hapter 3 Deferred Taxation Reference: IAS 12 and SI 21 ontents: Page 1. Definitions 90 2. Normal tax and deferred tax 91 2.1 urrent tax versus deferred tax 91 2.1.1 A deferred tax asset 91 2.1.2 A deferred tax liability 91 2.1.3 Deferred tax balance versus the current tax payable balance 92 2.1.4 Basic examples 92 Example 1A: creating a deferred tax asset 92 Example 1B: reversing a deferred tax asset 93 Example 2A: creating a deferred tax liability 94 Example 2B: reversing a deferred tax liability 95 2.2 alculation of Deferred tax the two methods 97 2.2.1 The income statement approach 97 Example 3A: income received in advance (income statement approach) 98 2.2.2 The balance sheet approach 100 Example 3B: income received in advance (balance sheet approach) 101 Example 3: income received in advance (journals) 102 Example 3D: income received in advance (disclosure) 102 2.3 Year-end accruals, provisions and deferred tax 103 2.3.1 Expenses prepaid 104 Example 4: expenses prepaid 104 2.3.2 Expenses payable 107 Example 5: expenses payable 107 2.3.3 Provisions 109 Example 6: provisions 109 2.3.4 Income receivable 112 Example 7: income receivable 113 2.4 Depreciable non-current assets and deferred tax 115 2.4.1 Depreciation versus capital allowances 115 Example 8: depreciable assets 116 2.5 Rate changes and deferred tax 119 Example 9: rate changes date of substantive enactment 120 Example 10: rate changes 120 Example 11: rate changes 123 2.6 Tax losses and deferred tax 124 Example 12: tax losses 124 3. Disclosure of income tax 3.1 Overview 3.2 Statement of comprehensive income disclosure 3.2.1 Face of the statement of comprehensive income 3.2.2 Tax expense note 127 127 127 127 128 88 hapter 3
ontents continued Page 3.3 Statement of financial position disclosure 3.3.1 Face of the statement of financial position 3.3.2 Accounting policy note 3.3.3 Deferred tax note 3.3.3.1 Other information needed on deferred tax assets 3.3.3.2 Other information needed on deferred tax liabilities 3.3.3.3 Other information needed on the manner of recovery or settlement 3.4 Sample disclosure involving tax 129 129 129 129 130 130 130 131 4. Summary 133 89 hapter 3
1. Definitions The following definitions are provided in IAS 12 (some of these definitions have already been discussed under chapter 2): Accounting profit: is profit or loss for a period before deducting (the) tax expense. Taxable profit (tax loss): is the profit (or loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable). Tax expense (tax income): is the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax. urrent tax: is the amount of income tax payable (recoverable) in respect of the taxable profit (tax loss) for a period. Deferred tax liabilities: are the amounts of income taxes payable in future periods in respect of taxable temporary differences. Deferred tax assets: are the amounts of income taxes recoverable in future periods in respect of: - deductible temporary differences; - the carry forward of unused tax losses; and - the carry forward of unused tax credits. Temporary differences: are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base: - taxable temporary differences, which are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled; or - deductible temporary differences, which are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. Tax base: the tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. Tax base of an asset: is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount. 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 that is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods. Other definitions that are not provided in IAS 12 but which you may find useful include: arrying amount: the amount at which an asset or liability is presented in the accounting records. Permanent differences: are the differences between taxable profit and accounting profit for a period that originate in the current period and will never reverse in subsequent periods, (for example, some of the income according to the accountant might not be treated as income by the tax authority because he doesn t tax that type of income, or alternatively, the tax authority might tax an item that the accountant will never treat as income. The same type of differences may arise when dealing with expenses). 90 hapter 3
omprehensive basis: is the term used to describe the method whereby the tax effects of all temporary differences are recognised. Applicable or standard tax rate: is the rate of tax, as determined from time to time by tax legislation, at which entities pay tax on taxable profits, (a rate of 30% is assumed in this text). Effective tax rate: is the taxation expense charge in the statement of comprehensive income expressed as a percentage of accounting profits. 2. Normal tax and deferred tax 2.1 urrent tax versus deferred tax As mentioned in the previous chapter, the total normal tax for disclosure purposes is broken down into two main components: current tax; and deferred tax. urrent normal tax is the tax charged by the tax authority in the current period on the current period s taxable profits. The taxable profits are calculated based on tax legislation (discussed in the previous chapter). Since this tax legislation is not based strictly on the accrual concept, differences may arise such as income being included in taxable profits before it is earned! The total normal tax expense recognised in the statement of comprehensive income is the tax incurred on the accounting profits. Accounting profits are calculated in accordance with the international financial reporting standards, which are based on the concept of accrual. The difference between current normal tax (which is not based on the accrual concept), and the total normal tax in the statement of comprehensive income (which is based on the accrual concept), is an adjustment called deferred tax. The deferred tax adjustment is therefore simply an accrual of tax. In other words: current normal tax (i.e. the amount charged by the tax authority) is adjusted upwards or downwards so that the total normal tax in the statement of comprehensive income is shown at the amount of tax incurred. This results in the creation of a deferred tax asset or liability. 2.1.1 A deferred tax asset (a debit balance) A debit balance on the deferred tax account reflects the accountant s belief that tax has been charged but which has not yet been incurred. This premature tax charge must be deferred (postponed). In some ways, this treatment is similar to that of a prepaid expense. Deferred tax asset Taxation expense reating a deferred tax asset 2.1.2 A deferred tax liability (a credit balance) Debit xxx redit xxx A credit balance reflects the accountant s belief that tax has been incurred, but which has not yet been charged by the tax authority. It therefore shows the amount that will be charged by the tax authority in the future. This is similar to the treatment of an expense payable. Taxation expense Deferred tax liability reating a deferred tax liability Debit xxx redit xxx 91 hapter 3
