tax income @ 20%

+120 0 0

Net profit -80 -200 -200The expense is the same for each year, but the net profit changes due to the tax credit. The expense in years 2 & 3 is credited for tax in the first year.

Deferred tax is used to apportion the tax credit by accrual to match the expense:


120 0 0

Deferred tax @ 20%

-80 +40 +40

Net profit -160 -160 -160The total tax credit for year 1 will be 40 (120 minus 80), so the Income Statement for each year will be the same, matching the economic reality. The deferred tax reduces

the tax credit in year 1, but increases it in years 2 & 3.




1 2 3 4 5 6 7 8 9 10 11 12 13

Calculation (2)/10 (2)-(4) (2)/12 (2)-(7) (4)-(7) (9) x 24% (3 - 6) x 24% (6) x 24%(11)+(12

)

YEAR COSTDEPRECIATION

EXPENSE NET

TAX ALLOWANCE

(CREDIT) TAX BASETIMING

DIFFERENCE

DEFERRED TAX-

BALANCE SHEET

DEFERRED TAX-INCOME STATEMENT

CURRENT TAX

TOTAL TAX

Year Cum Year Cum1 6 000 600 600 5 400 500 500 5 500 100 24 24 120 1442 600 1200 4 800 500 1000 5 000 200 48 24 120 1443 600 1800 4 200 500 1500 4 500 300 72 24 120 1444 600 2400 3 600 500 2000 4 000 400 96 24 120 1445 600 3000 3 000 500 2500 3 500 500 120 24 120 1446 600 3600 2 400 500 3000 3 000 600 144 24 120 1447 600 4200 1 800 500 3500 2 500 700 168 24 120 1448 600 4800 1 200 500 4000 2 000 800 192 24 120 1449 600 5400 600 500 4500 1 500 900 216 24 120 144

10 600 6000 0 500 5000 1 000 1 000 240 24 120 14411 0 500 5500 500 500 120 -120 120 012 0 500 6000 0 0 0 -120 120 0

EXAMPLE - the purchase of a building in year 1. See table above.

Depreciation is charged in years 1-10, after which the building is fully depreciated. The tax allowance is spread over years 1-12.

In years 1-10, depreciation is more than the tax allowance. In years 11 and 12, tax credits are received even though no depreciation is charged. This creates timing differences.

By charging deferred tax in years 1-10, and crediting deferred tax in years 11 and 12, the total tax for years 1-10 is equalised each year and matches the depreciation. In years 11 and 12, there is no total tax which matches the lack of depreciation in these years.

DR/CR 0 1 2 3 4Balance SheetCost 3000Amortisation -1000 -1000 -1000 0

Off-Balance-SheetTax -3000Amortisation 750 750 750 750

Tax Base -3000 -2250 -1500 -750 0

Income Statement

Amortisation 1000 1000 1000 0Tax @ 2 4 % -180 -180 -180 -180

820 820 820 -180Deferred taxNet profit/loss

In the above example, a computer is bought for 3.000 with an economic life of 3 years, but the tax benefit will be spread over 4 years. The tax base is shown as the tax benefit less is accumulated amortisation. (The income statement is an extract, excluding other items.)

This creates 2 problems of presentation: the loss after tax is NOT at 76% (100-24), and in year 4 there is a tax credit without any economic activity.



Tax Base -3000 -2250 -1500 -750 0

mailto:Tax@

Income Statement

Amortisation 100% 1000 1000 1000 0Tax @ 2 4 % -180 -180 -180 -180

820 820 820 -180Deferred taxNet profit/loss 76% 760 760 760 0

The first step is to calculate the net loss as 76% of the expense for each period.



Tax Base -3000 -2250 -1500 -750 0

Income Statement


820 820 820 -180Deferred tax CR -60 -60 -60 180Net profit/loss 76% 760 760 760 0

The second step is to compute the deferred tax as the difference between the net loss and the loss after tax. Identify whether the entry for Year 1 is a debit or a credit.


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Tax Base -3000 -2250 -1500 -750 0

Income Statement


820 820 820 -180Deferred tax CR -60 -60 -60 180

76% 760 760 760 0Balance SheetDeferred tax DR 60 60 60 -180Asset / liability???

Cumulative 60 120 180 0

The entry to the balance sheet for each year is computed by double entry bookkeeping: Year 1 Year 2 Year 3 Year 4Income Statement -60 -60 -60 180 Credit Credit Credit DebitBalance Sheet 60 60 60 -180 Debit Debit Debit Credit

The cumulative figure shows the number that will be seen in the balance sheet.

In this example, the balance sheet entry is a debit. A debit in the balance sheet is an ASSET, so the result is a deferred tax asset.

At the end of year 4, the balance on the balance sheet is eliminated – a control check that the deferred tax accrual has been reversed.

In the next example, a security is bought for 1.000 with an economic life of 5 years, but the tax benefit will be spread over 4 years. The tax base is shown as the tax benefit less is accumulated amortisation. (The income statement is an extract, excluding other items.)

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This creates 2 problems of presentation: the loss after tax is NOT at 76% (100-24), and in year 5 there is economic activity a tax credit without a tax credit.

DR/CR 0 1 2 3 4 5Balance SheetCost 1000Amortisation -200 -200 -200 -200 -200

Off-Balance-SheetTax -1000Amortisation 250 250 250 250 0

Tax Base -1000 -750 -500 -250 0 0

Income Statement

Amortisation 100% 200 200 200 200 200Tax @ 2 4 % -60 -60 -60 -60 0

140 140 140 140 200Deferred taxNet profit/loss 76% Balance SheetDeferred taxAsset / liability???

Cumulative

Following the procedure of the previous example:

DR/CR 0 1 2 3 4 5Balance SheetCost 1000Amortisation -200 -200 -200 -200 -200

Off-Balance-SheetTax -1000

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Amortisation 250 250 250 250 0

Tax Base -1000 -750 -500 -250 0 0

Income Statement

Amortisation 100% 200 200 200 200 200Tax @ 2 4 % -60 -60 -60 -60 0

140 140 140 140 200Deferred tax DR 12 12 12 12 -48Net profit/loss 76% 152 152 152 152 152

Balance SheetDeferred tax -12 -12 -12 -12 48Asset / liability???

Cumulative CR -12 -24 -36 -48 0

The entry to the balance sheet for each year is computed by double entry bookkeeping:

Year 1 Year 2 Year 3 Year 4 Year 5Income Statement 12 12 12 12 -48 Debit Debit Debit Debit CreditBalance Sheet -12 -12 -12 -12 48 Credit Credit Credit Credit Debit

The cumulative figure shows the number that will be seen in the balance sheet.

In this example, the balance sheet entry is a credit. A credit in the balance sheet is a liability, so the result is a deferred tax liability.

At the end of year 5, the balance on the balance sheet is eliminated – a control check that the deferred tax accrual has been reversed.

From these examples, we can conclude that if management accelerates depreciation faster than the tax authorities, a

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deferred tax ASSET will arise.

In contrast, if management depreciates an asset over a longer period than the tax authorities, a deferred tax LIABILITY will arise.

The use of deferred tax does not change the dates of payment of any tax. It is an extension of the matching (accruals) concept used in IFRS.

6 Tax Accounting – the process

Tax accounting comprises the following steps:

i) calculate and record current income tax payable (or receivable);

ii) determine the tax base of assets and liabilities;

iii) calculate the differences between (the accounting) carrying amount of assets and liabilities and their tax base to determine temporary differences;

iv) identify temporary differences that are not recorded due to specific exceptions in IFRS;

v) calculate the net temporary differences;

vi) review net deductible temporary differences and unused tax losses to decide if recording deferred tax assets is correct;

vii) calculate deferred tax assets and liabilities by applying the appropriate tax rates to the temporary differences;

viii) determine the movement between opening and closing deferred tax balances;

ix) decide whether offset of deferred tax assets and liabilities between different group undertakings is appropriate in the consolidated financial statements; and

x) record deferred tax assets and liabilities, with the net change recorded in income or equity as appropriate.

The current tax expense (or income) is the amount payable (or receivable) as calculated in the tax return, plus any adjustment to deferred tax.

The current tax expense is recorded in the income statement, except any tax relates to a transaction that is recorded in equity rather than the income statement. For example, any tax related to the revaluation of property, plant and equipment should be recognised in equity.EXAMPLE- Tax expense split between the income statement and equity.Your tax computation shows an expense of $87m for the year, of which $3m relates to a property revaluation under IAS 16.

I/B DR CRTax expense – income statement I 84mTax expense-revaluation reserve B 3mTax accrual B 87mTax expense split between the income statement and equity

If the tax already paid exceeds the tax due for the period, the excess will be recorded as an asset, assuming it is recoverable.EXAMPLE- Tax expense: Prepayment You have paid $100m as a tax prepayment.Your tax computation shows an expense of $87m for the year, of which $3m relates to a property revaluation.

I/B DR CRTax prepayment B 100mCash B 100mRecording tax prepaymentTax expense – income statement I 84mTax expense-revaluation reserve B 3mTax prepayment B 87mTax expense split between the income statement and equity, matched against the tax prepayment

A tax loss, that can be carried back to recover tax of a previous period, should be recorded as an asset in the period in which the tax loss occurs.

EXAMPLE- Tax loss: assetYour tax computation shows a loss of $6m for the year, which can be carried back to recover tax of a previous tax period.

I/B DR CRTax recoverable B 6mTax income I 6mRecording recoverable tax lossThe tax base of an asset or liability is the amount attributed to it for tax purposes.

The depreciation for an item of property plant or equipment on an accounting basis may differ from the calculation on a tax basis.

EXAMPLE- Different depreciation rates for accounting and tax

Your building is to be depreciated over 20 years for accounting purposes, but the tax authorities insist on a minimum life of 30 years for this type of building.

Whilst the accounting records will reflect the 20-year depreciation period, the tax base will use the 30-year depreciation model.

i) Revenue received in advance

Special rules apply to liabilities that represent revenue received in advance. The tax base is equivalent to:

-the liability's carrying amount, if the revenue is taxable in a subsequent period;

EXAMPLE- Revenue received in advanceRevenue is taxed in a later period. In year 1, it has a tax base of 100.

I/B DR CRCash B 100Deferred revenue B 100Receipt of cash-period 1Deferred revenue B 100Revenue I 100

Tax expense @ 20% I 20Current tax liability B 20Revenue recognition and tax expense-period 2

-nil if the revenue is taxed in the period received.

EXAMPLE- Revenue received in advanceRevenue is taxed in the same period. In year 1, it has a tax base of 0. There is a timing difference as the revenue is recognised for tax before it is recognised for accounting.

I/B DR CRCash B 100Deferred revenue B 100Deferred tax asset @ 20% B 20Current tax liability B 20Receipt of cash and tax payment -period 1Deferred revenue B 100Revenue I 100Tax expense @ 20% I 20Deferred tax asset B 20Revenue and tax expense recognition -period 2

EXAMPLE - Revenues received in advance

IssueThe 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 received in advance, the tax base of the resulting liability is its carrying amount, less any amount of revenue that will not be taxable in future periods.

How should management calculate the tax base of revenue received in advance?

BackgroundEntity A receives royalties from users of its licensed technology of 25,000 relating to the following financial year. Royalties are taxed on a cash receipts basis. The royalty income is deferred in the balance sheet until the period it relates to.

SolutionManagement should calculate the tax base of the royalties received in advance as follows:

Carrying amount 25,000

Revenue not taxable in future period

(25,000) (Tax was assessed when revenue was received)

Tax base -

Entity A has a deductible temporary difference of 25,000 (25,000 - nil). Management should recognise a deferred tax asset in respect of the deductible temporary difference.

EXAMPLE - Tax base of long service leave provision

Issue 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 received in advance, the tax base of the resulting liability is its carrying amount, less any amount of revenue that will not be taxable in future periods.

How should management calculate the tax base of a long service leave provision?

BackgroundEntity C’s management has recognised a liability under IAS 19 for accrued long service leave of 150,000 at the balance sheet date. No deduction will be available for tax until the long service leave is paid.

SolutionManagement should calculate the tax base of the long service leave provision as follows:Carrying amount 150,000

Future deductible amounts (150,000)(a deduction will be received for tax purposes when paid)

Future taxable amounts -

Tax base -

Entity C has a deductible temporary difference of 150,000 (150,000 - nil). Management should recognise a deferred tax asset in respect of the deductible temporary difference.

ii) Amounts not reflected in the balance sheet

Deductible or taxable amounts may arise from items that are not recorded in the balance sheet.

Research and development costs may be expensed in the current period, but deductible for tax purposes over subsequent periods. The tax base reflects the amount of the deduction that can be claimed in future periods.

EXAMPLE-Research and development costsYou spend $20m on research in the current period, and it is treated as an expense. Tax authorities only allow the expense to be deducted over a 4-year period. Only $5m is allowed in this period.

The remaining $15m is the tax base at the end of year 1, and will be allowed over the next 3 years.

I/B DR CRResearch cost I 20mCash B 20m

Tax credit @ 20% I 4mCurrent tax liability (reduction) B 1mDeferred tax asset B 3mResearch cost and tax income -period 1Current tax liability (reduction) B 1mDeferred tax asset B 1mTax income -period 2 (and the same for periods 3 & 4)

EXAMPLE - Deferred tax on provision for general insurance risk

Issue

Some items have a tax base but are not recognised as assets and liabilities in the balance sheet. The difference between the tax base and the carrying amount of nil is a temporary difference that results in a deferred tax balance.

Should management recognise a deferred tax liability regarding

provision for general insurance risk that was not included in the financial statements but which was claimed in the tax accounts?

