CH.7 Income Taxes (Deferred Tax Assets and Liabilities) Flashcards
What are the 2 Main elements Noted in IAS12 Income Taxes?
Definitions:-
Current Tax
Deferred Tax
Tax Base
Temporary Difference
IAS 12 Income Taxes notes that there are two elements to tax that an entity must deal with:
- - Current Tax – the amount payable to the tax authorities in relation to the trading activities of the current period.
- - Deferred Tax – is an accounting measure used to match the tax effects of transactions with their accounting treatment. It is not a tax that is levied by the government that needs to be paid, but simply an application of the accruals concept.
Definitions:
- Tax Base - of an asset or liability is the amount used for tax purposes. = Tax Written Down the Amount
-
Temporary Difference - is the difference between the C.A of an asset/liability in the SFP (value from an accounting perspective) and its tax base (value from a tax perspective).
- NBV-TAX BASE = Temporary Difference
Define Deferred Tax Liability?
Deferred tax liability:
- - Represents taxes that must be paid at a future date. (Taxes due on a revaluation gain)
- - or that they represent a tax-deductible expense that has been accelerated and must be spread out, e.g (Capital allowances)
Define Deferred Tax Asset?
Deferred tax assets are items that may be used for tax relief purposes in the future.
Deferred tax asset is Debit Balance on the B/S,
- It accounts for taxes that have been paid but are chargeable against future profits.
- Overpaid taxes
- Tax Relief on past losses
How do you calculate “Tax Expense” for the year?
(The tax amount the is presented on final Profit and loss)
Tax Expense = Current Tax (+/–) Movement in Deferred tax
Note:
Pre Tax Profits
Add Back: None Tax Decutable Expenses(e.g Depreciation)
Less: Tax Allowances (e.g Capital Allowances)
= Current Year Tax (Current Liability for tax due to be paid)
(+/–) Movement in Deferred Tax in the Year
(Tax % on the Temporary difference of the Carrying Amount of an asset or Liability and its Tax Base/Tax Written down Amount)
= TOTAL TAX EXPENSE for the year
How do you account for Current Tax?
and
How is it affected by over and underprovisions?
Current Tax: the amount payable for current years trading activities.
Taxable Income (-)Less Allowable expenses = Current Tax
Journal:
- Dr - Tax Expense - P/L
- Cr - Tax Payable - SFP.C.L
Affect of over and Underprovisions?
- **Current tax is usually based on estimates.
- So this means it is likely been over provided or underprovided in the financial year. (by small amounts)**
- - The Next year when the final bill is calculated it will likely be more or less the amount provisioned in the previous year.
But the small difference is charged in the current year. This is treated as a change in estimates which is accounted for Prospectively. i.e Charged in the year.
Note:
- Under provision in the previous year (DR in TB/P.L) = Increase next yrs expense
- Over provision in the previous year (CR in TB/P.L) = Reduce next yrs expense.
What are the main principles of Deferred Tax?
Hint
- Temporary and Non-Temporary tax differences.
- Conceptual framework -
- Definition of an asset and liability
- Accruals concept
Deferred Tax is an accounting measure, used to match the tax effects of transactions with their accounting effect. (it is how the accruals concept is applied on tax differences)
During a year a company will apply accounting principles that often do not align with local tax legislation. This difference in accounting profits and losses and taxable profits and losses, some of these differences are temporary as others are not.
e.g.
*Non-Temporary difference - entertainment or fines for late filing are none deductible expenses and must be added back to taxable profits.
Temporary difference - New Machine purchased in the current year is held for 10 years and depreciated over a Straight Line basis. But the tax rules allow (AIA) the full cost to be deductible in the current year.
This creates an issue in the financial reporting if the difference is not recognised, it will misrepresent the performance of the organisation. As in the first year, it will show a small amount of tax, and the declining performance of the organisation in the following years.
- Temporary differences may mean that profits are reported in the financial statements before they are taxable by the authorities.