2.1.3 Deferred tax balance versus the current tax payable balance The balance on the deferred tax account differs from the balance on the current tax payable account in the following ways: the current tax payable account reflects the amount currently owing to or by the tax authorities based tax legislation. This account is therefore treated as a current liability or asset; whereas the deferred tax account reflects the amount that the accountant believes to still be owing to or by the tax authorities in the long-term based on the concept of accrual. Since this amount is not yet payable according to tax legislation, this account is treated as a noncurrent liability or asset. 2.1.4 Basic examples onsider the following examples: Example 1A: creating a deferred tax asset (debit balance) The current tax charged by the tax authority (using the tax legislation) in is expected to be 10 000. The accountant calculates that the tax incurred for to be 8 000. The 2 000 excess will be deferred to future years. There are no components of other comprehensive income. Required: Show the ledger accounts and disclose the tax expense and deferred tax for. Solution to example 1A: creating a deferred tax asset (debit balance) The tax expense that is shown in the statement of comprehensive income must always reflect the tax that is believed to have been incurred for the year, thus 8 000 must be shown as the expense. Ledger accounts: Tax: normal tax (E) urrent tax payable: normal tax (L) TP: NT (1) 10 000 DT (2) 2 000 Tax (1) 10 000 Total c/f 8 000 10 000 10 000 Total b/f 8 000 Deferred tax (A) Tax (2) 2 000 (1) recording the current tax (the estimated amount that will be charged/ assessed by the tax authority). (2) deferring a portion of the current tax expense to future years so that the balance in the tax expense account is the amount considered to have been incurred (i.e. 8 000). Notice that the deferred tax account has a debit balance of 2 000, meaning that the 2 000 deferred tax is an asset. This tax has been charged but will only be incurred in the future and so it is similar to a prepaid expense. 92 hapter 3
Disclosure for : The disclosure will be as follows (the deferred tax asset note will be ignored at this stage): Statement of comprehensive income For the year ended Note Profit before tax xxx Taxation expense (current tax: 10 000 deferred tax: 2 000) 3. 8 000 Profit for the period xxx Other comprehensive income 0 Total comprehensive income xxx Statement of financial position As at ASSETS Non-current Assets - Deferred tax: normal tax 2 000 Notes to the financial statements For the year ended 3. Taxation expense Normal taxation expense 8 000 - urrent 10 000 - Deferred (2 000) Example 1B: reversing a deferred tax asset Use the same information as that given in 1A and the following additional information: The current tax charged by the tax authorities (based on tax legislation) in is expected to be 14 000. The accountant calculates the tax incurred for to be 16 000 (the excess tax charged in is now incurred). There are no components of other comprehensive income. Required: Show the ledger accounts and disclose the tax expense and deferred tax in. Solution to example 1B: reversing a deferred tax asset Ledger accounts: Tax: normal tax (E) urrent tax payable: normal tax TP: NT (1) 14 000 Tax (1) 14 000 DT (2) 2 000 16 000 Deferred tax (A) Balance b/d 2 000 Taxation (2) 2 000 93 hapter 3
(1) recording the current tax (estimated amount that will be charged by the tax authorities) (2) recording the reversal of the deferred tax asset in the second year. The total tax expense in will be the current tax charged for plus deferred tax (the portion of the current tax that was not recognised in, is incurred in ). Disclosure for : Statement of comprehensive income For the year ended Note Profit before tax xxx xxx Taxation expense (: current tax: 14 000 + 3. 16 000 8 000 deferred tax: 2 000) Profit after tax xxx xxx Other comprehensive income 0 0 Total comprehensive income xxx xxx Statement of financial position As at Note ASSETS Non-current Assets - Deferred tax: normal tax 0 2 000 Notes to the financial statements For the year ended 3. Taxation expense Normal taxation expense 16 000 8 000 - urrent 14 000 10 000 - Deferred 2 000 (2 000) It can be seen that over the period of 2 years, the total current tax of 24 000 (10 000 + 14 000) charged by the tax authorities, is recognised as a tax expense in the accounting records: the tax expense in the first year is 8 000; and the tax expense in the second year 16 000. Example 2A: creating a deferred tax liability (credit balance) The current tax expected to be charged by the tax authorities (based on tax legislation) is 10 000 in. The accountant calculates that the tax incurred for to be 12 000. There are no components of other comprehensive income. Required: Show the ledger accounts and disclose the tax expense and deferred tax in. Solution to example 2A: creating a deferred tax liability (credit balance) The tax shown in the statement of comprehensive income must always be the amount incurred for the year rather than the amount charged, thus 12 000 must be shown as the tax expense. 94 hapter 3