Background An insurance entity’s management has recognised in the income statement net premium income of 5,000 during the year.

Management is permitted for tax purposes to set up a provision for general insurance risks of 10% of the entity’s net premium income. Management claims this benefit in full and recognises a provision of 500 during the year in the tax accounts. It does not recognise the provision in the entity’s financial statements.

The accumulated provision in the tax accounts has been increasing every year. The balance at the balance sheet date is 3,500, net of any utilisation of the provision. The possibility of a decrease in this provision is remote, probably occurring only if the entity was liquidated.

SolutionYes, management should recognise a deferred tax liability in respect of this provision with the corresponding entry to the tax charge in the income statement.

Management should calculate the tax base of the provision as follows:

Carrying amount - (the provision is not recognised in the financial statements)

Future deductible amounts

- (the provision is deductible for tax purposes in the current period)

Future taxable 3,500 (the expense of future

amounts utilisation of the provision will not be deductible for tax purposes)

Tax base 3,500

The entity has a taxable temporary difference of 3,500 (nil - 3,500). Management should recognise a deferred tax liability in respect of the taxable temporary difference.

IFRS adopt the balance sheet model. Management should therefore recognise the deferred tax liability even though a future liquidation of the entity might appear to be remote.iii) Investments within groups

The acquisition of an investment in a subsidiary, associate, branch or joint venture will give rise to a tax base for the investment in the parent undertaking's financial statements. The tax base is often the cost paid.

Differences between the tax base and the carrying amount will arise in the periods after acquisition due to changes in the carrying amount. The carrying amount will change, for example, if the investment is accounted for using the equity method, or if an impairment charge is recorded.

EXAMPLE- Investment in subsidiary and impairmentYou buy a subsidiary for $70m. Trading is poor, and you book an impairment charge of $10m.

The tax base is $70m, representing the cost. It is not adjusted for the impairment charge, creating a difference between the tax base and the carrying amount of $10m.

I/B DR CRInvestment in subsidiary B 70mCash B 70mRecording purchase of subsidiaryImpairment of subsidiary I 10m

Investment in subsidiary B 10mTax income (deferred tax) @ 20% I 2mDeferred tax asset B 2mRecording impairment charge and (deferred) tax charge. The deferred tax asset will be released when the investment is finally liquidated and the loss is allowed for tax.

iv) Expected manner of liquidating assets and liabilities

The measurement of deferred tax liabilities and assets should reflect the way in which management expects to liquidate the underlying asset or liability.

For example, in some countries a different tax rate may apply depending on whether management decides to sell or use the asset.

However, the deferred tax liabilities or assets associated with non-depreciable assets (such as land) can only reflect the tax consequences that would follow from the sale of that asset.

This is because the asset is not depreciated. Therefore, for tax purposes, the carrying amount (or tax base) of the non-depreciable asset reflects the value recoverable from the sale of the asset.

Calculate temporary differences

The concept of temporary differences is central to deferred tax accounting. This means that the difference will eventually reverse. Temporary may not mean short-term: it may take many years until the accruals are completely reversed.

Temporary differences arise when the carrying amount of an asset or liability differs from its tax base.

A deductible temporary difference generates a deferred tax asset (which will reduce future payments) and a taxable temporary difference gives rise to a deferred tax liability (which will increase future payments).

Taxable temporary differences occur when tax is charged in a period after the accounting period suffers the expense in the financial accounts.

Taxable temporary differences arise when:

-an asset's carrying amount is greater than its tax base; or when

-a liability's carrying amount is less than its tax base.

Many taxable temporary differences arise because the transaction is recognised in different periods for tax and accounting purposes.

EXAMPLE- Deductible Temporary Differenceinterest revenue is included in pre-tax accounting profit on a time-apportionment basis but may be taxable on a cash basis.

I/B DR CRCash B 300Interest revenue I 100Deferred interest revenue B 200

Tax expense @ 20% I 20Deferred tax asset B 40Current tax liability B 60Receipt of cash and tax payment -period 1 Partial recognition of revenue and taxDeferred interest revenue B 100Interest revenue I 100Tax expense @ 20% I 20Deferred tax asset B 20Interest revenue and tax expense recognition -period 2 (Same for period 3)

EXAMPLE- Taxable Temporary Differencei) interest revenue is included in pre-tax accounting profit when accrued but may be taxable on a cash basis.

I/B DR CR

Interest receivable B 700Interest revenue I 700Deferred tax liability B 140Tax expense @ 20% (deferred tax) I 140Recognition of revenue and application of deferred tax- period 1Cash B 700Interest receivable I 700Tax expense @ 20% I 140Cash – tax payment B 140Deferred tax liability B 140Tax expense I 140Receipt of cash and tax payment- period 2

EXAMPLE- Taxable Temporary Difference ii) revenue from the sale of goods is included in pre-tax accounting profit when goods are delivered, but may be included in taxable profit when cash is collected. Goods sold for 100 delivered in year 1, cash collected and taxed in year 2.

I/B DR CRAccounts receivable B 100Revenue I 100Deferred tax liability B 20Tax expense (deferred tax) @ 20% I 20Receipt of cash and tax recognition -period 1Cash B 100Accounts receivable B 100Deferred tax liability B 20Current tax liability B 20Receipt of cash and tax liability recognition -period 2

EXAMPLE- Taxable Temporary Difference iii) accumulated accounting depreciation may differ from cumulative tax depreciation because depreciation is accelerated for tax purposes; Accounting depreciation is 100 and for tax purposes it is 150.

I/B DR CRDepreciation I 100Accumulated depreciation B 100Current tax (reduction) 150 @ 20% B 30Tax income I 20Deferred tax liability B 10Depreciation and higher tax credit -period 1Depreciation I 100Accumulated depreciation B 100Current tax (reduction) 50 @ 20% B 10Tax income I 20Deferred tax liability B 10Depreciation and lower tax credit -period 2

EXAMPLE- Taxable Temporary Difference iv) development costs have been capitalised for accounting purposes and will be amortised to the income statement, but may have been deducted as an expense in determining taxable profit in the period in which they were incurred. Amortised over 4 years starting from the year after they were incurred.

I/B DR CRDevelopment costs (capitalised) B 100Cash B 100Current tax (reduction) @ 20% B 20Deferred tax liability B 20Development costs capitalised but

allowed for tax credit -period 1Depreciation – development costs I 25Accumulated depreciation B 25Deferred tax liability B 5Tax income @ 20% I 5Depreciation and adjustment for tax -period 2

EXAMPLE- Taxable Temporary Difference v) prepaid expenses for accounting purposes may have been deducted on a cash basis in determining the taxable profit.

I/B DR CRCash B 100Prepaid expenses B 100Current tax (reduction) @ 20% B 20Deferred tax liability B 20Payment of cash and tax credit -period 1Expense I 100Prepaid expenses B 100Deferred tax liability B 20Tax income (deferred tax) @ 20% I 20Cost and tax income recognition -period 2The tax laws of the undertaking's operations will determine the temporary differences.

Deductible temporary differences occur when tax is charged in a period after the accounting period suffered the expense in the financial

accounts.

Deductible temporary differences arise when:

-an asset's carrying amount is less than its tax base; or when

-a liability's carrying amount is greater than its tax base.

Like taxable temporary differences, many deductible temporary differences arise from differences in the timing of recording the underlying transaction for accounting and tax purposes.

Deductible temporary differences examples:

EXAMPLE- Deductible Temporary Difference i) accumulated depreciation differs from cumulative tax depreciation as depreciation may be accelerated for accounting purposes. Accumulated depreciation is 150 but cumulative tax depreciation is 100.

I/B DR CRDepreciation I 100Accumulated depreciation B 100Current tax (reduction) 50 @ 20% B 10Tax income I 24Deferred tax asset B 10Depreciation and lower tax credit -period 1Depreciation I 100Accumulated depreciation B 100Current tax (reduction) 150 @ 20% B 30Tax income I 20Deferred tax asset B 10Depreciation and higher tax credit -period 2

EXAMPLE- Deductible Temporary Differenceii) employee expenses, or pension payments, are recorded when incurred for accounting purposes and but only for tax purposes when paid in cash.

I/B DR CR

Pension expense I 100Accrual B 100Deferred tax asset B 20Tax income (deferred tax) @ 20% I 20Accrual of pension costsCash B 100Accrual B 100Current tax (reduction) @ 20% B 20Deferred tax asset B 20Cost and tax income recognition -period 2

EXAMPLE- Deductible Temporary Difference iii) an impairment loss recorded for accounting purposes will not affect the current tax liability until disposal of the property.

I/B DR CRImpairment of property I 10mAccumulated depreciation of property B 10mTax income (deferred tax) @ 20% I 2mDeferred tax asset B 2mRecording impairment charge and (deferred) tax charge

EXAMPLE- Deductible Temporary Difference iv) research costs are expensed in the period for accounting purposes, but may only be deducted in a later period for tax purposes.

I/B DR CRResearch cost I 10mCash B 10mTax income (deferred tax) @ 20% I 2mDeferred tax asset B 2mResearch cost and deferred tax asset -period 1

Current tax liability (reduction) B 2mDeferred tax asset B 2mTax income -later period

EXAMPLE- Deductible Temporary Difference v) the recognition of income is deferred for accounting purposes, but may be included in taxable profit in the current period.

I/B DR CRCash B 500Deferred revenue B 500Deferred tax asset @ 20% B 100Current tax liability B 100Receipt of cash and tax payment -period 1Deferred revenue B 500Revenue I 500Tax expense (deferred tax) @ 20% I 100Deferred tax asset B 100Revenue and tax expense recognition -period 2

EXAMPLES- Deferred tax on share options1. E plc has granted share options to key employees both before and after 7 November 2002. On adoption of IFRS 2, Share-based Payment, E plc is not opting to apply the standard fully retrospectively so no expense will be recognised in the income statement in respect of those share awards granted before 7 November 2002.

Under UK tax legislation, a tax deduction, equal to the intrinsic value of the options at exercise date, will be available to E plc when the employees exercise their options and receive the shares.

Does this give rise to a deferred tax asset during the period between the options being granted and exercised? If the amount of

that deferred tax asset changes in the future, will the change be recognised in profit or loss or directly in equity?

IAS 12 requires deferred tax to be recognised on all temporary differences. That is, the difference between the tax base and the accounting carrying amount of assets and liabilities.

In respect of the options granted after 7 November 2002, a temporary difference arises between the tax base of the share option that has been recognised in the income statement (based on the future tax deductions) and its carrying value in the balance sheet (nil because the IFRS 2 share-based payment expense is offset by a corresponding credit entry in retained earnings). This gives rise to a deferred tax asset.

Similarly, a deferred tax asset will arise in respect of the options granted before 7 November 2002.

The tax base of these options, like those granted more recently, is basedon the future tax deductions. The carrying value of the options in the balance sheet is, again, nil because there is no share-based payment expense.

On first-time adoption of IFRS, the credit entry in respect of this deferred tax asset will be recognised in equity.

The tax deduction will, on exercise of the option, be equal to the intrinsic value of the options at the exercise date, which cannot be known for certain until the date of exercise. Therefore, the tax base (that is, the amount of the tax deduction to be obtained in the future) should be estimated on the basis of the information available at the end of the period (the entity’s share price at the balance sheet date).

At each balance sheet date, the deferred tax asset will be re-estimated on the basis of information available at that time and the movements in the asset recognised in profit or loss for share options granted after 7 November 2002 (except to the extent that the deferred tax exceeds the total IFRS 2 charge, in which case movements are recognised in equity) and in equity for share options granted before that date.

2. Deferred tax on share-based payments

Entity A is resident in a country where equity-settled share-based payments are deductible for tax purposes. The tax authorities allow the entire tax deduction on the grant date of the award.

Entity A grants an equity-settled share-based payment award to its employees on the last day of its 2007 financial year. The award vests in three years’ time. On grant date, the full tax deduction is provided by the tax authorities. Since no service has been provided when the year-end financial statements aredrawn up, entity A records no expense in terms of IFRS 2.

Should entity A recognise deferred tax in respect of the award in its year-end financial statements?

There are no recognised assets or liabilities in the accounts of entity A in respect of this award. The initial recognition exemption however does not apply since the taxable profit has been affected by this transaction (para 22(b) of IAS 12).

This situation is analogous to example 5 of Appendix B in IAS 12. In that example, the tax authorities provide the company with a tax deduction after the IFRS 2 expense is recorded.

There is no recognised asset or liability in that example either, yet a deferred tax asset is recognised since, in the future, the company

will pay less tax than it should based on its accounting profit.

Entity A should therefore recognise a deferred tax liability in its 2007 financial statements. This treatment is confirmed in para 314 of the basis of conclusion toIFRS 2.

Taxable and deductible temporary differences arise where the accounting measurement of assets and liabilities differs from the tax basis.

7 Fair Value AdjustmentsDifferences arising from fair value adjustments, whether on acquisition or otherwise, are treated the same as any other taxable and deductible differences.

In simple terms, sales generally generate a tax charge. Revaluations (fair value adjustments) generate a deferred tax charge (an accrual for tax).

Differences arising from fair value adjustments examples:

EXAMPLE - Fair Value Adjustments i) financial instruments are carried at fair value, but no matching revaluation may be made for tax purposes.

I/B DR CRFinancial instrument B 100Gain – fair value adjustment I 100Tax expense (deferred tax) @ 20% I 20Deferred tax liability B 20Revaluation of financial instrument

EXAMPLE - Deferred tax on available-for-sale equity investments

An entity holds an available-for-sale investment, ie, shares in a

listed company. The tax base of the shares is £500, which was the amount initially paid for the shares.