- Conversely, it might mean that tax is payable to the authorities even though profits have not yet been reported in the financial statements.
Conceptual framework
- Meets the definition of asset and liability
- According to the accruals concept, the tax effect of a transaction should be reported in the same accounting period as the transaction itself.
To ensure this, entities are required to account for deferred tax on temporary differences.
How do you calculate the Tax base of asset or liability?
The Tax base of an asset:
the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset.
If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount’
Simply - The Amount deductible against the taxable income.
- PPE Tax written down value = COST LESS TAX DEPRECIATION
Give examples of when a Temporary Tax Difference might occur?
- Tax deductions for the cost of non-current assets that have a different pattern to the write-off of the asset in the financial statements. (Capital Allowances)
- Intra-group profits in inventory that are unrealised for consolidation purposes yet taxable in the computation of the group entity that made the unrealised profit.
- (Loss relief Carried forward) Losses reported in the financial statements but the related tax relief is only available by carrying forward against future taxable profits.
- (Revaluation Gains) Assets are revalued upwards in the financial statements, but no adjustment is made for tax purposes.
- Development costs are capitalised but were deducted for tax purposes on a cash basis.
- The cost of granting share options to employees is recognised in profit or loss, but no tax deduction is obtained until the options are exercised. - (deferred tax asset)
How are the following differences Treated?
Taxable Temporary Differences
Tax Deductible Temporary Differences
Taxable Temporary Differences —) Deferred Tax liability
- Tax Base is lower than the Carrying Amount (positive balance)
-
Means Tax to pay in the future
- Initially recognised as:
Cr- SFP - Deferred Tax Liability
Dr- P/L - Deferred Tax Charge
- Initially recognised as:
Tax Deductible Temporary Differences —-) Deferred Tax Asset (negative balance)
- The Tax Base is higher than the carrying amount
-
Tax saving in the future
- Initially recognised as:
Dr - SFP - Deferred Tax Asset
Cr - P/L - Deferred Tax Charge
- Initially recognised as:
When are Deferred Tax Asset/Liability Recognised?
IAS 12 Income Taxes states that:
- Deferred Taxes should be “RECOGNISED ON ALL TAXABLE TEMPORARY DIFFERENCES”
EXCEPT FOR:-
-
Deferred Tax Liability arising from:
- Goodwill, for which amortisation is not tax-deductible
- - Initial recognition of an asset or liability that does not affect accounting profits and taxable profits
-
Deferred Tax Assets should be recognised on all deductible temporary differences unless:
- Goodwill, for which amortisation is not tax-deductible
- Initial recognition of an asset or liability that does not affect accounting profits and taxable profits
- -Insufficient profits are expected to be available in the future for which tax would be chargeable, meaning the deferred tax asset could not be deductible.
How is a Deferred Tax Measured?
Measurement basis
The tax rate in force/or expected to be in force. When the asset is realised or the liability is settled.
IAS 12 specifies that this rate must be based on legislation the is being enforced or substantively enacted by the reporting date.
Deferred tax assets and liabilities are not discounted to present value.
Calculation
Carrying Amount of asset or liability
Less: Tax Base (Tax written down Value)
= Temporary Difference
X Current Tax % rate in force (or expected to be in force)
= Deferred Tax
-
- Deferred Tax Asset = If the deferred tax is Positive/Debit
- Dr - SFP,
- Cr - P/L
-
- Deferred Tax Liability =If the deferred tax is Negative/Credit
- Dr - P/L
- Cr - SFP
How are Deferred Taxes Presented in the accounts?
Hints?
Income statement
SFP
Offsetting
Presentation
Income statement
- If the Temporary difference on the item is dealt with in P/L then charge deferred tax to P/L
- If the Temporary difference on the item is dealt with in OCI then charge deferred tax to OCI
SFP
Deferred tax liabilities and assets are presented as non-current on the statement of financial position.
Offsetting
IAS 12 notes that deferred tax can be offset as long as:
- legally enforceable right to set off current tax assets and liabilities
- the deferred tax assets and liabilities relate to the same tax authority.