Ledger accounts: Tax: normal tax (E) urrent tax payable: normal tax TP: NT (1) 10 000 Tax (1) 10 000 DT (2) 2 000 12 000 Deferred tax (L) Tax (2) 2 000 (1) Recording the current tax (the estimated amount that will be charged by the tax authorities). (2) Providing for extra tax that has been incurred but which will only be charged/assessed by the tax authorities in future years (tax owing to the tax authorities in the long term): we have only been charged 10 000 in the current year, but have incurred 12 000, thus there is an amount of 2 000 that will have to be paid sometime in the future. Notice that the deferred tax account has a credit balance of 2 000, (a deferred tax liability). Disclosure for : Statement of comprehensive income For the year ended Profit before tax xxx Taxation expense (current tax: 10 000 + deferred tax: 2 000) 3. 12 000 Profit for the year xxx Other comprehensive income 0 Total comprehensive income xxx Statement of financial position As at.. LIABILITIES Non-current Liabilities - Deferred tax: 2 000 Notes to the financial statements For the year ended 3. Taxation expense Normal taxation expense 12 000 - urrent 10 000 - Deferred 2 000 Example 2B: reversing a deferred tax liability Use the same information as that given in example 2A as well as the following information: The tax authority is expected to charge 14 000 for but the tax incurred is calculated to be 12 000. There are no components of other comprehensive income. Required: 95 hapter 3
Show the ledger accounts and disclose the tax expense and deferred tax in. Solution to example 2B: reversing a deferred tax liability The deferred tax liability (a non-current liability) will have to be reversed out in since the amount will now form part of the current tax payable liability instead (a current liability). Ledger accounts: Tax: normal tax (E) urrent tax payable: normal tax TP: NT (1) 14 000 DT (2) 2 000 Tax (1) 14 000 Total 12 000 Deferred tax (L) Tax (2) 2 000 Balance b/f 2 000 (1) recording the current tax (charged by the tax authority) (2) recording the reversal of the deferred tax in the second year. Disclosure for : Statement of comprehensive income For the year ended.. Profit before tax xxx xxx Taxation expense (current tax and deferred tax) 3. 12 000 12 000 Profit for the year xxx xxx Other comprehensive income 0 0 Total comprehensive income xxx xxx Statement of financial position As at.. LIABILITIES Non-current Liabilities - Deferred Tax 0 2 000 Notes to the financial statements For the year ended 3. Taxation expense Normal taxation expense 12 000 12 000 - current 14 000 10 000 - deferred (2 000) 2 000 It can be seen that over the period of 2 years, the total current tax of 24 000 (10 000 + 14 000) charged by the tax authority is recognised as a tax expense in the accounting records: the tax expense in the first year is 12 000 and the tax expense in the second year is 12 000. 96 hapter 3
2.2 alculation of Deferred tax the two methods Although IAS 12 refers to only one method of calculating deferred tax, (the balance sheet method), there are in fact two methods: Balance sheet method: a comparison between the carrying amount and the tax base of each of the entity s assets and liabilities; and the Income statement method: a comparison between accounting profits and taxable profits. The method used will not alter the journals or disclosure. You will generally be required to calculate the Deferred tax using the balance sheet method. The income statement method is still useful though since it serves as a tool to check your balance sheet calculations and is useful in that it is easier to explain the concept of deferred tax. If there was deferred tax on a gain or loss that is recognised directly in equity (i.e. not in profit or loss), then the income statement method will need to bear this into account, since the income statement method looks only at the deferred tax caused by items of income and expense recognised in profit or loss. IAS 12 expressly prohibits the discounting (present valuing) of deferred tax balances. 2.2.1 The income statement approach The accountant and the tax authorities calculate profits in different ways: International Financial Reporting Standards govern the manner in which the accountant calculates accounting profit: profit or loss for a period before deducting (the) tax expense. Tax legislation governs the manner in which the tax authorities calculate taxable profit: the profit (or loss) for the period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable or recoverable. In order for the accountant to calculate the estimated current tax for the year, he converts his accounting profits into taxable profits. This is done as follows: onversion of accounting profits into taxable profits: Profit before tax (accounting profits) Adjusted for permanent differences: - less exempt income (e.g. certain capital profits and dividend income) - add non-deductible expenses (e.g. certain donations and fines) Accounting profits that are taxable (A x 30% = tax expense incurred) Adjusted for movements in temporary differences: - add depreciation - less depreciation for tax purposes (e.g. wear and tear) - add income received in advance (closing balance): if taxed when received - less income received in advance (opening balance): if taxed when received - less expenses prepaid (closing balance): if deductible when paid - add expenses prepaid (opening balance): if deductible when paid - add provisions (closing balance): if deductible when paid - less provisions (opening balance): if deductible when paid Taxable profits (B x 30% = current tax charge) xxx xxx (xxx) xxx A xxx xxx (xxx) xxx (xxx) (xxx) xxx xxx (xxx) B 97 hapter 3
