[Music] good day welcome to the taldi accounting intelligence lecture on is12 theer tax basic concepts first of all let's understand that ias2 is the International Accounting standard and the IFRS for accounting for income taxes in their entire pry today we're going to focus purely on one aspect thereof namely the thir tax now it is very important to note that the principle behind deferred tax is the matching of the relevant tax charge to the relevant period as well as the relevant income ias1 12 designates that we should use the financial position approach under both um us gar and under International Accounting Standards we use something called the comprehensive basis and not the partial basis is what used to be used in many areas in Europe and Asia now I'm going to spend a bit of time talking about the ACU basis in terms of the framework of International Accounting Standards and the fact that expenses should be recognized in the period in which they are incurred and matched back to the related incomes so tax expense in its entirety should be recognized in the period in which it is incurred not necessarily when the tax is paid now here we must understand that tax legislation in different countries throughout the world will often result in different timing of recognition for tax income as compared to accounting income the third tax is our measure to try and match the full accounting tax tax expense to the operating profits and profit before tax so before we go on let's understand that our accounting is based on assets and liabilities Assets in terms of the framework definition are future economic benefits liabilities of future outflows of resources embodying economic benefits so therefore when I recognize an or liability I need to ask myself what about the tax effects of those future benefits and future outflows now for assets the core thing to remember here is what is the carrying amount of an asset let's say we are talking about property plant and equipment in terms of is-16 that carrying amount represents future economic benefits now for an item such as property plant and Equipment those future economic benefits probably are operating profits going to use the abbreviation for profit their P so on reporting date that're carrying amount of the asset is no longer thought of as a snapshot of the past and the cost thereof but it is thought of as the crystal ball to try and View and estimate what those future economic benefits are this concept's important as those future economic benefits will in all likelihood have tax consequences so at carrying amount at reporting date we we should also recognize the consequences of those future tax outflows on the future operating profits so the future outflows in the future I.E the tax expense or tax payments to the revenue Authority well should that not also be recognized if we recognize the carrying amount of the PPE and that carrying amount is going to be a referred tax liability now a similar thought process can be followed for liability side of the statement of financial position namely at reporting date I might have a carrying amount of a liability let's say a provision for instance that will result in future outflows to settle that liability or obligation now depending on the tax treatment let's assume we are using a provision that is only tax deductible once it is paid in the future well at reporting date I've gone debit expense credit provision I've got an obligation that obligation will be settled with future outflows let's say that there will be a payment to settling cash and what's going to happen is that there will be also tax consequences in the future and there will be a future economic benefit when I make that payment sounds a little bit counterintuitive but what will that future economic benefit be it will be a tax deduction in my current tax computation so at reporting date what are those future tax deductions well those are going to be my theer tax asset okay so let's make sure we've got the basic concept of assets equal future economic benefits and therefore there will be future tax expense there on deferred tax liability when I have a liability on my books such as a provision and I have future outflows in order to settle that obligation well there will be future tax deductions attached there to and that will be the F tax asset in order just to cover this a bit more conceptually we need to have a look at a small illustration so let's look at company a and Company a has profit before tax of 100,000 in 2011 as well as 100,000 Rand in 2010 now company a purchased an asset let's assume a item of property plant and Equipment a manufacturing machine and they purchased it for 5,000 Rand on the first day of 2010 the useful life of this asset for accounting purposes is 2 years and a zero residual value therefore the asset will be depreciated straight line over two years 2,500 Grand per year just do a quick journal for that I'll go debit depreciation profit and loss credit well the asset but I have a sub account for the asset called accumulated depreciation in the statement of financial position each year that will be 2,500 the tax Authority however has said that in year one you will get 100% tax reduction so the tax expense for once of a better word is the full 5,000 in year