The fair value of the shares at the year end is £1,000. At the balance sheet date, the entity expects to sell the shares in five years and receive dividends of £500 during this five-year period. Dividends are not expected to impair the carrying amount of the investment when paid.

Dividends are non-taxable. Based on the current tax legislation, if the shares were sold after five years, capital gains tax at a rate of 10% would be payable on the excess of sales price over cost.

How much deferred tax (if any) should the entity recognise at the balance sheet date?

The principle in IAS 12 is that an entity should recognise deferred tax based on the expected manner of recovery of an asset, or liability, at the balance sheet date.

The dividends are expected to be derived from the investee’s future earnings rather than from its existing resources at the balance sheet date. Given that there is no impairment expectation arising from the dividends, the entity does not expect the carrying amount at the balance sheet date to be recovered through future dividends but rather through sale.

This is important since the expected manner of recovery will determine the deferred tax treatment.

The carrying amount of £1,000 has a corresponding tax base of £500 on sale. There is a taxable temporary difference of £500 at the balance sheet date. The applicable tax rate is the capital gains rate of 10%. The entity should recognise a deferred tax liability of £50 relating to the shares.

EXAMPLE - Fair Value Adjustments ii) revaluation of property, plant and equipment (IAS 16) to fair value, but no adjustment for is allowed for tax purposes.

I/B DR CRRevaluation of property, plant and equipment B 700Revaluation reserve-equity B 700Tax expense (deferred tax) @ 20% charged to equity

B 140

Deferred tax liability B 140Revaluation of property

EXAMPLE - Recognition of capital losses

Entity F (a UK company subject to UK tax) has a portfolio of properties and has capital tax losses arising from that portfolio. In the current year, entity F has revalued its land and buildings resulting in a (capital gains tax) deferred tax liability being recognised in respect of land and buildings.

Entity F does not expect to realise the capital gain arising from the revaluation for a number of years. Is entity F required to recognise a deferred tax asset now in respect of the capital losses under IAS 12?

IAS 12 uses the word shall when it states that deferred tax assets shall be recognised for all deductible temporary differences to the extent that taxable profit will be available against which the deductible temporary difference can be utilised.

Entity F is required, therefore, to recognise a deferred tax asset in respect of the capital losses if those losses can properly be utilised against the future crystallisation of the capital gains.

The fact that there is no current intention to realise the capital gain

through the sale of the properties does not affect the recognition of the deferred tax liability. The difference between the tax base, which remains the same despite the revaluation, and the revalued carrying amount of the asset, is a temporary difference that gives rise to a deferred tax liability.

Entity F should offset the presentation of the deferred tax liability arising from the revaluation and the deferred tax asset in respect of the capital losses if they meet the criteria in IAS 12. In other words, there is a legal right to offset the deferred tax assets and liabilities and they relate to the same taxation authority.

As long as these criteria are met, there is no requirement to schedule the reversal of the temporary differences to ensure that the timing matches.

On acquisition, assets of the company purchased should be fair valued. This will reflect their market value rather than their book value. These values will be used in the consolidated accounts.

Normally any change in value will not immediately create a tax charge or tax credit. Deferred tax should reflect the value change. Revaluations (fair value adjustments) generate a deferred tax charge (an accrual for tax).The net difference will increase or decrease goodwill.

EXAMPLE - Fair Value Adjustments iii) fair value of assets and liabilities on acquisition, does not affect the current tax in the consolidated accounts until each asset is realised.

I/B DR CRFair value of property, plant and equipment B 600Inventory – fair value provision B 75Accounts receivable – fair value provision B 25

Goodwill B 400Deferred tax liability (600-75-25) @20% B 100Fair valuing assets after acquisition

Temporary differences will arise from consolidation when the carrying amount of an item in the consolidated financial statements differs from its tax base. The tax base is often based on the carrying values and tax charges of the individual group members.

Temporary differences will arise from consolidation examples:

(In consolidated accounts, profits that have been generated from moving inventory from one unit to another are eliminated, unless the inventory has left the group. This removes unrealised profits.)

EXAMPLE – Consolidation i) unrealised profits resulting from intra-group transactions are eliminated on consolidation but not from the tax base.

I/B DR CRRevenue-Intra-group sales I 5000Cost of sales-Intra-group purchases I 5000Cost of sales-reduction of intra-group profit I 400Inventory B 400Deferred tax asset B 80Tax income (deferred tax) @ 20% B 80

Provision against loss of investment I 300

Investment B 300Deferred tax asset B 60Tax income (deferred tax) @ 20% I 60Intra-group transactions eliminated on consolidation

EXAMPLE – Consolidationii) the retained earnings of controlled undertakings are included in consolidated retained earnings, but taxes are paid on profits when distributed to the parent.

I/B DR CRNet assets of subsidiary B 4000Profits/retained earnings I/B 4000Deferred tax liability B 800Tax expense (deferred tax) @ 20% I 800Retained earnings of controlled undertakings included in consolidated retained earnings

EXAMPLE – Consolidation iii) investments in foreign undertakings that are affected by changes in foreign exchange rates. The carrying amounts of assets and liabilities are restated for accounting purposes for changes in exchange rates, but no similar adjustment is made for tax purposes. (See IAS 21.)

I/B DR CRNet assets of subsidiary B 6000Foreign currency gain - equity B 6000Deferred tax liability B 1200Tax expense (deferred tax) @ 20% -equity B 1200Foreign currency gain of controlled undertakings included in consolidated retained earnings

EXAMPLE – Deferred tax on subsidiary loan

Entity C, a French entity with a euro functional currency, has a Russian subsidiary, entity D, with a rouble functional currency. Entity C has made a US dollar loan to entity D, which qualifies as part of C’s net investment (quasi-capital) in D in accordance with IAS 21.

A temporary difference exists between the book value and the tax base of the loan for the parent, C, and the subsidiary, D. There also exists a temporary difference in respect of the loan on consolidation.

The book value of the loan is nil on consolidation because the amount receivable by the parent eliminates against the amount payable by the subsidiary.

However, the tax base of the parent’s loan receivable and the tax base of the subsidiary’s loan payable are not eliminated because they relate to different tax jurisdictions and are of different values.Management is considering the accounting for the temporary differences and deferred tax in the parent’s separate financial statements, in the subsidiary’s separate financial statements and in the consolidated financial statements.

No, deferred tax should be recognised in the parent’s separate financial statements in respect of the temporary difference between the book value of the loan and the tax base of the loan. This is because IAS 12 does not permit the recognition of deferred tax by a parent in respect of investments in subsidiaries provided certain conditions are met.

The conditions are:a) for taxable temporary differences that the parent can control

the timing of the reversal of the temporary difference; and it

is probable that the temporary difference will not reverse in the foreseeable future.

b) for deductible temporary differences, it is not probable that the temporary difference will reverse in the foreseeable future; and that there will be taxable profit against which the deductible temporary difference can be utilised.

Similarly, no deferred tax is recognised in the consolidated financial statements. The exceptions provided by IAS 12 apply in the consolidated financial statements provided the conditions set out above are met.

However, deferred tax should be recognised in the separate financial statements of the subsidiary in respect of the temporary difference that arises on the loan from the parent. The exceptions in IAS 12 only apply for investments of investors and not for corresponding loans payable by the investees.EXAMPLE –Deferred tax- sales to associates

Entity A has a 31 December year end. A acquired a 40% interest in an associate, entity B, on 31 December 20X5 for 500,000. On the same date, A sold goods costing 60,000 to B for 70,000. B still holds all these goods in inventory at the year-end.

Entity B did not earn any profits on 31 December 20X5 so there is no share of B.s profits for A torecognise when applying equity accounting.

However, A recognises an adjustment in its consolidated financial statements to eliminate its share of the unrealised profit of 10,000 arising on the sale of inventory to B.

This consolidationadjustment is:

Dr: Share of results of associates (40% x 10,000) 4,000Cr: Investment in associate 4,000

B will probably sell the inventory in the next 12 months. If so, the deductible temporary difference associated with the unrealised profit will reverse in the next 12 months.

Entities A and B reside in different tax jurisdictions and pay income tax at 40% and 30% respectively.

What deferred tax adjustments should A’s management recognise in respect of the inventory sold by A to B?

Entity A should recognise a deferred tax asset of 1,600, provided it is probable that it will have taxable profits against which to utilise this deferred tax.

The adjustment to eliminate A’s share of the unrealised profit on sale of inventory to B creates a temporary difference in respect of the carrying amount of A’s investment in B in A’s consolidated financial statements.

The temporary difference relates to A’s asset (its investment in B). It is therefore A’s tax rate that is used to calculate the deferred tax.The temporary difference is calculated in accordance with IAS 12 as:

Accounting base of investment in B (500,000 - 4,000) 496,000

Tax base of investment in B 500,000

Deductible temporary difference 4,000

Deferred tax asset (4,000 x 40%) 1,600

EXAMPLE –Accounting for a tax revaluationEntity B operates in country X. B has undertaken a group restructuring during the current year and as a consequence the tax authorities have allowed a revaluation of the fixed assets to market value at the date of the reorganisation for tax purposes.

However, the reorganisation is not a business combination for IFRS purposes and so there has been no change in the IFRS carrying value of the fixed assets.Consequently the tax base on all the fixed assets concerned has increased and is now higher than the IFRS book values.

How should entity B account for this change in tax values of the fixed assets in its consolidated financial statements?

The differences between the IFRS book values for the fixed assets and the tax values represent temporary differences.

The temporary differences will potentially result in the recognition of deferred tax assets. B should therefore assess whether it is probable that the deferred tax assets will be recovered and recognise them to the extent that it is probable.The recognition of the deferred tax assets will result in the recognition of deferred tax income in the income statement.

This credit cannot be reported in equity as IAS 12, Income Taxes, only allows deferred tax to be recognised in equity if the corresponding IFRS entry was also to equity. This is not the case here as the revaluation was not recognised at all for IFRS purposes.

EXAMPLE – Recognition of deferred tax – first-time adoption

Entity B, a manufacturing entity, is adopting IFRS for the year ending 31 December 2005 with a transition date of 1 January 2004.

Entity B operates in a country where the government provides tax incentives to invest in property, plant and equipment (PPE) in certain sectors of the economy by providing additional tax deductions for the cost of the PPE.

For example, an item of plant and machinery which cost 100 qualifies for tax deductions (capital allowances) of 130.The additional tax deduction of 30 (130 - 100) represents a temporary difference that arises on initial recognition of the asset.The guidance IAS 12 requires that no deferred tax is recognised in respect of the temporary difference that arises on initial recognition of the PPE except when the asset concerned is acquired in a business combination (the initial recognition exemption.).

When preparing the transition balance sheet at 1 January 2004, should entity B apply the initial recognition exemption when calculating the deferred tax:

(a) to PPE purchased directly by the group;

(b) to PPE acquired in a business combination?

(a) Yes, entity B should apply the initial recognition exemption when calculating deferred tax in the transition balance sheet.

The basic principle in IFRS 1, First-time Adoption of IFRS, is the retrospective application of all IFRSs except where an exemption or exception permits or requires otherwise. Consequently entity B should not recognise deferred tax on transition in respect of that portion of the temporary difference that arose on initial recognition of a directly purchased item of PPE.

(b) The initial recognition exemption does not apply to assets and liabilities acquired in a business combination. Consequently deferred tax is calculated on transition on the full temporary difference between accounting base and tax base for PPE originally acquired in a business combination.

This includes business combinations where the IFRS 1 business combinations exemption is applied due to the requirement of IFRS 1 that the measurement of deferred tax should follow from the measurement of other assets and liabilities.Not all temporary differences are recognised as deferred tax balances.

The exceptions are:

i) goodwill and negative goodwill;

ii) initial recognition of certain assets and liabilities; and

iii) certain investments.

Goodwill

Goodwill is the residual amount after deducting assets and liabilities at fair value from the purchase price in an acquisition.

IFRS do not permit the recognition of a deferred tax liability for goodwill when its amortisation/impairment is not deductible. (If it is fully deductible, there is no timing difference, so no deferred tax arises.) Since March 2004, goodwill can no longer be amortised under IFRS (see IFRS 3 workbook).

A deferred tax liability in respect of goodwill is not permitted, because it would increase the value of goodwill.

Generally, goodwill is a group accounting concept. In most countries, it is the individual companies that are taxed, not the group. It is quite rare for goodwill (and its amortisation or impairment) to be items that attract tax relief.

Where authorities do tax a business combination, deferred tax may arise.If an item (income or expense) is not taxable, it should be excluded from the calculations as a permanent difference (see above).

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.

Negative Goodwill

IAS 12 does not permit the recognition of a deferred tax asset arising from deductible temporary differences associated with negative goodwill, which is treated immediately as income (see IFRS 3).

It is therefore a permanent difference (see above) and deferred tax does NOT apply.

Initial recognition of certain assets and liabilities

The second exception relates to a temporary difference that arises from the initial recognition of an asset or liability (other than from a business combination) and affects neither accounting income nor taxable profit.

This exception will apply in limited circumstances, such as:

i) assets for which no deductions are available for tax purposes and will be recovered through use. For example, some tax authorities do not tax the gain or loss on disposal of an equity investment; the tax base of such an investment is therefore zero; and

ii) assets which have a tax base that is different from the cost base at acquisition. For example, an asset which attracts an investment tax credit.

This may also apply when a non-taxable government grant related to an asset is deducted in arriving at the carrying amount of the asset but, for tax purposes, is not deducted from its tax base; the carrying amount of the asset is less than its tax base, and this gives rise to a deductible temporary difference.