As can be seen from the calculation above, the difference between accounting profits and taxable profits may be classified into two main types: temporary differences; and permanent differences. Accounting profits = Profit before tax +/- Permanent differences Taxable accounting profits = Portion of the accounting profits that are taxable although not necessarily now +/- Temporary differences X 30% = X 30% = Tax expense Deferred tax expense/ income Taxable profits = Profits that are taxable now, based purely on tax laws X 30% = urrent tax expense The difference between total accounting profits and the taxable accounting profits are permanent differences. These differences include, for instance, items of income that will never be taxed as income and yet are recognised as income in the accounting records. The difference between taxable accounting profits (A above) and taxable profits (B above) are caused by the movement in temporary differences. These differences relate to the issue of timing: for instance, when the income is taxed versus when it is recognised as income in the accounting records. A deferred tax adjustment is made for the movement relating to temporary differences only. Example 3A: income received in advance (income statement approach) A company receives rent income of 10 000 in that relates to rent earned in and then receives 110 000 in rent income in (all of which was earned in ). The company has no other income. The tax authority taxes income on the earlier of receipt or earning. Required: alculate, for and, the current tax expense, the deferred tax adjustment and the final tax expense to appear in the statement of comprehensive income and show the related ledger accounts. Solution to example 3A: income received in advance (income statement approach) urrent tax calculation: Profits Tax at 30% Profit before tax (accounting profits) (10 000 10 000) (1) 0 Adjusted for permanent differences: 0 Taxable accounting profits and tax expense (3) 0 0 Adjusted for movement in temporary differences: (5) 10 000 3 000 add income received in advance (closing balance): taxed in the current 10 000 year (2) less income received in advance (opening balance): previously taxed (0) 98 hapter 3
Taxable profits and current normal tax (4) 10 000 3 000 Since the income is not recognised in the statement of comprehensive income in, it does not make sense to recognise the related tax in, (it makes more sense to recognise the tax on income when the income is recognised). Thus the recognition of this current tax is deferred to this future year (). urrent tax calculation: Profits Tax at 30% Profit before tax (accounting profits) (110 000 + 10 000) (6) 120 000 Adjusted for permanent differences: 0 Taxable accounting profits and tax expense (8) 120 000 36 000 Adjusted for movement in temporary differences: (9) (10 000) (3 000) add income received in advance (closing balance): taxed in the 0 current year less income received in advance (opening balance): previously taxed (7) (10 000) Taxable profits and current normal tax (7) 110 000 33 000 (1) The receipt in is not yet earned and is therefore not recognised as income but as a liability. (2) The income is taxed by the tax authority on the earlier date of receipt or earning: the amount is received in and earned in and is therefore taxed in (the earlier date). (3) The tax that appears on the face of the statement of comprehensive income should be zero since it should reflect the tax owing on the income earned. Since no income has been earned, no tax should be reflected. (4) The difference between the current tax charged (3 000) and the tax expense (0) is the deferred tax adjustment, deferring the current tax to another period. (5) Notice that the deferred tax account has a debit balance at the end of and is therefore classified as an asset: tax has been charged in for taxes that will only be incurred in. (6) The income in includes the 10 000 received in since it is earned in. The income received in advance liability is reversed out. (7) Notice that the tax authority charges current tax in on just the 110 000 received since the balance of 10 000 was received and taxed in an earlier year. (8) The accountant believes that the 36 000 tax should be expensed in (together with the related income of 120 000). (9) This requires that the 33 000 current tax recorded in the books in be adjusted to include the tax of 3 000 that was charged in but not recognised in. This results in a reversal of the deferred tax balance of 3 000 brought forward from. Ledger accounts: Bank Rent received in advance (L) RRIA (1) 10 000 Bank (1) 10 000 Tax: normal tax (E) urrent tax payable: normal tax (L) TP: NT (2) 3 000 DT (4) 3 000 Tax (2) 3 000 Total b/f (3) 0 Deferred tax (A) Tax (4 & 5) 3 000 99 hapter 3
Ledger accounts: Bank Rent received in advance (L) Rent 110 000 Rent (6) 10 000 Balance b/f 10 000 Tax: normal tax (E) urrent tax payable: normal tax (L) TP:NT (7) 33 000 Balance b/f 3 000 DT (9) 3 000 Tax (7) 33 000 Total (8) 36 000 Deferred tax Rent (I) Balance b/f 3 000 Tax (9) 3 000 RRIA (6) 10 000 Bank 110 000 120 000 2.2.2 The balance sheet approach When calculating deferred tax using the balance sheet approach, the carrying amount of the assets and liabilities are compared with the tax bases of these assets and liabilities. Any difference between the carrying amount and the tax base of an asset or liability is termed a temporary difference : The carrying amounts are the balances of the assets and liabilities as recognised in the statement of financial position based on International Financial Reporting Standards. The tax bases are the balances of the assets and liabilities, as they would appear in a statement of financial position drawn up based on tax law (please read these definitions again you will find them at the beginning of this chapter). The total temporary differences multiplied by the tax rate will give: the deferred tax balance in the statement of financial position. The difference between the opening and closing deferred tax balance in the statement of financial position will give you: the deferred tax journal adjustment. arrying amount: Opening balance Temporary difference X 30% = Deferred tax balance: beginning of year Movement: Deferred tax journal adjustment Tax base: Opening balance arrying amount: losing balance Temporary difference X 30% = Deferred tax balance: end of year Tax base: losing balance 100 hapter 3
