Deferred Tax Basic Concepts

Overview

• IAS 12: International Accounting Standard for accounting for income taxes.
• Focus: Deferred tax.
• Principle: Matching the relevant tax charge to the relevant period and income.
• Approach: Financial position approach.

Key Concepts

Financial Position Approach

• Used by: Both US GAAP and International Accounting Standards.
• Framework: Comprehensive basis, not partial.

Deferred Tax

• Objective: Match accounting tax expense to operating profits and profit before tax.
• Recognition: Expenses recognized in the period they are incurred, not necessarily when paid.
• Timing Differences: Different countries have different timing for recognition of tax income vs. accounting income.

Assets and Liabilities

• Assets: Future economic benefits.
• Liabilities: Future outflows of resources embodying economic benefits.
• Carrying Amount: Represents future economic benefits, not past costs.
• Tax Effects: Recognize future tax outflows based on carrying amount.

Deferred Tax Liabilities and Assets

• Deferred Tax Liability (DTL): Tax consequences of future economic benefits from assets (e.g., PPE).
• Deferred Tax Asset (DTA): Tax consequences of future tax deductions from liabilities (e.g., provisions).
• Matching Concept: Assets lead to future tax expense (DTL), liabilities lead to future tax deductions (DTA).

Illustration: Company A

Scenario

• Profit before tax: 100,000 (2010 & 2011).
• Asset Purchase: PPE for 5,000 on the first day of 2010.
• Depreciation: Straight-line over 2 years (2,500/year).
• Tax Authority: 100% tax deduction in year 1.

Current Tax Computation

• 2010
  • Profit before tax: 100,000
  • Add back depreciation: 2,500
  • Deduct tax allowance: 5,000
  • Taxable income: 97,500
  • Temporary difference: 2,500
• 2011
  • Profit before tax: 100,000
  • Add back depreciation: 2,500
  • No tax allowance: 0
  • Taxable income: 102,500
  • Temporary difference reverses: 2,500

Tax Expense Calculation

• 2010
  • Hypothetical tax at 28%: 28,000
  • Actual tax expense: 27,300
  • Increase in tax expense by deferred tax: 700
• 2011
  • Hypothetical tax at 28%: 28,000
  • Actual tax expense: 28,700
  • Decrease in tax expense by deferred tax: 700

Statement of Financial Position Approach

Columns

1. Carrying Amount: Future economic benefits (e.g., PPE).
2. Tax Base: Future tax deductions (e.g., wear and tear allowances).
3. Temporary Difference: Difference between carrying amount and tax base.
4. Deferred Tax Balance: Tax rate applied to temporary difference.

Example Calculation

• Day One
  • Carrying amount: 5,000
  • Tax base: 5,000
  • Temporary difference: 0
  • Deferred tax: 0
• 2010 Reporting Date
  • Carrying amount: 2,500
  • Tax base: 0
  • Temporary difference: 2,500
  • Deferred tax: 700 (liability)
• 2011 Reporting Date
  • Carrying amount: 0
  • Tax base: 0
  • Temporary difference: 0
  • Deferred tax: 0

Journal Entries

2010

1. Debit deferred tax expense P&L: 700
2. Credit deferred tax liability: 700

2011

1. Debit deferred tax liability: 700
2. Credit deferred tax expense P&L: 700

Disclosure in Financial Statements

Income Tax Expense Note

• Current Tax Expense
  • 2010: 27,300
  • 2011: 28,700
• Deferred Tax Expense
  • 2010: 700
  • 2011: -700
• Total Tax Expense: Matches hypothetical 28% tax rate.

Key Takeaways

• Deferred Tax: Align tax expense recognition with accounting income periods.
• IAS 12: Financial position approach for deferred tax accounting.
• Disclosure: Clear presentation of current vs deferred tax in financial statements.

Future Topics

• Other Comprehensive Income
• Tax Rate Reconciliation
• Deferred Tax Financial Position Note

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