Government grants may also be set up as deferred income (see IAS 20), in which case the difference between the deferred income, and its tax base of nil, is a deductible temporary difference. Whichever method of presentation an undertaking adopts, the undertaking does not record the resulting deferred tax asset.

This exception does not apply to a compound financial instrument that is recognised as both debt and equity.

The deferred tax impact of the temporary difference on the debt component is recognised as part of the carrying amount of the equity component.

Certain investments

Undertakings should recognise deferred tax assets or liabilities for investments in subsidiaries, associates and joint ventures except in the following situations:

i) deferred tax liabilities should not be recorded where the parent (or investor) is able to control the timing of the reversal of the temporary difference, and it is probable that the temporary difference will not reverse in the foreseeable future; and

ii) deferred tax assets should not be recorded if the temporary differences are expected to continue to exist in the foreseeable future.EXAMPLE-Control of timing of dividendsThese conditions may be met where a parent has control over a subsidiary's dividend policy and has decided that undistributed profits will not be distributed in the foreseeable future.

Investors should usually record deferred tax liabilities for associates and joint ventures, unless there is an agreement between the parties that profits will not be distributed in the foreseeable future.EXAMPLE-AssociateYou have a 40% share of a company. It has been agreed that dividends will be paid annually, if cash is available. Deferred tax should be calculated for any timing differences.

This reflects the tax that would be paid in the parent undertaking if dividends are received from group companies, especially foreign investments.

The assumption is that the profits made by these investments will be paid to the parent, and that deferred tax needs to be provided.

To avoid providing deferred tax, the parent must show that such dividends will not be paid.

8 Deferred Tax Assets

Deferred tax assets arising from deductible temporary differences must be reviewed to determine to what extent they should be recognised. The realisation of deferred tax assets depends on taxable profits being available in the future.

EXAMPLE-Unusable deferred tax assetsYou have a deferred tax asset of $1m. The firm is continually generating losses, and the directors decide to liquidate the firm over the next two years. Further losses are anticipated in the next two years.

The deferred tax asset should be written off, unless there is a realistic method to transfer it to another firm that can use it.

I/B DR CRDeferred tax asset B 1mTax expense I 1mWrite off of deferred tax asset

Taxable profits (on which tax will be paid) arise from three sources:

i) Existing taxable temporary differences: taxable temporary differences exist relating to the same tax authority and the same taxable undertaking.

To qualify as a deferred tax asset, these differences should reverse in the same period as the expected reversal of the deductible temporary difference; or in the periods into which a tax loss arising from a deferred tax asset can be carried back or forward.EXAMPLE-Usable deferred tax assetsYou have a tax loss of $10m. The firm will have a tax liability next year from a taxable temporary difference of $15m. A deferred tax asset should be recorded, as it will reduce next year’s payment.

I/B DR CRDeferred tax asset B 10mTax income I 10mCreation of deferred tax asset from a tax lossii) Future taxable profits: the undertaking may recognise a deferred tax asset where it anticipates sufficient future taxable profits.

iii) Tax-planning activities: undertakings commonly engage in tax-planning activities to use tax assets.

Tax-planning activities manage taxable profit so that existing tax losses and credits do not expire. Tax-planning activities usually attempt to

move taxable profit between periods to use credits and losses.

Tax-planning opportunities should be considered in determining whether recognition of a deferred tax asset is appropriate. They should not

however be used as a basis for reducing a deferred tax liability until it is settled.

Unused tax losses and credits

An undertaking may record a deferred tax asset arising from unused tax losses (or credits) when it is probable that future taxable profit will be available against which the unused losses (and credits) may be utilised.

Tax losses, however, may indicate that future taxable profit will not be available. This would be the case if the undertaking is continually trading at a loss.Outstanding sales contracts and a strong earnings history, exclusive of a loss (for example from the sale of an unprofitable operation), may provide evidence of future taxable profit.

EXAMPLE - Interim financial statements - change in estimate

IssueIncome tax expense is recognised in each interim period based on the best estimate of the weighted average annual income tax rate expected for the full financial year. Amounts accrued for income tax expense in one interim period may have to be adjusted in a subsequent interim period of that financial year if the estimate of the annual income tax rate changes [IAS34].

How should management account for the change in interim tax estimates in the subsequent financial statements?

Background

Entity A has unused tax losses carried forward at 31 December

20X2 of 3,000,000. A’s management did not recognise a deferred tax asset in the 20X2 annual financial statements because of uncertainties regarding the utilisation of those losses. Forecasts showed no expected taxable profits for the next three years.

Management took the same view in the first quarter of 20X3 after incurring further losses. Management therefore did not recognise a deferred tax asset in respect of the losses. The losses carried forward at 31 March 20X3 were 3,060,000.

Management signed a new 3-year contract with a major customer during the second quarter of 20X3.The contract provided a significant increase in plant utilisation. Management revised their profit forecasts based on this new contract and predict that the tax losses will be fully utilised in 24 months.

Management therefore have a valid basis for recognising a deferred tax asset for the whole of the tax losses carried forward in the second quarter interim financial statements.

SolutionManagement should recognise a deferred tax asset for the whole of the tax losses carried forward, with the corresponding deferred tax credit recognised in the second quarter income statement.

The event that has caused the recognition of the deferred tax asset is the signing of the contract in the second quarter. Recognition of the deferred tax in the second quarter is appropriate even though the income to be generated from the contract will not be earned until future quarters.

The undertaking should record a deferred tax asset only to the extent that it has sufficient taxable temporary differences to match it, or where there is strong evidence that sufficient taxable profit will be available.

EXAMPLE - Deferred tax assets for losses

Entity C has significant tax losses, having made trading losses for the last two years and is considering how much of this can be recognised as a deferred tax asset. The budgets and forecasts for the next five years show a return to profitability in year four.

What factors should be taken into account when determining whether a deferred tax asset can be recognised?

IAS 12 does not specify a time period in which recognised tax losses should be recovered. Therefore, there should be no arbitrary cut-off in the timehorizon over which an assessment of recoverability is made, whether or not budget information is available after a certain period.

Only if it is not probable that future taxable profit will be available at all is a deferred tax asset not recognised. Otherwise, a deferred tax asset is recognised to the extent it is considered probable there will be future taxable profits.

Where an entity has a history of recent losses, it recognises a deferred tax assetonly where there are sufficient taxable temporary differences or where there is convincing other evidence that there will be future taxable profits; such a historymay be strong evidence that future taxable profit will not be available.

It may be that the probability of taxable profits decreases the further into the future we look, but any such assessment should be based on the facts. In some cases, it may be clear that no taxable profits are probable after a specific time, for example, where significant contracts or patent rights terminate at a specific date.

In other cases, the assessment should take into account the

maximum taxable profits that are considered just more probable than not in each year prior to expiry of the taxlosses. This may result in lower estimates for years in the distant future, but it does not mean that those years should not be considered.

Care should also be taken to ensure that the projections on which such assessments are made are consistent with other communications made by management and with the assumptions made about the future in relation to other aspects of financial accounting (eg, impairment testing), except where relevant standards require a different treatment (eg, impairment testing must not take account of future investment).

In addition, in such circumstances, consideration should be given to the disclosures about key sources of uncertainty required by IAS 1, Presentation of Financial Statements.

EXAMPLE - Portfolio provision - deferred tax

IssueA 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 the deductible temporary difference can be utilised, unless certain limited exceptions apply.

Should a bank’s management calculate a deferred tax asset on the allowance for loan impairment determined on a portfolio basis?

BackgroundBank A calculates its allowance for loan impairment on a portfolio basis. The approach is applied to sub-portfolios of loans that either have not been identified as individually impaired or are not

individually significant. Impairment and uncollectibility are measured and recognised in the financial statements of the bank in accordance with IFRS 9.

A’s management expect the loan portfolio to increase in future years and the amount of the provision is also expected to increase. Tax relief is obtained only when a specific loan is written off. Management believe that is not likely that the temporary differences will reverse in the medium term, if at all.SolutionYes, management should recognise a deferred tax asset.

The allowance for loan impairment affects the carrying value of the loan portfolio and accounting profit. There is no adjustment to the tax base of any loans. Consequently, a deductible temporary difference exists between the tax base of the loan portfolio and its carrying value. Deferred tax should be recognised on this temporary difference.

The undertaking must also consider the time limits for which tax authorities permit such losses and credits to be carried forward, in assessing recoverability.

EXAMPLE - Deferred tax asset on deductible temporary differences based on a business plan

Issue When there are insufficient taxable temporary differences relating to the same taxation authority and the same taxable entity, a deferred tax asset is recognised to the extent that taxable profit will be available.

Can management recognise a deferred tax asset if the entity does not have a track record of profit generation?

Background

Management of entity C, a car-making entity, undertakes a reorganisation. The reorganisation involves the transfer of C’s IT services department to a separate entity, entity A.

Entity A will have a net deductible temporary difference, because of the transfer of accrued pension costs related to the employees of the IT department.Management expects A to incur losses for the first year of A’s operations but expects it to become profitable thereafter. The forecast future profit is based on sales to third parties using existing business processes.

SolutionManagement should not recognise a deferred tax asset.

A’s performance will depend on sales to third parties, with which management is not experienced. Management should therefore not recognise the deferred tax asset because it is not probable that taxable profits will be available.

9 Determine appropriate tax rates

Deferred tax assets and liabilities should be measured at the tax rates expected to apply to the period when the asset or liability is liquidated.

EXAMPLE-Tax rates

You have a taxable temporary difference of $200m. The rate of income tax is 20%. Although there are rumours that the rate for future years will be lower, no official announcement has yet been made.The current rate must be used.

The deferred tax liability will be $200m * 20% = $48m.

I/B DR CR

Deferred tax liability B 40mTax expense – deferred tax I 40mCreation of a deferred tax liabilityThe best estimate of the tax rate that will apply in the future is the tax rates that have been enacted (or ‘substantively enacted’) at the balance sheet date.

Tax rates have been ‘substantively enacted’ when draft legislation is nearing the end of the approval process.

When different rates of tax apply to different types and amounts of taxable income, an average rate is used.

EXAMPLE - Use of average rate

Issue Deferred tax assets and liabilities are measured using the average rates that are expected to apply to the taxable profit (tax loss) of the periods in which the temporary differences are expected to reverse, when different tax rates apply to different levels of taxable income [IAS12R.49].

Can management use one tax rate for a specific temporary difference and a different, average, tax rate for the remaining temporary differences, when graduated tax rates apply? Background Entity A operates in a country where different rates apply to different levels of taxable income.

At 31 December 20X3 the net deductible temporary differences total 30,000. Management expects the temporary differences to reverse over the next seven years. The average projected profit for the next seven years is 60,000.

A deductible temporary difference related to impairment of trade receivables of 25,000 is expected to fully reverse in 20X5, when the related expense will be deductible for tax purposes.

SolutionYes, management should consider separately the impact of this temporary difference reversing in a single year.

The reversal of this large temporary difference will cause a distortion in the average statutory tax rate. Management should therefore consider its effect separately when calculating the average statutory rate to be used for deferred tax assets and liabilities.

The following table illustrates how management may calculate the deferred tax assets and liabilities, assuming certain graduated tax rates:Average Year 2005

Range Tax rate Profit Income tax Profit Income tax

- 1,000 18% 1,000 180 1,000 180

1,001 10,000 25% 10,000 2,500 10,000 2,500

10,001 25,000 30% 25,000 7,500 24,000 7,200

25,001 50,000 40% 24,000 9,600

60,000 19,780 35,000 (a) 9,880

Average rate 33% 28%

(a) Average profit - temporary difference (60,000 - 25,000 = 35,000)

Management should apply a tax rate of 28% for the deferred tax asset related to impairment of trade receivables, and 33% for the remaining temporary differences.

The measurement of a deferred tax asset or liability should reflect the way the undertaking expects to liquidate the asset's carrying value or the liability.

For example, if the undertaking expects to sell an investment and the transaction is subject only to capital gains tax, the undertaking should measure the related deferred tax liability at the tax rate applicable to capital gains, if different from the income tax rate.

Profits may be taxed at different rates depending on whether they are distributed to shareholders. An undertaking should measure deferred tax assets and liabilities using the tax rates applicable to undistributed profits.

When a dividend is subsequently declared and recorded in the financial statements, the undertaking should recognise the dividend's tax consequences to the undertaking (if any).

Deferred tax assets and liabilities must not be measured on a discounted basis.

EXAMPLE - Applicable tax rate for reconciliation between tax

expense and accounting profit when there are several domestic income-based taxes

IssueManagement must explain the relationship between tax expense (income) and accounting profit. This may be a numerical reconciliation between actual and expected tax expense (income) or between the average effective tax rate and the applicable tax rate.

The applicable tax rate that provides the most meaningful information to the users of the financial statements should be used.

What tax rates should management include in the applicable tax rate when an entity operates under a tax regime levying more than one income-based tax?

BackgroundEntity G operates in country H in two locations A and B. All entities in country H incur three principal taxes; a Federal tax, a Local tax and a President’s Special tax. G generates profits and incurs tax in regions A and B as follows:

Region A B Total

Accounting profit 75,600 19,100 94,700Taxable profit for Federal and President’s Special tax purposes

70,350 18,860

Taxable profit for Local tax purposes

48,600 13,000

Federal tax rate 25% 25%President’s Special Tax rate

5.5% 5.5%

Local tax rate 4% 7%

The source of profits is consistent from year to year, that is G consistently generates approximately 80% of its profits in region A each year.