A useful format for calculating deferred tax using the balance sheet approach is as follows: arrying amount (SOFP) (a) Tax base (per IAS 12) (b) Temporary difference (b) (a) (c) Deferred tax (c) x 30% (d) Deferred tax balance/ adjustment Opening balance: in the SOFP Movement: deferred tax charge in the SOI losing balance in the SOFP Asset/ liability dr FP; cr I or cr FP; dr I Asset/ liability Example 3B: income received in advance (balance sheet approach) Use the information given in example 3A. Required: alculate the Deferred tax adjustment using the balance sheet approach for both years. Solution to example 3B: income received in advance (balance sheet approach) Rule for liability: revenue received in advance (per IAS 12): The tax base of revenue received in advance is the carrying amount of the liability less the portion representing income that will not be taxable in future periods. Applying the rule for revenue received in advance (L) to the calculation of the tax base: tax base: arrying amount 10 000 Less that which won t be taxed in the future (because taxed in the (10 000) current year) This means that there will be no related current tax charge in the future. 0 tax base: arrying amount 0 Less that which won t be taxed in the future 0 0 The carrying amount is zero since the income was earned in so the balance on the liability account was reversed out to income (see journal 6 in the t-accounts above). alculation of Deferred tax (balance sheet approach): Income received in advance arrying amount (SOFP) (a) Tax base (IAS 12) (b) Temporary difference (b) (a) (c) Deferred tax at 30% (c) x 30% (d) Deferred tax balance/ adjustment Opening balance 0 0 0 0 Deferred tax charge (balancing: movement) (10 000) 0 10 000 (3) 3 000 dr DT; cr TE losing balance (1) (10 000) 0 10 000 3 000 Asset (2) Deferred tax charge (balancing: movement) 10 000 0 (10 000) (5) (3 000) cr DT; dr TE losing balance (4) 0 0 0 0 101 hapter 3
Explanation of the above: 1) During, the 10 000 rent is received in advance. The accountant treats this as a liability whereas the tax authority treats it as income. Thus the carrying amount of the income received in advance account is 10 000 whereas the tax authority has no such liability: the tax base is therefore zero. This results in a temporary difference of 10 000 and therefore a deferred tax balance of 3 000. 2) The tax base of a liability that represents income, is that portion of the liability that will be taxed in the future. The difference between the carrying amount and the tax base represents the portion of the liability that won t be taxed in the future with the result that the deferred tax balance is an asset to the company: the tax that has been prepaid. 3) The deferred tax charge in will be a credit to the statement of comprehensive income. 4) During, the 10 000 rent that was received in advance in is now recognised as income (the accountant will debit the liability and credit income) with the result that the accountant s liability reverses out to zero. As mentioned above, the tax authority had no such liability since he treated the receipt as income in. The carrying amount and the tax base are now both zero, with the result that the temporary difference is now zero and the deferred tax is zero. 5) The deferred tax charge in is a debit to the statement of comprehensive income. Example 3: income received in advance (journals) Use the current tax calculation done in example 3A and the deferred tax calculation done in 3B. Required: Show the related tax journal entries. Solution to example 3: income received in advance (journals) Debit redit Taxation expense: normal tax (SOI) 3 000 urrent tax payable: normal tax (SOFP) 3 000 urrent tax payable per tax law (see calculation in 3A) Deferred tax: normal tax (SOFP) 3 000 Taxation expense: normal tax (SOI) 3 000 Deferred tax adjustment (see calculation in 3B) Taxation expense: normal tax (SOI) 33 000 urrent tax payable: normal tax (SOFP) 33 000 urrent tax payable per tax law (see calculation in 3A) Taxation expense: normal tax (SOI) 3 000 Deferred tax: normal tax (SOFP) 3 000 Deferred tax adjustment (see calculation in 3B) Example 3D: income received in advance (disclosure) Use the information given in example 3A, 3B or 3. The current tax for is paid in and that the current tax for is paid in 20X3. There are no components of other comprehensive income. Required: Disclose all information in the financial statements. 102 hapter 3
Solution to example 3D: income received in advance (disclosure) ompany name Statement of financial position As at 31 December ASSETS Non-urrent Assets Note Deferred tax: normal tax 6 0 3 000 LIABILITIES urrent Liabilities urrent tax payable: normal tax 33 000 3 000 Income received in advance 0 10 000 ompany name Statement of comprehensive income (extracts) For the year ended 31 December Note Profit before taxation 120 000 0 Taxation expense 5 36 000 0 Profit for the year 84 000 0 Other comprehensive income 0 0 Total comprehensive income 84 000 0 ompany name Notes to the financial statements (extracts) For the year ended 31 December 5. Taxation expense Normal taxation 36 000 0 urrent 33 000 3 000 Deferred 3 000 (3 000) Total tax expense per the statement of comprehensive income 36 000 0 6. Deferred tax asset The closing balance is constituted by the effects of: Year-end accruals 0 3 000 It can be seen that the deferred tax effect on profits is nil over the period of the two years. 2.3 Year-end accruals, provisions and deferred tax Five statement of financial position accounts resulting directly from the use of the accrual system include: income received in advance; expenses prepaid; expenses payable; provisions; and income receivable. Income received in advance has already been covered in example 3 above. The deferred tax effect of each of the remaining four examples will now be discussed. Since IAS 12 refers only to the use of the balance sheet approach, this is the only approach shown in this text. 103 hapter 3