How is deferred tax on revaluation of property treated?
Deferred tax should be recognised on the revaluation of PPE :
- Even if: There is no intention to sell the asset
- Even if: (Rollover relief is allowed) Any tax due on the gain made on any sale of an asset can be deferred by being ‘rolled over’ against the cost of a replacement asset.
Calculation
Carrying Amount = Revalued Amount
Less: Tax Base = (Cost of asset less tax allowances)
= Temporary Difference
X % Tax Rate
= Likely to be Deferred Tax Liability
Presentation
Reduce current year profits in the OCI, by charging the deferred tax liability, where the revaluation gain will be recorded.
- Cr - Deferred Tax Liability - SFP
- Dr - Deferred Tax Liability charge - OCI
How is deferred tax on Share Options Schemes Treated?
Hints:
Intrinsic Value
Pro-Forma
Excess on the Estimated Future Tax Deduction
Background
Share option schemes require recognising an annual expense in P/L over the vesting period.
But Tax relief is usually only given when the options are granted.
This means the expense recognised for the scheme current year is a temporary non-tax-deductible expense in the accounts, this temporary difference creates a deferred tax asset.
Tax Relief granted on the intrinsic value
Tax Relief granted is based on the Intrinsic Value (difference between market price and the exercise price)
Market Value at the reporting date
Less: Excercise Price of Share Options
= Intrinsic Value of Share Options
Pro forma to calculate share options deferred tax:
Carrying Amount of Share-based payment = (NIL)
Tax Base
(Intrinsic ValueNumber of shares options expected to vestperiod chargeable)
X %Tax Rate
= Deferred Tax Asset
Dr - SFP
Cr - P/L
Cr - Equity
Excess of the Estimated Future Tax Deduction
If the future tax deduction (TAX BASE) exceeds the Accumulated Share Option Scheme Expense.
This indicates that the tax deduction relates partly to the:
- Remuneration expense/Cost of the share option scheme
- Partly to Equity.
Therefore, the deferred tax must be recognised partly in P.L and partly in Equity - OCE.
Journal
Dr - SFP
Cr - P/L
Cr - Equity
How do you account for deferred tax on unused tax losses?
Hints:
Signs of future available profits
Calculation of carried forward loss relief is expected to be used.
Unused tax losses
Tax losses usually allow for future carried forward relief, i.e losses that are deductible against future taxable profits.
For any Unused Tax Losses, IAS 12 allows a Deferred Tax Asset to be recognised.
* Only when it is probable future taxable profits will be available, which the unused tax losses can be used to deduct.
IAS 12 advises that the deferred tax asset should only be recognised after considering:
- Sufficient taxable temporary differences against which the unused tax losses can be offset.
- Before the tax losses expire.
- Cause of the tax losses can be identified and whether it is likely to recur (otherwise, the existence of unused tax losses is strong evidence that future taxable profits may not be available).
- Whether tax planning opportunities are available.
SIMPLY - Recognise a deferred tax asset for the expected, Amount/% of Carried Forward Loss Relief will be used on future expected Taxable profits
Calculation
Lower of
- Estimated Future Taxable Income (available for carried forward loss relief)
- Tax Deductible Expense
X% Tax Rate (for the year the tax deduction will take place)
= Deferred Tax Asset
Journal on Recognition
DR - Deferred Tax Asset - SFP
CR - Deferred Tax Asset - P.L
How is deferred tax treated on consolidation of group accounts?
Specifically:- Fair Value revaluations
When Consolidated accounts are prepared, the assets and liabilities of the subsidiary are revalued to the group accounting policies.
This may create revaluations gains or losses on assets and liabilities acquired.
But the application of the group accounting policies will create a temporary tax difference, meaning deferred tax needs to be accounted for.
*Simply - Calculate the temporary tax difference on applying the group accounting policies and the deferred tax on the adjustments will be included as an asset or liability acquired in the goodwill calculations.