The taxable profit for local income tax purposes is based on the taxable profit for Federal purposes, less the amount of Federal and President’s Special tax charged plus or minus some additional minor items.

Management propose that only the Federal tax rate of 25% be included in the applicable tax rate.

Solution

Management should provide a reconciliation of the expected tax charge rather than the effective tax rate.

EXAMPLE - Change in tax status effective during the period

IssueThe carrying amount of deferred tax assets and liabilities may change even though there is no change in the amount of the related temporary differences. This can result, for example, from a change in tax rates or tax laws.

Can management recognise directly in equity the tax consequences of a change in an entity’s tax status effective during the accounting period?

BackgroundOn 31 August 20X2, entity A changed its status from one type of limited company to another. Entity A therefore became subject to a higher income tax rate (30%) than it was previously (25%).

The change in applicable tax rate applies to taxable income generated from 1 September 20X2. The tax rates applicable to a profit on sale of land are also different and amount to 40% compared with 30% previously.

The information below relates to temporary differences that exist at 1 January 20X2 and at 31 December 20X2 (the end of accounting period) and which will all reverse after 1 January 20X3.

Carrying amount Tax base Temporary difference

Carrying amount Tax base Temporary difference

01/01/X2 01/01/X2 31/12/X2 31/12/X2Trade receivables

2,200 2,500 (300) 2,500 2,800 (300)

Land (carried at revalued amount)

800 500 300 800 500 300

Plant and machinery

3,000 800 2,200 2,900 600 2,300

Warranty provisions

(1,000) 0 (1,000) (1,000) 0 (1,000)

Total 5,000 3,800 1,200 5,200 3,900 1,300

Solution

No, the tax consequences of the change in applicable tax rate should be included in net profit or loss for the period, unless they relate

to items originally recognised directly in equity.

The deferred tax at the opening and closing balance sheet dates is calculated as follows:

Temporary difference

Deferred tax Temporary difference

Deferred tax

01/01/X2 31/12/X2Trade receivables (300) (300)Plant and machinery 2,200 2,300Warranty provisions (1,000) (1,000)Total 900 225 (900x25%) 1,000 300 (1,000x30%)

Land (carried at revalued amount) 300 90 (300x30%) 300 120 (300x40%)

The change in deferred tax relating to the receivables, the plant and machinery and the warranty provisions is included in the income statement. The change in deferred tax relating to the land is included in equity because the revaluation of the land is included in equity.

Management must disclose the change in the entity’s tax status and the quantification of this change in the notes to the financial statements.

EXAMPLE - Dividends declared after balance sheet date

Issue Income taxes might be payable at a higher or lower rate if part or all of the net profit or retained earnings is paid out as a dividend to an entity’s shareholders. Management should, in these circumstances, measure current and deferred tax assets and liabilities at the tax rate applicable to undistributed profits.Should management apply the tax rate applicable to distributed profits for the portion of net profit corresponding to dividends declared after the balance sheet date?

Background

Management declared in February 20X4 a dividend of 400 payable on 31 March 20X4. Management did not recognise a liability for the dividend at 31 December 20X3 in accordance with the requirements of IAS 37. The profit before tax was 2,000. The tax rate is 30% for undistributed profits and 40% for distributed profits.

SolutionNo, management should apply the tax rate applicable to undistributed profit.

The recognition of the obligation to pay dividends is the trigger that requires management to use the tax rate for distributed profit. Management should therefore recognise a current income tax

expense of 600 (2,000 x 30%).

During 20X4 management will recognise a liability for dividends payable of 400. It should also recognise additional tax liability 40 (400 x 10%) as a current tax liability and an increase of the current income tax expense for 20X4.

Zero capital gains tax

IssueThe measurement of deferred tax liabilities and deferred tax assets should reflect the tax consequences that would follow from the way in which management expects to recover or settle the underlying asset or liability [IAS12R.51].

How would this affect the calculation of deferred tax of an entity that does not suffer any tax consequences from the gain on sale of an asset?

BackgroundAn entity acquired a building on 1 January 20X1 for 3,000,000. Depreciation for the building is over 30 years and is not deductible for tax purposes. Any gain on the sale of building is not taxable. The entity carries the building at revalued amount. As at 31 December 20X1, the building is revalued at 3,200,000. Tax rate of 30% would apply to other income.

SolutionOn 1 January 20X1 (date of acquisition)

The temporary differences as at 1 January 20X1 can be measured as follows:

Carrying amount 3,000,000 (acquisition cost)

Less: future taxable income

(3,000,000) (future assessable income should be at least the carrying amount)

Add: future deductible amounts

- Depreciation is not deductible

Tax base -

Carrying amount 3,000,000

Taxable temporary differences

3,000,000

There is a taxable temporary difference, but it arises from the initial recognition of the asset and, accordingly, no deferred tax liability is recognised.

As at 31 December 20X1 (Carrying amount recovered through use of asset)

As at the end of the financial year, the entity intends to recover the building’s carrying amount through the use of the building. The temporary differences as at 31 December 20X1 can be measured as follows:

Carrying amount 3,200,000 (revalued amount)

Less: future taxable (3,200,000) (future assessable

income income should be at least the carrying amount)


- Depreciation is not deductible

Tax base -



3,200,000

Taxable temporary differences Tax

rateDeferred

tax liability

Initial recognition * 2,900,000

(3,000,000-100,000)

- -

Revalued amount** 300,000 30% 90,000

3,200,000 90,000

*: Taxable temporary differences arise from the initial recognition

and accordingly no deferred tax liability is provided

**: Taxable temporary differences arise from subsequent recognition of the increase in the building’s value. The subsequent increase will be recovered through the use of the building, which will generate profit from operation that is taxable at 30%. The tax rate applicable therefore would be 30%, and a deferred tax liability would be recognised. The corresponding entry is to equity because the underlying revaluation is recognised in equity.

As at 31 December 20X1 (Carrying amount recovered through the sale of asset)

As at the end of the financial year, the entity intends to recover the building’s carrying amount by selling it. The entity has entered into a binding agreement to sell the building before the end of the financial year. The temporary differences as at 31 December 20X1 can be measured as follows:

Carrying amount 3,200,000 (revalued amount)

Less: future taxable income

(3,200,000) (future assessable income should be at least the carrying amount)


3,000,000 Initial cost is deductible on sale

Tax base 3,000,000



200,000


Tax rate

Deferred tax liability

Proceeds in excess of cost*

200,000 0%0

*: Taxable temporary difference arising from the sale of the building, which is taxable at a rate of 0%.

10 Determine movement in deferred tax balances

The movements in deferred tax assets and liabilities should be recorded: -either as deferred tax expense/credit in the income statement; -or in equity, for those transactions for which the tax effects are recognised in equity.

EXAMPLE-Tax rates changes

You have a temporary taxable difference of $200m. The rate of income tax is 24%.

In the next period, an official announcement is made that the income tax rate will fall to 20%.

The deferred tax liability will be reduced to $200m * 20% = $40m. (This example assumes that all of the deferred tax relates to the income statement.)

I/B DR CRDeferred tax liability B 48mTax expense – deferred tax I 48mCreation of a deferred tax liabilityDeferred tax liability B 8mTax income (or reduction of tax expense) – deferred tax

I 8m

Change of rate of deferred liability

Subsequent recognition

At each balance sheet date, an undertaking should review unrecorded deferred tax assets to determine whether new conditions will permit the recovery of the asset.

EXAMPLE-Unrecognised deferred tax asset

Your firm has been making losses, and has generated tax losses of $50m. These were not shown on the balance sheet as no trading improvement was anticipated.

A Japanese company signs contracts to use your components in its new factory, which will return your firm to profit.

You decide that you will be able to use the carried-forward losses before they expire. You recognise these losses as a deferred tax asset.

The deferred tax asset will be $50m * 20% = $10m.

I/B DR CRDeferred tax asset B 10mTax income – deferred tax I 10mCreation of a deferred tax asset

For example, an acquirer in a business combination may not have recorded a deferred tax asset in respect of tax losses.

Subsequently, the acquired undertaking may however generate sufficient taxable profit to absorb these losses and permit recognition in the consolidated financial statements.

Similarly, an acquiree may have an unrecorded deferred tax asset relating to tax losses. Subsequent to acquisition, these losses are recoverable through utilisation of future taxable profit generated by the acquired group.

(This scenario assumes that the tax losses are not cancelled by the change in ownership of the acquiree.)

Subsequent measurement

The carrying amount of deferred tax assets and liabilities will change in subsequent periods with the recognition and reduction of temporary differences.

The carrying amount of a deferred tax asset should be reviewed at each balance sheet date for:

i) changes in tax rates;

ii) changes in the expected manner of recovery of an asset;

iii) changes in future profits.EXAMPLE- Changes in future profits

Your firm has been making losses, and has generated tax losses of $50m. These were not shown on the balance sheet as no trading improvement was anticipated.

A Japanese company signs contracts to use your components in its new factory, which will return your firm to profit.

You decide that you will be able to use the carried-forward losses before they expire. You recognise these losses as a deferred tax asset. The deferred tax asset will be $50m * 20% = $10m.

The following year, increased costs indicate that taxable profits will only use $10m of the $50m losses. You reduce the deferred tax asset by $40*20% = $8m.

I/B DR CRDeferred tax asset B 10mTax income – deferred tax I 10mCreation of a deferred tax assetTax expense – deferred tax I 8mDeferred tax asset B 8mReduction of deferred tax asset due to changes in future profits

11 Presentation

Change in tax status of an undertaking or its shareholder

A change in the tax status of an undertaking or its shareholder (parent) may have an immediate impact on the undertaking's current tax liabilities and assets, and alter its deferred tax assets or liabilities.

EXAMPLES –Change of tax status1. Your head office is relocated to another country. It adopts

the new country’s tax system.2. Your firm changes its legal status from a company to a

limited partnership, which requires it to adopt tax rules for limited partnerships.

3. Your firm is bought by another firm. The tax authorities cancel all brought-forward tax losses due to the change in ownership.

The tax consequences of a change in tax status should be included in tax expense, unless the underlying transaction was recorded in equity.

Tax assets and liabilities

Current and deferred tax assets and liabilities should be presented separately on the face of the balance sheet.

Deferred tax assets and liabilities should be classified as non-current.

Offset (netting an asset and a liability)

Current tax assets and liabilities should only be offset when:

-an undertaking has a legal right of offset; and -intends to settle on a net basis, or -to liquidate the asset and liability simultaneously.

The legal right only arises when the same tax authority levies the taxes, and that authority accepts settlement on a net basis.

EXAMPLE-OffsetYour firm has carry-forward tax losses of $15m that are recorded as a current asset. These were caused by trading losses last year.This year you have a tax charge for the year, due to trading profits.This is a current liability. When the tax authorities agree that the loss may be used to reduce the liability, it can be offset.

I/B DR CRTax loss-current asset B 15mTax income I 15mRecording previous year tax lossTax expense I 40mTax liability B 40mRecording tax charge for this yearTax liability B 15mTax loss-current asset B 15mOffsetting carry- forward loss against current liability

EXAMPLE- IAS 12 disclosures

At the year-end company C, reporting under IFRS, has property, plant and equipment (PPE) with carrying amounts, tax bases and temporary differences outlined in Table 1.These result from assets being deductible for tax purposes in a manner that differs from the depreciation recognised for accounting purposes.

At an effective tax rate of 30%, the PPE in a deferred tax liability position (the property and the office equipment) give rise to a deferred tax liability of £9 and the assets in a deferred tax asset position give rise to a deferred tax asset of £4.50.

The entity has a right to use the deferred tax asset to offset the deferred tax liabilities so, on the face of the balance sheet, the company discloses the net deferred tax liability position of £4.50.

IAS 12 requires disclosure in the notes to the financial statements in respect of each type of temporary difference. The amount of the deferred tax assets and liabilities recognised in the balance sheet for each period presented. Does this mean that the disclosure in the notes to the financial statements should show the gross position (that is, a deferred tax asset of £4.50 and a deferred tax liability of £9?)

No. We do not believe that IAS 12 requires a gross presentation because the deferred tax noted in the above table relates to the same type of temporary difference: that is, differences between depreciation for tax and accounting purposes.

The company has the right to offset the deferred tax asset and liability (so is presenting the net position in the balance sheet) so the amount of that net position relating to the difference between the carrying amount and tax base of PPE (that is, £4.50) should be disclosed as a component of the total deferred tax liability

recognised.

Table 1

Tax assets in consolidated financial statements of one group member may only be offset against a tax liability of another member if there is a right to offset and the group intends to settle on a net basis, or to liquidate the asset and liability simultaneously.

Similar conditions apply to offsetting deferred tax assets and liabilities. Deferred tax assets and liabilities in consolidated financial statements relating to different tax jurisdictions should not be offset.

The group's tax planning opportunities are not usually grounds for offset unless the opportunity relates to income taxes levied by the same tax authority on different group members, and the undertakings intend to liquidate the tax assets and liabilities on a net basis or simultaneously.

Tax expense

Tax expense (income) related to profit from ordinary activities should be presented on the face of the income statement. The main components of the tax expense (income) should also be disclosed (see Disclosure below).

12 Accounting for Deferred Tax - Detailed Rules Assets Carried at Fair Value

Standards permit certain assets to be carried at fair value, or to be revalued (for example, IAS 16, IAS 38, IFRS 9, and IAS 40).

In some countries, the revaluation of an asset to fair value affects taxable profit for the current period. As a result, the tax base of the asset is adjusted, and no temporary difference arises.