2.3.1 Expenses prepaid Remember that, although the tax authority normally allows a deduction of expenses when the expenses are incurred, he may, however, allow a deduction of a prepaid expense depending on criteria in the tax legislation. If this happens, deferred tax will result. Example 4: expenses prepaid Profit before tax is 20 000 in and in, according to the accountant and the tax authority, before taking into account the following information: An amount of 8 000 in respect of electricity for January is paid in December. The Receiver allows the payment of 8 000 as a deduction against taxable profits in. The company paid the current tax owing to the tax authorities for, in. There are no permanent differences, no other temporary differences and no taxes other than normal tax at 30%. There are no components of other comprehensive income. Required: A. alculate the Deferred tax for and using the balance sheet approach. B. alculate the current normal tax for and.. Show the related journal entries in ledger account format. D. Disclose the tax adjustments for the financial year. Solution to example 4A: expenses prepaid (deferred tax) Rule for assets: expenses prepaid (IAS 12): The tax base of an asset (that represents an expense) is the amount that will be deducted 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 (e.g. an investment that renders dividend income). Applying the rule to the calculation of the tax base (expenses prepaid): tax base: arrying amount 8 000 Less amount already deducted from taxable profits (deducted in current year: ) (8 000) Deduction from taxable profits in the future 0 tax base: arrying amount 0 Less that which won t be deducted for tax purposes in the future 0 0 The carrying amount will now be zero since the expense was incurred in with the asset balance transferred to an expense account (see journal 1 in the t-accounts). alculation of Deferred tax (balance sheet approach): Expenses prepaid arrying amount (per SOFP) (a) Tax base (IAS 12) (b) Temporary difference (b) (a) (c) Deferred tax at 30% (c) x 30% (d) Deferred tax balance/ adjustment Opening balance: 0 0 0 0 Movement (balancing) 8 000 0 (8 000) (2 400) cr FP; dr I (3) losing balance: (1) 8 000 0 (8 000) (2 400) Liability (2) 104 hapter 3
Solution to example 4B: expenses prepaid (current tax) alculation of current normal tax: The prepayment of 8 000 is allowed as a deduction by the tax authority in but the accountant recognises the 8 000 as a prepaid expense, (an asset), thus causing a temporary difference. Profits Tax at 30% Profit before tax (accounting profits) (1) 20 000 Adjusted for permanent differences: 0 Taxable accounting profits and tax expense (1) 20 000 6 000 Adjusted for movement in temporary differences: (3) (8 000) (3) (2 400) Less expense prepaid (closing balance): deductible in current year (8 000) Taxable profits and current normal tax (6) 12 000 3 600 alculation of current normal tax: The accountant recognises (deducts) the 8 000 as an expense in since this is the period in which the expense is incurred but the tax authority, having already allowed the deduction of the expense in, will not deduct it again in. The difference in reverses the difference in. Profits Tax at 30% Profit before tax (accounting profits) (20 000 8 000) (4) 12 000 Adjusted for permanent differences: 0 Taxable accounting profits and tax expense (4) 12 000 3 600 Adjusted for movement in temporary differences: (5) 8 000 (5) 2 400 Add expense prepaid (opening balance): deducted in prior year 8 000 Taxable profits and current normal tax (7) 20 000 6 000 Solution to example 4: expenses prepaid (ledger accounts) Ledger accounts: Bank Expenses prepaid (A) Exp Prepaid (1) 8 000 Bank (1) 8 000 Tax: normal tax (E) urrent tax payable: normal tax (L) TP: NT (6) 3 600 Tax (6) 3 600 DT (3) 2 400 Total 6 000 Deferred tax (L) Tax (3) 2 400 T-accounts: Electricity and water Expenses prepaid (A) EP (4) 8 000 Balance b/f 8 000 E&W (4) 8 000 Tax: normal tax (E) urrent tax payable: normal tax (L) TP: NT (7) 6 000 DT (5) 2 400 Bank (8) 3 600 Balance 3 600 Total c/f 3 600 Tax (7) 6 000 6 000 6 000 Total b/f 3 600 Deferred tax (L) Bank Tax (5) 2 400 Balance b/d 2 400 TP: NT (8) 3 600 105 hapter 3
omments on example 4 A, B and 1) The accountant treats the payment as an asset since the expense has not yet been incurred whereas the tax authority treats the payment as an expense and therefore has no asset account. 2) This represents a deferred tax liability since it represents a premature tax saving (received before the related expense is incurred). 3) In order to create a deferred tax credit balance, the deferred tax liability must be credited and the tax expense debited. 4) The expense is incurred in, so the expense prepaid (asset) is reversed out to electricity expense (reducing profits). Now both accountant and tax authority have zero balances on the expense prepaid (asset) account and so there is no longer a temporary difference and thus a zero deferred tax balance. 5) In order to adjust a deferred tax credit balance to a zero balance, the liability must be debited and the tax expense credited. 6) urrent tax charged by the tax authority in. 7) urrent tax charged by the tax authority in. 8) Payment of the balance owing to the tax authority for (the prior year). It can be seen that over 2 years: the accountant recognises tax expense of 9 600 (6 000 + 3 600) as incurred; and this equals the actual tax charged by the tax authority over 2 years is 9 600 (3 600 + 6 000). The difference relates purely to when the tax is incurred versus when the tax is charged, thus the difference reverses out once the tax has both been charged and incurred. Solution to example 4D: expenses prepaid (disclosure) ompany name Statement of financial position As at 31 December Note ASSETS urrent assets Expense prepaid 0 8 000 LIABILITIES Non-current liabilities Deferred tax: normal tax 6 0 2 400 urrent liabilities urrent tax payable: normal tax 6 000 3 600 ompany name Statement of comprehensive income (extracts) For the year ended 31 December Note Profit before taxation : 20 000 8 000 12 000 20 000 Taxation expense 5 3 600 6 000 Profit for the year 8 400 14 000 Other comprehensive income 0 0 Total comprehensive income 8 400 14 000 ompany name Notes to the financial statements (extracts) For the year ended 31 December 5. Taxation expense Normal taxation 3 600 6 000 current 6 000 3 600 deferred (2 400) 2 400 Total tax expense per the statement of comprehensive income 3 600 6 000 106 hapter 3
6. Deferred tax asset/ (liability) The closing balance is constituted by the effects of: Year-end accruals 0 (2 400) It can be seen that the deferred tax effect on profits is nil over the period of the two years. 2.3.2 Expenses payable The tax authority generally allows expenses to be deducted when they have been incurred irrespective of whether or not the amount incurred has been paid. This is the accrual system and therefore there will be no deferred tax on an expense payable balance. Example 5: expenses payable Profit before tax is 20 000 in and in, according to the accountant and the tax authority, before taking into account the following information: A telephone expense of 4 000, incurred in, is paid in. The Receiver will allow the expense of 4 000 to be deducted from the taxable profits. The current tax owing to the tax authorities is paid in the year after it is charged. There are no permanent or other temporary differences and no taxes other than normal tax at 30%. There are no components of other comprehensive income Required: A. alculate the Deferred tax for and using the balance sheet approach. B. alculate the current normal tax for and.. Show the related journal entries in ledger account format. D. Disclose the tax adjustments for the financial year. Solution to example 5A: expenses payable (deferred tax) Rule for liabilities: expenses payable (IAS 12 adapted): The tax base of a liability (representing expenses) is its carrying amount less any amount that will be deductible for tax purposes in respect of that liability in future periods. Applying the rule to the example (expenses payable): tax base: arrying amount 4 000 Less deductible in the future (all deducted in the current year) 0 4 000 tax base: arrying amount 0 Less deductible in the future (already deducted in ) 0 0 The carrying amount will now be zero since the expense was paid in with the balance on the liability account being reversed. alculation of Deferred tax (balance sheet approach): arrying Tax amount base Expenses payable (per SOFP) (IAS 12) (a) (b) Temporary difference (b) (a) (c) Deferred tax at 30% (c) x 30% (d) Deferred tax balance/ adjustment Opening balance: 0 0 0 0 N/A Movement (balancing) (4 000) (4 000) 0 0 N/A losing balance: (3) (4 000) (4 000) 0 0 N/A Movement (balancing) 4 000 4 000 0 0 N/A losing balance: (5) 0 0 0 0 N/A 107 hapter 3
Solution to example 5B: expenses payable (current tax) alculation of current normal tax: Since the telephone expense is recognised as an expense and is also deducted for tax purposes in, the effect on accounting profits and taxable profits is identical. There is, therefore, no deferred tax. Profits Tax at 30% Profit before tax (accounting profits) (20 000 4 000) (1) 16 000 Adjusted for permanent differences: 0 Taxable accounting profits and tax expense (1) 16 000 4 800 Adjusted for temporary differences: (3) 0 0 Taxable profits and current normal tax (2) 16 000 4 800 alculation of current normal tax: Since the telephone expense is recognised as an expense in the statement of comprehensive income in, it will have no impact on the statement of comprehensive income in. Similarly, since the telephone expense is deducted for tax purposes in, it will not be deducted for tax purposes in. Since the effect on accounting profits and taxable profit is the same, there is no deferred tax. Profits Tax at 30% Profit before tax (accounting profits) (4) 20 000 Adjusted for permanent differences: 0 Taxable accounting profits and tax expense 20 000 6 000 Adjusted for movement in temporary differences: (6) 0 0 Taxable profits and current normal tax (5) 20 000 6 000 Solution to example 5: expenses payable (ledger accounts) Ledger accounts - Telephone Expenses payable (L) EP (1) 4 000 Tel (1) 4 000 Tax: normal tax (E) urrent tax payable: normal tax (L) TP: NT (2) 4 800 Tax (2) 4 800 Ledger accounts Bank Expenses payable (L) EP (4) 4 000 Bank (4) 4 000 Balance b/f 4 000 TP: NT (7) 4 800 Tax: normal tax (E) urrent tax payable: normal tax (L) TP: NT (5) 6 000 Bank (7) 4 800 Balance 4 800 Tax (5) 6 000 omments on example 5A, B and (1) The telephone expense is incurred but not paid in and is therefore recognised as an expense and expense payable in. (2) urrent tax charged by the tax authority in. (3) Since the accountant and tax authority both treat the expense payable as an expense in the calculation of profits, there is no temporary difference and therefore no deferred tax adjustment. (4) Notice that although the telephone expense is paid in, the payment is not taken into account in the calculation of the profits for. The payment of the expense in simply results in the reversal of the expense payable account. (5) urrent tax charged by the tax authority in. (6) Since the tax authority has treated the expense in the same manner as the accountant, there is no temporary difference and therefore no deferred tax adjustment. (7) The balance owing to the tax authority at the end of is paid in. 108 hapter 3
Solution to example 5D: expenses payable (disclosure) ompany name Statement of financial position As at 31 December Note LIABILITIES urrent liabilities Expense payable 0 4 000 urrent tax payable: normal tax 6 000 4 800 ompany name Statement of comprehensive income (extracts) For the year ended 31 December Note Profit before taxation : 20 000 4 000 20 000 16 000 Taxation expense 5 6 000 4 800 Profit for the year 14 000 11 200 Other comprehensive income 0 0 Total comprehensive 14 000 11 200 income ompany name Notes to the financial statements (extracts) For the year ended 31 December 5. Taxation expense Normal taxation 6 000 4 800 urrent 6 000 4 800 Deferred 0 0 Total tax expense per the statement of comprehensive income 2.3.3 Provisions 6 000 4 800 Although the tax authority generally allows expenses to be deducted when they have been incurred, he often treats the deduction of provisions with more suspicion. In cases such as this, the tax authority generally allows the provision to be deducted only when it is paid. Example 6: provisions Profit before tax is 20 000 in and in, according to the accountant and the tax authority, before taking into account the following information: A provision for warranty costs of 4 000 is journalised in and paid in. The tax authority will allow the warranty costs to be deducted only once paid. The current tax owing to the tax authority is paid in the year after it is charged. There are no permanent differences, no other temporary differences and no taxes other than normal tax at 30%. There are no components of other comprehensive income. Required: A. alculate the Deferred tax using the balance sheet approach. B. alculate the current normal tax for and.. Show the related ledger accounts. D. Disclose the above information. 109 hapter 3