EXAMPLE-Revaluation of asset that is taxedYour group wishes to revalue its balance sheet prior to a public listing. Its subsidiary will suffer current tax on the revaluation.

I/B DR CRProperty B 200mRevaluation reserve B 200mRecording property revaluationTax expense –revaluation reserve B 48mCurrent tax liability B 48mRecording current tax charge on the equity component

In other countries, the revaluation of an asset does not affect taxable profit in the period, and the tax base of the asset is not adjusted. Such revaluations require deferred tax to be accrued.

The future liquidation of the carrying amount will result in a taxable flow of benefits to the undertaking, and the amount that will be assessed for tax purposes will differ from the amount of those benefits.

The difference between the carrying amount of a revalued asset, and its tax base, is a temporary difference and gives rise to a deferred tax liability, or asset.

EXAMPLE-Revaluation of an IAS 16 asset that is not subject to current tax. Your group wishes to revalue its balance sheet prior to a public listing. Its subsidiary will suffer no current tax on the revaluation.

I/B DR CRProperty B 300mRevaluation reserve B 300mRecording property revaluationRevaluation reserve - Tax expense B 60mDeferred tax liability B 60mRecording deferred tax charge on the equity component

This is true even if:

(1) the undertaking does not intend to dispose of the asset. The revalued carrying amount of the asset will be recovered through use (for example, depreciation). This will generate taxable income which exceeds the depreciation that will be allowable for tax purposes in future periods; or

(2) tax on capital gains is deferred, if the proceeds of the disposal of the asset are reinvested in similar assets. In such cases, the tax will become payable on sale (or use) of the similar assets.

EXAMPLE - Deferred tax arising from revaluation of land

Issue A deferred tax liability should be measured at the tax rates that are expected to apply to the period in which the liability is settled [IAS12R.47].

Which tax rate should management use for calculating the deferred tax liability in respect of revalued land?

BackgroundEntity A conducts its business in country Z. Management has revalued the land on which the entity’s industrial plant is located, and has recognised the increase from the revaluation in equity [IAS16R.39].

The tax rate applicable to a profit on sale of PPE in Country Z is 30%, and the tax rate applicable to taxable profits earned from using the asset is 40%.

SolutionManagement should use the tax rate applicable to a profit on sale of the land, that is, 30%, to determine the deferred tax associated with the property.

The difference between the revalued amount of the land and its tax base is a temporary difference and gives rise to a deferred tax liability [IAS12R.20]. The corresponding deferred tax charge should be recognised in equity because the revaluation increase is recognised in equity.

The land is a non-depreciable asset. The corresponding deferred tax liability that arises from the revaluation is measured based on the tax consequences that would follow from recovery of the land’s carrying amount through sale [SIC-21.5]. This is because the revalued amount of the land is not recovered through an accounting charge such as depreciation.

EXAMPLE - Convertible debt

Issue

The tax base of a liability component of a compound instrument on initial recognition may be equal to the initial carrying amount of the sum of the liability and equity components. The resulting taxable temporary difference arises from the initial recognition of the equity component separately from the liability component.

How should management calculate the deferred tax liability on the taxable temporary difference arising from the initial recognition of a compound instrument?

Background

An entity issues a convertible bond on 1 January 20X3 which will mature on 31 December 20X7. The holders of the bond have the right to convert the instrument into a fixed number of the entity’s ordinary shares at any time. The interest rate of the bond is 5% and is paid annually. The market interest rate is 7%.

Management calculates the initial amount of the liability and equity components by discounting the future cash flows associated with the liability element at 7%. Management determines the components as follows:

Liability component 1,836

Equity component 164

Total amount of the bond 2,000

Management will recognise an interest expense for accounting purposes based on 1,836 at the market interest rate of 7%. The

interest charge for accounting purposes will therefore be higher than the cash paid as interest on the bond.

A tax deduction will be received for the interest paid in cash. The difference between the interest expense for accounting purposes and the cash amount of interest is not deductible for tax purposes. The entity is subject to an income tax rate of 40%.

Solution

Management should calculate the deferred tax liability as the difference between the carrying amount of the liability element and the tax base of the bond.

Carrying amount of the liability component 1,836

Tax base of the liability component 2,000

Temporary difference 164

Deferred tax liability (164 x 40%) 66

The corresponding entry to the deferred tax liability is to the equity instrument. The equity element will therefore be stated at 98 (164-66). However, the effect of the subsequent changes in the carrying value of the liability component will be reflected as a deferred tax expense in the income statement.

The following table summarises the effects of the deferred tax over the period to maturity:

1/1/X3

31/12/X3

31/12/X4

31/12/X5

31/12/X6

31/12/X7

Carrying amount of the liability component

1,836 1,865 1,895 1928 1,963 2,000

Tax base

of the liability component

2,000 2,000 2,000 2,000 2,000 2,000

Taxable temporary difference

164 135 105 72 37 -

Deferred tax liability

66 54 42 29 15 -

Deferred tax expense

- 12 12 13 14 15

The deferred tax expense corresponds to the difference between the accounting interest expense and the cash interest expense of the bond. The following table illustrates:

31/12/X3 31/12/X4 31/12/X5 31/12/X631/12/X7

Nominal interest (5%)

100 100 100 100100

Interest market rate (7%)

129 131 133 135137

Difference 29 31 33 35 37

Income tax on the

difference (40%)

12 12 13 14 15

Items Credited or Charged Directly to Equity

Current tax and deferred tax should be charged, or credited, directly to equity, if the tax relates to items that are credited, or charged, in the same or a different period, directly to equity (see revaluation examples above).

Standards require or permit certain items to be credited, or charged, directly to equity. Examples of such items are:

(1) a change in carrying amount arising from the revaluation of property, plant and equipment under IAS 16 ;

(2) an adjustment to the opening balance of retained earnings, resulting from either a change in accounting policy applied retrospectively, or the correction of an error. IAS 8 has seriously limited this application;

(3) exchange differences, arising on the translation of the financial statements of a foreign undertaking in consolidation; and

(4) amounts arising on initial recognition of the equity component of a compound financial instrument (see IFRS 9).

It may be difficult to determine the amount of current and deferred tax that relates to items credited, or charged, to equity. This may be the case when:

(1) there are graduated rates of income tax, and it is impossible to determine the rate at which a specific component of taxable profit (tax loss) has been taxed;

(2) a change in the tax rate or rules, affects a deferred tax asset, or liability, relating to an item that was previously charged to equity; or

(3) an undertaking determines that a deferred tax asset should be recorded, or should no longer be recorded in full, and the deferred tax asset relates to an item that was previously charged to equity.

In such cases, the current and deferred tax is based on a reasonable pro-rata allocation of the current, and deferred tax in the tax jurisdiction concerned, or other method that achieves a better allocation in the circumstances.

Under IAS 16, an undertaking may transfer each period, from revaluation surplus to retained earnings, an amount equal to:the difference between the depreciation (or amortisation) on a revalued asset, and the depreciation (or amortisation) based on the cost of that asset. (see IAS 16 workbook.)

If an undertaking makes such a transfer, the amount transferred is net of any related deferred tax.

Similar considerations apply to transfers made on disposal of an item of property, plant or equipment and any related revaluation surplus.

When an asset is revalued for tax purposes, and that revaluation is related to an accounting revaluation of an earlier period, or to a future period, the tax effects of both the asset revaluation and the adjustment of the tax base are credited (or charged) to equity, in the periods in which they occur.

However, if the revaluation for tax purposes is not related to an accounting revaluation, any tax effects of the adjustment of the tax base are recorded in the income statement.

Current and deferred tax arising from share-based payment transactions

An undertaking may receive a tax deduction that relates to remuneration paid in shares, share options or other equity instruments of the entity. The amount of that tax deduction may differ from the related cumulative remuneration expense, and may arise in a later accounting period.

For example, an entity may recognise an expense for the salaries paid for in share options granted, in accordance with IFRS 2 Share-based Payment, and not receive a tax deduction until the share options are exercised, with the tax deduction based on the entity's share price at the date of exercise.

The difference between the tax base of the employee services received (the amount the taxation authorities will permit as a

deduction in future periods), and the carrying amount of nil, is a deductible temporary difference that results in a deferred tax asset.

If the amount of the tax deduction for future periods is not known at the end of the period, it shall be estimated, based on information available at the end of the period.

For example, if the amount that the tax deduction in future periods is dependent upon the undertaking's share price at a future date, the measurement of the deductible temporary difference should be based on the entity's share price at the end of the period.

Revaluations under IAS 16 + IAS 40

If a deferred tax liability or deferred tax asset arises from a non-depreciable asset measured using the revaluation model in IAS 16 or IAS 40, the measurement of the deferred tax liability or deferred tax asset shall reflect the tax consequences of recovering the carrying amount of the non-depreciable asset through sale, regardless of the basis of measuring the carrying amount of that asset.

Accordingly, if the tax law specifies a tax rate applicable to the taxable amount derived from the sale of an asset that differs from the tax rate applicable to the taxable amount derived from using an asset, the former (sale) rate is applied in measuring the deferred tax liability or asset related to a non-depreciable asset.

In the case of IAS 40, this assumption can be rebutted.

Other Comprehensive Income

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Deferred tax on revaluation movements listed in Other Comprehensive Income will be included with them in that financial statement. The notes will identify the amount of deferred tax relating to each component.

13 Disclosure

(Please also refer to ‘Illustrated Corporate Consolidated Financial Statements’ and ‘Illustrative consolidated financial statements for Banks’ published by PricewaterhouseCoopers and available on its website. This provides sample notes illustrating some of the disclosures listed here.)

The major components of tax expense (income) should be disclosed separately.

Components of tax expense (income) may include:

(1) current tax expense (income);

(2) any adjustments, recorded in the period, for current tax of prior periods;

(3) the amount of deferred tax expense (income) relating to the start, and reversal, of temporary differences;

(4) the amount of deferred tax expense (income) relating to changes in tax rates, or new taxes;

(5) the amount arising from a previously unrecorded tax loss, tax credit, or temporary difference of a prior period, that is used to reduce current tax expense;

(6) the amount from a previously unrecorded tax loss, tax credit, or temporary difference of a prior period, that is used to reduce deferred tax expense;

(7) deferred tax expense arising from the write-down, or reversal of a previous write-down, of a deferred tax asset; and

(8) the amount of tax expense (income) relating to those changes in accounting policies, and errors, which are included in the net profit for the period.

Group’s reconciliation between tax expenses and accounting profit when there are several subsidiaries with different tax rates

Issue Management should disclose an explanation of the relationship between tax expense and accounting profit, by presenting a numerical reconciliation either between tax expense and accounting profit or between the average effective tax rate and the applicable tax rate.

How should management present such a reconciliation in a group’s financial statements when there are several subsidiaries with different tax rates?

Background Entity L is incorporated in Luxembourg and is a non-operating holding entity. L has subsidiaries in Italy, Finland and Brazil. The following table provides information for each member of the group in respect of its statutory tax rate and its profit before tax:

Country Statutory tax rate (A)

Profit before tax (B)

Tax at statutory tax

rate (AxB)

Tax at difference between

Luxembourg rate and statutory rate

(A-25%)x(B)

Tax charge per consolidated

financial statements

Luxembourg 25% 20 5 -

Italy 37% 700 259 84

Finland 29% 400 116 16

Brazil 33% 500 165 40

Total 1,620 545 140 520

Management would prefer to present a reconciliation of monetary amounts rather than a reconciliation of the tax rates.

Solution

Management may choose to reconcile the tax charge to the tax rate of the parent, L, or to reconcile to an aggregate of separate reconciliations for each country. The following illustrates the two alternative methods:

Reconciliation of tax expense

Tax rate of parent Average tax rate

Profit before tax 1,620 1,620

Tax at the domestic rate of 25% 405 NA

Tax calculated at the domestic rates applicable

to profits in the country concerned NA 545

Income tax not subject to tax (50) (50)

Expenses not deductible for tax purposes 25 25

Effect of different tax rates in countries in which the group operates 140 NA

Tax charge 520 520

Management should take into consideration what is the most meaningful information to the users of its financial statements when selecting the way to present the reconciliation.

The following should also be disclosed separately:

(1) the total current and deferred tax relating to items that are charged, or credited, to equity;

(2) an explanation of the relationship between tax expense (income) and accounting profit, in either, or both, of the following forms:

(i) a numerical reconciliation between tax expense (income) and the product of accounting profit multiplied by the applicable tax rate(s), disclosing

also the basis on which the applicable tax rate(s) is (are) computed, or

(ii) a numerical reconciliation between the average effective tax rate and the applicable tax rate, disclosing also the basis on which the applicable tax rate is computed;

(3) an explanation of changes in the applicable tax rate(s) compared to the previous accounting period;

(4) the amount (and expiry date, if any) of deductible temporary differences, unused tax losses, and unused

tax credits for which no deferred tax asset is recorded in the balance sheet;

(5) the total amount of temporary differences associated with investments in subsidiaries, branches and associates, and in joint ventures, for which deferred tax liabilities have not been recorded;

(6) for each type of temporary difference, and for each type of unused tax losses and credits:

(i) the amount of the deferred tax assets, and liabilities, recorded in the balance sheet for each period presented;

(ii) the amount of the deferred tax income, or expense, recorded in the income statement, if this is not apparent from the changes in the amounts recorded in the balance sheet;

(7) in respect of discontinued operations, the tax expense relating to:

(i) the gain (or loss) on discontinuance; and

(ii) the profit (or loss) from the ordinary activities of the discontinued operation for the period, with the corresponding amounts for each prior period presented; and

(8) the income tax consequences of dividends that were proposed, or declared, before the financial statements were approved for issue, but are not recorded as a liability in the financial statements.

An undertaking should disclose the amount of a deferred tax asset, and the evidence supporting its recognition, when:

(1) the undertaking has suffered a loss, in either the current, or preceding, period in the tax jurisdiction to which the deferred tax asset relates; and

(2) the utilisation of the deferred tax asset is dependent on future taxable profits, in excess of the profits arising from the reversal of existing taxable temporary differences.

In these circumstances, an undertaking should disclose the nature of the potential tax consequences that would result from the payment of dividends to its shareholders.

In addition, the undertaking should disclose the amounts of the potential tax consequences determinable, and whether there are any potential tax consequences not determinable.

These disclosures enable users to understand whether the relationship between tax expense (income) and accounting profit is unusual, and to understand the factors that could affect that relationship in the future.

The relationship between tax expense (income), and accounting profit may be affected by such factors as:- revenue that is exempt from tax, - expenses that are not deductible in determining taxable

profit,- the effect of tax losses, and- the effect of foreign tax rates.

In explaining the relationship between tax expense (income) and accounting profit, an undertaking uses an applicable tax rate that provides the most meaningful information to the users.

Usually the most meaningful rate is the undertaking’s local rate of tax.

For an undertaking operating in several countries, it may be more meaningful to aggregate separate reconciliations, prepared using the domestic rate in each individual jurisdiction.

The average effective tax rate is the tax expense (income) divided by the accounting profit.

It would often be impracticable to compute the amount of unrecorded deferred tax liabilities arising from investments in subsidiaries, branches and associates, and joint ventures.

Therefore, IAS 12 requires an undertaking to disclose the aggregate amount of the underlying temporary differences.

Undertakings may also disclose the amounts of the unrecorded deferred tax liabilities, as users may find such information useful.

An undertaking discloses the important features of the income tax systems, and the factors that will affect the amount of the potential income tax consequences (to the undertaking) of dividends, if any.

It may not be practicable to compute the tax consequences from the payment of dividends to shareholders. This may be the case where an undertaking has a large number of foreign subsidiaries.

However, even in such circumstances, some portions of the total amount may be easily determinable. For example, in a consolidated group, a parent, and some of its subsidiaries, may

have paid taxes at a higher rate on undistributed profits, and be aware of the amount that would be refunded on the payment of future dividends, from consolidated retained earnings. In this case, that refundable amount is disclosed.

If applicable, the undertaking also discloses that there are additional tax consequences not determinable.

In the parent's separate financial statements, if any, the disclosure of the tax consequences relates to the parent's retained earnings. An undertaking, required to provide these disclosures, may also be required to provide disclosures related to temporary differences, associated with investments in subsidiaries, branches and associates or joint ventures.

For example, an undertaking may be required to disclose the aggregate amount of temporary differences associated with investments in subsidiaries, for which no deferred tax liabilities have been recorded.

If it is impracticable to compute the amounts of unrecorded deferred tax liabilities, there may be tax consequences of dividends not determinable, related to these subsidiaries.

An undertaking discloses any tax-related contingent liabilities and contingent assets (see IAS 37). Contingent liabilities, and contingent assets, may arise from unresolved disputes with the tax authorities.

Similarly, where changes in tax rates, or tax laws, are enacted, or announced, after the balance sheet date, an undertaking discloses any significant effect of those changes on its current and deferred tax assets and liabilities.

Exchange Differences on Deferred Foreign Tax Liabilities or Assets

Exchange differences that arise on foreign deferred tax assets and liabilities, may be included as part of the deferred tax expense (income).

A more usual presentation would be to include the exchange differences on deferred taxes as part of the foreign exchange gains and losses (see IAS21). Foreign currency-denominated deferred tax assets and liabilities are non-monetary items that are translated at the closing balance sheet rate, being the date at which they are measured (see IAS21).

14 Appendix – Some IFRS / Russian Accounting Comparisons.

This document was written based on the assumption that the client will undertake all reasonable legal efforts to calculate current tax liability correctly. At the same time tax planning schemes, which are not present at balance sheet date, are not taken into account for IAS 12 does not allow this.

Abbreviations used:

1. TAX - Russian tax calculation

2. IFRS - IFRS accounting

3. DTL - Deferred tax liability

4. DTA - Deferred tax asset

Balance sheet area

Nature of differenceTax treatment IAS 12

treatmentRationale Consult

with tax specialist?

All financial assets and liabilities

Interest income and expenses/Accruals

Accruals are taxable and deductible.

Interest expenses in excess of 1.1 of CBR refinancing rate for RR and 15% for USD (article #269 of the Tax Code) are not deductible.

Non-market income/expenses (article #40 of the Tax Code) not adjusted for the purposes of IAS 39.

Temporary

Permanent

Permanent

The differences may arise when special types of accrual are used (e.g. amortized cost). Result recognized in IFRS will be recognized later in TAX.

Excess expenses won’t be ever recognized.

Excess expenses recognized in IFRS won’t be ever recognized in TAX. Excess income recognized in TAX won’t be ever recognized in IFRS.

Yes

Yes

All financial assets and liabilities

Fair value adjustment under IFRS 9

These adjustments are not taxable/deductible. But if the financial instrument is exchanged for the similar instrument with market interest rate the resulting interests will be taxed / deducted.

Temporary Result recognized in IFRS will be recognized later in TAX. E.g. when the instrument will be disposed off before maturity.

Loans/Interbank

Provision for loan impairment

Provisions created for first group of risk are not deductible. There is no difference between secured and unsecured loans.

Temporary Result recognized in IFRS will be recognized later in TAX since all accounting ‘losses’ become deductible when REAL problems occur and the company can assign to loan higher group of risk.

Balance sheet area




Loans/ Interbank/Securities

Provision for promissory notes

Provisions are not deductible.

Exceptions for securitiesProvisions are deductible only for professional participants holding the dealer’s license.When promissory notes become overdue and there is legal evidence that the Bank would incur losses (decision of the court; sale of the promissory note to third party with losses; etc.) it is deductible.

Temporary Result recognized in IFRS will be recognized later in TAX when all accounting ‘losses’ become deductible (eg. through sale of the bad promissory note with loss).

Yes

Balance sheet area




Securities Dealing gains/losses

Revaluation is not deductible/taxable. Only realized results are deductible/taxable.

Note that clients not possessing professional licenses have to account for dealing gains/losses using different baskets. The result of each basket can’t be offset against each other.

Non-market income/expenses (articles #40 and #280 of the Tax Code). E.g. the Tax authorities may recalculate the prices of deals for listed securities using “convenient” quotations.

Temporary

Permanent

The MTM will be realized in future periods when the security will be disposed off. Thus it will be recognized in TAX.


Yes

Yes

Securities Interest income All results are taxable (including accruals). But different tax rates are used (see below).

Temporary The differences may arise when special types of accrual are used (e.g. amortized cost). Result recognized in IFRS will be recognized later in TAX.

Balance sheet area




Securities Coupon income on RR federal, subfederal and municipal bonds

All results are taxable (including accruals). Special rate applies to these gains – 15%.

Temporary

Permanent (reconciling item)

The differences may arise when special types of accrual are used (e.g. amortised cost).

The difference between the basic rate of 20% and 15% should be shown as reconciling item.

Securities Dividend income All results are taxable at source. Special rate applies to these gains – 6%.


If they are material we should gross them up. Dr. Income tax paidCr. Dividends received

The difference between the basic rate of 20% and 6% should be shown as reconciling item.

Balance sheet area




Investments in subs,associates

Equity accounting Capital gains are taxed at 20%.

But the company may decide to receive the gains from the investment in the form of dividends. Then 6% is applicable.

If the company doesn’t have intentions to sell investment forever and has the same intentions concerning dividends THEN these differences will never have tax implications.

Temporary


Permanent (but these differences are not disclosed in reconciling table. They are shown separately)

The difference may be recognized in TAX later when the investment will be sold.

If the management plans to receive dividends use 6%.

The differences from investments may not be recognized if:1) the parent, investor or venturer is able to control the timing of the reversal of the temporary difference; 2) and it is probable that the temporary difference will not reverse in the foreseeable futureTo identify the type of difference we should consider the intentions of the management (sale or dividends).

Investments available for sale

Fair value accounting The same rules (see preceding para) are applicable to these gains/losses.

Temporary The provisions of IAS 12 allowing not to recognize DTL if the company can control the timing of the reversal of the temporary difference are not applicable here since the definition of the investment available for sale involves the point that it will be realized in the foreseeable future.

Balance sheet area




Investments in subs,associates

Goodwill Amortization of goodwill is not deductible under Tax rules.

Permanent IAS 12 states that if amortization of goodwill is not deductible than this difference should be permanent.

Fixed assets Fixed assets revaluation

Revaluation performed before 1 January 2002 is deductible. Revaluation performed in RAS accounts after 1 January 2002 is not deductible. Revaluation performed on 1 January 2002 may be deductible (not more that 30% of the book value as at 01 January 2001). There is ambiguity in tax legislation. But the treatment may be in favour of client.

Temporary Difference will be realized either through sale of a fixed asset or through cash flows generated by the asset in the future.

If the tax treatment is approved by the client and our tax specialist we should calculate the temporary difference between two revaluations (RAS and IFRS) and recognize the deferred tax liability (DTL) or deferred tax asset (DTA). The corresponding entry will be to equity.

Yes

Fixed assets Depreciation Only depreciation within tax rates is deductible.

Temporary Differences between TAX and IFRS rates will become deductible either through sale of a fixed asset or through cash flows generated by the asset in the future. Thus they will lead to either to DTA or DTL.

Balance sheet area




Fixed assets Non-production Fixed Assets

Depreciation and losses from sale of fixed assets used for non-production purposes are never deductible.

BUT gains received from the sale are likely to be taxable.

Permanent

Temporary

If cost of purchase is greater than IFRS value than the tax value must be equal to IFRS value.

The excess of an IFRS value of the asset and tax base leads to DTL.

Yes

Other Assets/Liabilities

Forex Net losses from non-deliverable forwards on OTC market may be carried forward to future periods (not more than 10 years, not more than 30% of the taxable profit).

Temporary This is an example of tax loss carried forward. It can be used to decrease the current tax liabilities in future periods. We should estimate the recoverability of the asset and consider the creation of provision for it.

Yes

Other Assets/Liabilities

Forex/Securities/Precious metals (Term deals)

Revaluation of off-balance sheet position is taxable/deductible depending on the policy chosen by the company.

Temporary Irrespective of taxability/deductibility the revaluation will be realized in future periods when the delivery or offset will occur. Thus it will be recognized in TAX.Tax base equals zero. Thus IFRS value multiplied by tax rate = DTL/DTA.

Yes

Other liabilities

Provision for credit related commitments

Provisions for credit related commitments are not deductible.

Temporary When the payment under the guarantee is made and there is legal evidence that the Bank will incur losses (decision of the court; sale of the debt to third party with losses; etc.) it will be deductible.

Yes

Balance sheet area




Other liabilities

Accruals of expenses on other operations

General rule: all expenses are deductible.

But expenses in excess of norms are not deductible:1) Advertisement (% from salary)2) Representative expenses (% from salary)3) R&D expenses (less than 70% of the incurred expenses.

Temporary

Permanent

Accruals in IFRS will be paid in cash in future periods thus they will be deductible in TAX.

Excess expenses recognized in IFRS won’t be ever recognized in TAX.

Yes

Other assets Unused tax loss carried forward

It can be used during 10 years but not more than 30% of the current year profits.

Temporary It can be used to decrease the current tax liabilities in future periods. We should estimate the recoverability of the asset and consider the creation of provision for it.

Yes

Other assets DTA N/A N/A We should consider the recoverability of DTA. The major question is if the company will have enough taxable profits in next periods to utilize the DTA in full.

Balance sheet area




General Income/expenses created through SPVs and offshore zones

Examples:1) Dealing gains and losses;2) Interest earned/incurred in other tax zones while the asset/ liability is located in main zone.

The treatment of income and expenses earned and incurred in SPVs, offshore zones depends on the tax regulations valid for those territories. THUS the calculation of DTL for the consolidating SPV should be separate from the major one. Subsequently the calculations are consolidated.

Usually such income and expenses are subject to the tax rate different from the major rate.

BUT if there is an agreement between the SPV and Russian entity of the group to transfer the income/expenses then transferred results will be taxed using Russian tax rules.The rules of non-market income/expenses (articles #40 and #280 of the Tax Code) may be applicable. E.g. the Tax authorities may recalculate the prices of deals for listed securities using “convenient” quotations.


Temporary/Permanent

Permanent

The difference between the basic rate of 20% and offshore rate should be shown as reconciling item.

If the gains will be transferred to Russian entity then they will be subject to Russian tax rules. E.g. interest will be taxed at 20%.


Yes

15 Multiple Choice Questions

1.IAS 12 prescribes the accounting treatment for income taxes, and the tax consequences of:

(i) Transactions of the current period that are recorded in an undertaking's financial statements.

(ii) The future liquidation of the of assets and liabilities that are recorded in an undertaking's balance sheet.

(iii) Tax planning opportunities.

1. (i)2. (i)-(ii).3. (i)-(iii)

2. If liquidation of carrying amounts will make future tax payments larger or smaller, IAS 12 generally requires an undertaking to record a

1. Deferred tax liability (or deferred tax asset).2. Provision. 3. Contingent liability.

3. Permanent differences require:1.Deferred tax liability (or deferred tax asset).2. Provision. 3. Contingent liability.4. None of these.