Solution to example 6A provisions (deferred tax) Rule for liabilities: provisions (IAS 12 adapted) The tax base of a liability (representing expenses) is its carrying amount less any amount that will be deductible for tax purposes in respect of that liability in future periods. Applying the rule to the calculation of the tax base (provisions) tax base: arrying amount 4 000 Less deductible in the future (all will be deducted in the future: ) 4 000 0 tax base: arrying amount 0 Less deductible in the future (all deducted in since now paid) 0 0 The carrying amount will now be zero since the expense was paid in with the balance on the liability account being reversed. alculation of Deferred tax (balance sheet approach) Provision for warranty costs arrying amount (per SOFP) (a) Tax base (IAS 12) (b) Temporary difference (b) (a) (c) Deferred tax at 30% (c) x 30% (d) Deferred tax balance/ adjustment Opening balance 0 0 0 0 Movement (balancing) (4 000) 0 4 000 1 200 dr FP; cr I (3) losing balance (1) (4 000) 0 4 000 1 200 Asset (2) Movement (balancing) 4 000 0 (4 000) (1 200) cr FP; dr I (7) losing balance (5) 0 0 0 0 Solution to example 6B: provisions (current tax) alculation of current normal tax: Since in the tax authority disallows the provision and the accountant recognises the provision, the accounting profits will be less than the taxable profits in. Profits Tax at 30% Profit before tax (accounting profits) (20 000 4 000) (1) 16 000 Adjusted for permanent differences: 0 Taxable accounting profits and tax expense 16 000 4 800 Adjusted for movement in temporary differences: (3) 4 000 1 200 Add back provision for an expense disallowed in 4 000 Taxable profits and current normal tax (4) 20 000 6 000 alculation of current normal tax: The difference that arose in will reverse in when the tax authority allows the deduction of the provision since the taxable profits will now be less than the accounting profits (the provision will not affect the statement of comprehensive income again in ). Profits Tax at 30% Profit before tax (accounting profits) 20 000 Adjusted for permanent differences: 0 Taxable accounting profits and tax expense 20 000 6 000 Adjusted for movement in temporary differences: (7) (4 000) (1 200) - provision for warranty cost allowed in (4 000) Taxable profits and current normal tax (6) 16 000 4 800 110 hapter 3
Solution to example 6: provisions (ledger accounts) Ledger accounts: Warranty costs (E) Provision for warranty costs (L) Provision (1) 4 000 W (1) 4 000 Tax: normal tax (E) urrent tax payable: normal tax (L) TP: NT (4) 6 000 DT (3) 1 200 Tax (4) 6 000 Total c/f 4 800 6 000 6 000 Total b/f 4 800 Ledger accounts: Deferred tax (A) (2) Taxation (3) 1 200 Bank Provision for warranty costs (L) Provision (5) 4 000 Bank (5) 4 000 Balance b/f 4 000 TP: NT (8) 6 000 Tax: normal tax (E) urrent tax payable: normal tax (L) TP: NT (6) 4 800 Bank (8) 6 000 Balance b/f 6 000 DT (7) 1 200 Tax (6) 4 800 Total b/f 6 000 Deferred tax (A) Balance b/f 1 200 Tax (7) 1 200 omments on example 6A, B and 1) Warranty costs of 4 000 are incurred but not paid in and therefore an expense and expense payable are recognised in (reducing profits). Although the accountant believes these costs to be incurred, the tax authority does not believe this to be the case (therefore the tax authority does not recognise the expense and expense payable). 2) This represents a deferred tax asset since the expense (already incurred) will result in a future reduction in taxable profits (a future tax saving). 3) In order to create a deferred tax asset, the statement of financial position deferred tax account must be debited and the tax expense must be credited. Since the tax authority disallowed the deduction of the warranty costs in, the current tax was greater than the tax expense incurred, thus requiring a deferral of tax to future years. 4) urrent tax charged by the tax authority in. 5) The payment of 4 000 reverses the provision and thus both the accountant and the tax authority now have balances of zero in the liability account. When the balances are the same, there are no temporary differences meaning that the deferred tax balance must be zero. 6) urrent tax charged by the tax authority in. 7) In order to reverse a deferred tax asset, it is necessary to credit deferred tax and debit tax expense. 8) Payment of the current tax for in. 111 hapter 3
Solution to example 6D: provisions (disclosure) ompany name Statement of financial position As at 31 December Note ASSETS Non-current assets Deferred tax: normal tax 6 0 1 200 LIABILITIES urrent liabilities Provision for warranty costs 0 4 000 urrent tax payable: normal tax 4 800 6 000 ompany name Statement of comprehensive income (extracts) For the year ended 31 December Note Profit before taxation (: 20 000 4 000) 20 000 16 000 Taxation expense 5 6 000 4 800 Profit for the year 14 000 11 200 Other comprehensive income 0 0 Total comprehensive income 14 000 11 200 ompany name Notes to the financial statements (extracts) For the year ended 31 December 5. Taxation expense Normal taxation 6 000 4 800 urrent 4 800 6 000 Deferred 1 200 (1 200) Total tax expense per the statement of comprehensive income 6 000 4 800 6. Deferred tax asset/ (liability) The closing balance is constituted by the effects of: Year-end accruals 0 1 200 It can be seen that the deferred tax effect on profits is nil over the period of the two years. 2.3.4 Income receivable The tax authority generally taxes income on the earlier of the date the income is earned or the date it is received. Therefore the taxable income will equal the accounting income if the income is received on time or is receivable (as opposed to received in advance) and therefore there will be no deferred tax on an income receivable balance. 112 hapter 3