4. Permanent differences require adjustments in the:1. Periods prior to the transaction.2. The periods relating to the transaction.3. Periods following the transaction.4. Both 2 & 3.

5. Deferred tax assets are the taxes recoverable, in future periods, in respect of:

(i) Deductible temporary differences.

(ii) Unused tax losses.

(iii) Unused tax credits.

(iv) Taxable temporary differences.

1. (i)2. (i)-(ii).3. (i)-(iii)4. (i)-(iv)

6. Deferred tax relates to: (i) Deductible temporary differences.

(ii) Unused tax losses.

(iii) Unused tax credits.

(iv) Taxable temporary differences.

(v) Permanent differences.

1. (i).2. (i)-(ii).3. (i)-(iii).4. (i)-(iv).5. (i)-(v).

7. Deferred tax 1. Reverses over time.2. May reverse over time.3. Does not reverse.

8. The use of deferred tax:1. Change the dates of payment of tax.2. May change the dates of payment of tax.3. Does not change the dates of payment of any tax.

9. If the tax already paid exceeds the tax due for the period, the excess will be recorded as:

1. Deferred tax.2. A permanent difference.3. An asset.

10. If revenue is taxed in the period received, the tax base:1. Is nil.2. Is only nil if the revenue is recognised in the same

period.3. Is only nil if the revenue is recognised in the

following period.4. Is the amount received.

11. Research and development costs may be expensed in the current period, but deductible for tax purposes over subsequent periods. The tax base:

1. Is nil.

2. Is the amount of the deduction that can be claimed in future periods.

3. Is the amount expensed.

12. Temporary differences arise:1. When the carrying amount of an asset or liability

differs from its tax base. 2. When deferred tax is applied.3. When deferred tax differs from current tax.

13. A deductible temporary difference generates a 1. Deferred tax Liability.2. Deferred tax Asset.3. Either 1 or 2.

14. A taxable temporary difference gives rise to:1. Deferred tax Liability.2. Deferred tax Asset.3. Either 1 or 2.

15. Taxable temporary differences occur when tax is charged in a period:

1. Before the accounting period benefits from the income in the financial accounts.

2. After the accounting period benefits from the income in the financial accounts.

3. Either 1 or 2.

16. Deductible temporary differences occur when tax is charged in a period:

1. Before the accounting period benefits from the income in the financial accounts.

2. After the accounting period benefits from the income in the financial accounts.

3. Either 1 or 2.

17. Differences arising from fair value adjustments are treated:

1.The same as any other taxable and deductible differences.

2. Differently depending on whether they arise on acquisition or otherwise.

3. Separately for deferred tax.

18. Not all temporary differences are recognised as deferred tax balances.

The exceptions are:

(i) Goodwill.

(ii) Initial recognition of certain assets and liabilities.

(iii) Certain investments.

(iv) Property revaluations.1. (i).2. (i)-(ii).3. (i)-(iii).4. (i)-(iv).

19. The realisation of deferred tax assets depends on:1. Accounting profits being available in the future.2. Taxable profits being available in the future.3. No increase in the rate of income tax.

20. When different rates of tax apply to different types and amounts of taxable income:

1. An average rate is used.2. No deferred tax is charged.3. Each item must be listed.

21. An undertaking should review unrecorded deferred tax assets to determine whether new conditions will permit the recovery of the asset:

1. Every 3 years.2. Every 5 years.3. At each balance sheet date.

22. The carrying amount of a deferred tax asset should be reviewed for:

(i) Changes in tax rates.

(ii) Changes in the expected manner of recovery of an asset.

(iii) Changes in future profits.

1. (i).2. (i)-(ii).3. (i)-(iii).

23. The difference between the carrying amount of a revalued asset and its tax base is a:

1. Temporary difference.2. Permanent difference.3. Either 1 or 2.

24. Standards require or permit certain items to be credited, or charged, directly to equity. Examples of such items are:

(i) A change in carrying amount arising from the revaluation of property, plant and equipment;

(2) An adjustment to the opening balance of retained earnings, resulting from either a change in accounting policy applied retrospectively, or the correction of an error. IAS 8 has seriously limited this application.

(iii) Exchange differences, arising on the translation of the financial statements of a foreign undertaking.

(iv)Amounts arising on initial recognition of the equity component of a compound financial instrument.

1. (i).2. (i)-(ii).3. (i)-(iii).4. (i)-(iv).

16 Answers to multiple choice questionsQuestion Answer1. 22. 13. 44. 2

5. 36. 47. 18. 39. 310. 111. 212. 113. 214. 115. 216. 117. 118. 319. 220. 121. 322. 323. 124. 4

17 NUMERICAL QUESTIONS

1. -Permanent DifferencesYour firm receives a $80million grant to employ more staff. It is tax- free. It is later fined $20m for environmental misuse, after illegally discharging chemicals into a river. The fine cannot be deducted for tax.Your tax computation will reconcile these adjustments to the accounting profit.

Accounting Profit = $ 4.860 m

Assuming that both items are taken into profit in full in the same period, calculate the tax computation.

2. If a transaction takes place in year 1 and tax is paid in year 2, year 1 will show a transaction without a tax charge, and year 2 will show a tax charge without a transaction:

Year 1 Year 2Income 400 0Tax expense @ 20%

0 -80

Net profit 400 -80

Calculate the deferred tax.

3. In the next example, the cash is received and taxed in year 1, but the income is split between years 1, 2 and 3.

Year 1 Year 2 Year 3Income 2000 2000 2000Tax expense @ 20%

-1200 0 0

Net profit 800 2000 2000


4. If a transaction takes place in year 1 and tax is credited in year 2, year 1 will show a transaction without a tax credit, and year 2 will show a tax credit without a transaction:


0 +200

Net profit -1000 +200


5. Tax is credited on payment of the money in period 1, but only treated as an expense in period 2.

Year 1 Year 2Expense 0 -300Tax income @ 20%

+60 0

Net profit +60 -300

Calculate the deferred tax

6. The cash is paid and credited for tax in year 1, but the expense is split between years 1, 2 and 3.


+1200 0 0

Net profit -800 -2000 -2000

Calculate the deferred tax

7. Tax expense split between the income statement and equity.Your tax computation shows an expense of $187m for the year, of which $30m relates to a property revaluation.

Provide the journal entries.

8. Tax loss: asset

Your tax computation shows a loss of $16m for the year, which can be carried back to recover tax of a previous tax period.

Provide the journal entries.9. Research and development costsYou spend $200m on research in the current period, and it is treated as an expense. Tax authorities only allow the expense to be deducted over a 4-year period. Only $50m is allowed in this period.


Provide the journal entries for years 1 & 2.

10. Revenue of 400 from the sale of goods is included in pre-tax accounting profit when goods are delivered in year 1, but may be included in taxable profit when cash is collected in year 2.


11. Development costs of 1.000 have been capitalised for accounting purposes and will be amortised to the income statement, but have been deducted as an expense in determining taxable profit in the period in which they were incurred. Amortised over 4 years starting in year 2.


12. Pension payments of 1.000 are recorded in year 1 for accounting purposes and but only for tax purposes when paid in cash in year 2.


13. An impairment loss of $100m of property is recorded for accounting purposes is ignored for tax purposes.


14. Financial instruments are carried at fair value, revaluing them with a gain of 400, but no matching revaluation is made for tax purposes.


15. Goodwill impairment charge of 4.000 is not deductible for tax purposes.


16. 40.000 of the retained earnings of controlled undertakings are included in consolidated retained earnings, but taxes are only paid on profits when distributed to the parent.


17. Tax rates changes


In the next year, an official announcement is made that the income tax rate will fall to 20%.


18. OffsetYour firm has carry-forward tax losses of $55m that are recorded as a current asset. You have a tax charge for the year in the same tax jurisdiction.This is a current liability of $700. The tax authorities agree that the lossmay be used to reduce the liability.


IAS 11 CONSTRUCTION CONTRACTS

18 ANSWERS TO NUMERICAL QUESTIONS

1.

2. Year 1 Year 2

Income 400 0Tax expense @ 20%

0 -80

Deferred tax @ 20%

-80 80

Net profit 320 0

3. Year 1 Year 2 Year 3

Income 2000 2000 2000Tax expense @ 20%

-1200 0 0

Deferred tax @ +800 -400 -400

20%Net profit 1600 1600 1600

4. Year 1 Year 2

Expense -1000 0Tax income @ 20%

0 +200

Deferred tax @ 20%

+200 -200

Net profit -800 0

5. Year 1 Year 2

Expense 0 -300Tax income @ 20%

+60 0

Deferred tax @ 20%

-60 +60

Net profit 0 -240

6. Year 1 Year 2 Year 3

Expense -2000 -2000 -2000Tax income @ 20%

1200 0 0

Deferred tax @ 20%

-800 +400 +400

Net profit -1600 -1600 -1600

7. http://bankir.ru/technology/vestnik/uchebnye-posobiya-po-msfoeng

$mAccounting Profit 4.860Less grant -80Plus fine +20=Taxable profit 4.800

Tax charge = 4.800 * 20% = 960

I/B DR CRTax expense I 0.96mAccrual for income tax B 0.96mTax expense for the period

98




Tax expense split between the income statement and equity.Your tax computation shows an expense of $187m for the year, of which $30m relates to a property revaluation.

I/B DR CRTax expense – income statement I 157mTax expense-revaluation reserve B 30mTax accrual B 187mTax expense split between the income statement and equity

8. Tax loss: assetYour tax computation shows a loss of $16m for the year, which can be carried back to recover tax of a previous tax period.

I/B DR CRTax recoverable B 16mTax income I 16mRecording recoverable tax loss

9. Research and development costsYou spend $200m on research in the current period, and it is treated as an expense. Tax authorities only allow the expense to be deducted over a 4-year period. Only $50m is allowed in this period.


I/B DR CRResearch cost I 200mCash B 200m

Tax credit @ 20% I 40mCurrent tax liability (reduction) B 10mDeferred tax asset B 30mResearch cost and tax income -period 1Current tax liability (reduction) B 10mDeferred tax asset B 10mTax income -period 2 (and the same for periods 3 & 4)

10. Revenue from the sale of goods is included in pre-tax accounting profit when goods are delivered, but may be included in taxable profit when cash is collected.

I/B DR CRAccounts receivable B 400Revenue I 400Deferred tax liability B 80Tax expense @ 20% I 80Receipt of cash and tax recognition -period 1Cash B 400Accounts receivable B 400Deferred tax liability B 96Current tax liability B 96Receipt of cash and tax liability recognition -period 2

11.





Development costs have been capitalised for accounting purposes and will be amortised to the income statement, but have been deducted as an expense in determining taxable profit in the period in which they were incurred. Amortised over 4 years, starting from the year after they were incurred.

I/B DR CRDevelopment costs (capitalised) B 1000Cash B 1000Current tax (reduction) @ 20% B 200Deferred tax liability B 200Development costs capitalised but allowed for tax credit -period 1Depreciation – development costs I 250Accumulated depreciation B 250Deferred tax liability B 50Tax income @ 20% I 50Depreciation and adjustment for tax -period 2

12. Pension payments of 1.000 are recorded in year 1 for accounting purposes and but only for tax purposes when paid in cash in year 2.

I/B DR CRPension expense I 1000Accrual B 1000Deferred tax asset B 200Tax income @ 20% I 200Accrual of pension costsCash B 1000Accrual B 1000Current tax (reduction) @ 20% B 200Deferred tax asset B 200

Cost and tax income recognition -period 2

13. An impairment loss of $100m of property is recorded for accounting purposes is ignored for tax purposes;

I/B DR CRImpairment of property I 100mAccumulated depreciation of property B 100mTax income @ 20% I 20mDeferred tax asset B 20mRecording impairment charge and (deferred) tax charge

14. Financial instruments are carried at fair value, revaluing them with a gain of 400, but no matching revaluation is made for tax purposes.

I/B DR CRFinancial instrument B 400Gain – fair value adjustment I 400Tax expense @ 20% I 80Deferred tax liability B 80Revaluation of financial instrument

15. Goodwill impairment charge of 4.000 is not deductible for tax purposes.





I/B DR CRImpairment-goodwill I 4000Goodwill B 4000Impairment of goodwill. NO DEFERRED TAX LIABILITY IS RECORDED.

16. 40.000 of the retained earnings of controlled undertakings are included in consolidated retained earnings, but taxes are only paid on profits when distributed to the parent.

I/B DR CRNet assets of subsidiary B 40000Profits/retained earnings I/B 40000Deferred tax liability B 8000Tax expense @ 20% I 8000

17. Tax rates changes


In the next period, an official announcement is made that the income tax rate will fall to 20%.

The deferred tax liability will be reduced to $400m * 20% = $80m. (This example assumes that all of the deferred tax relates to the income statement.)

I/B DR CRDeferred tax liability B 96mTax expense – deferred tax I 96mCreation of a deferred tax liability

Deferred tax liability B 16mTax income (or reduction of tax expense) – deferred tax

I 16m

Change of rate of deferred liability18. OffsetYour firm has carry-forward tax losses of $55m that are recorded as a current asset. You have a tax charge for the year in the same tax jurisdiction.This is a current liability of $700. The tax authorities agree that the lossmay be used to reduce the liability.

I/B DR CRTax loss-current asset B 55mTax income I 55mRecording previous year tax lossTax expense I 700mTax liability B 700mRecording tax chargeTax liability B 55mTax loss-current asset B 55mOffsetting carry- forward loss against current liability

Note: Material from the following PricewaterhouseCoopers publications has been used in this workbook:

-Applying IFRS, IFRS News, Accounting Solutions




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