one so let's continue with this little illustration and the illustration now moves towards my current tax computation current tax computation starts with profit before tax and in 2010 that figure was given as 100,000 Rand remember that profit before tax already incorporates the accounting depreciation so to get from profit before tax which is an accounting figure down to taxable income which is a tax figure we need to reverse out any um accounting expenses that are different to the tax expenses so the first thing to consider is my depreciation I will add back the depreciation of 2500 that was already included as an expense in the 2010 profit before tax of 100,000 however the tax allowance tax expense once for a better word was 5,000 therefore I ended up decreasing my profit before tax from 100,000 Rand down to 97,500 R and that difference ladies and gentlemen is what I call a movement in temporary difference and that is in this scenario you will see later on that this taxable temperary difference movement will reverse out in the future such as 2011 where depreciation once again is added back and the tax allowance is now zero the full expense for accounting and tax over the life of this asset are exactly the same both 5,000 Rand but the periods in which they are expensed for accounting in tax are difference so the 2,500 Grand taxable temporary difference reverses out in the 2011 year and becomes a well we used to call it a reversing taxable temper difference now it's a deductible temperary difference okay and you'll see that that 20500 increases my tax expense from well my profit figure from 100,000 for accounting purposes to 102,5 for tax purposes now in a perfect world we need to go back and remember that I'm trying to match the accounting expense to the correct period in which the counting income is earned so in 2010 as well as 2011 I have profit before tax of 100,000 so hypothetically at a tax rate of let's assume 28% I would have a tax expense of 28,000 but because of these timing differences or temporary differences between accounting and tax profit and loss I'm ending up with a tax expense in 2010 of 27,300 and in 2011 of 28,700 take note the tax expense overall okay has not changed it's just the period in which it differs so if I take my 27,300 compare it to what my tax expense hypothetically should be at 28,000 well tax expense is sted for once of a better word by 700 Grand remembering that 27300 is the tax that I will actually have to pay over to the tax Authority in 2010 but the tax for accounting ignoring any permanent type differences well that should have been 28,000 so I need to go and increase tax expense by 700 and I'll have some type of liability of 700 and what you'll see is in the next year my tax expense suly is 28,700 that I have to pay over to the receiver and the accounting tax should have been 28,000 so in this scenario I need to decrease the tax expense by 700 and how do I decrease an expense well I'm going to debit the liability and I will credit tax expense to make it smaller now we haven't got into what we're calling that tax expense yet we know that the original 27,300 for instance is going to be your current tax expense and you'll credit your current tax liability with 273 300 I think you've guessed by now that the 700 Grand increase or decrease well that is going to be a deferred tax expense movement now IAS 12 is quite clear that we should be looking at this from the financial position approach whereas the current tax computation is looking at this more from your profit and loss side so let's go and have a look at the statement of financial position approach here there's a very welln and accepted methodology first of all you will split up your calculation into four columns First Column carrying amount carrying amounts well of PPE as we discussed earlier well that is representative of the future economic benefits okay which equals the future profits then my tax base well I'll deal with definitions of tax base in a separate lecture but take it for now that the tax base of an asset is equal to the Future tax deductions my wear and tell Capital allowances so in this scenario let's have a look on day one on day one of my property plant and Equipment life I purchased the asset and I purchased it for 5,000 units of currency whether it be Rands dollars Euros whatever that 5,000 Rand represents at a conservative estimate 5,000 RS worth of future economic benefits we wouldn't have paid 5,000 Rand if we didn't expect to at least get 5,000 Rand out in the future well the tax base at this stage well we have not claimed any allowances yet so that 5,000 Rand future tax deductions are still fully intact as a 5,000 Rand deduction still to be claimed temporary difference on day one zero times it by 28% the thir tax well that gives me zero now ignoring the movement column let's go and have a look next at the balance of the PPE at reporting date 2010 at reporting date 2010 I have depreciated this 5,000 Rand asset by 2,500 Rand therefore I have got 25 00 R left of future economic benefits the tax base however well we got 100% Capital allowance in the first year therefore I've got no future tax deductions remaining the difference carrying amount minus tax base well that leavs me with a temporary difference of 2,500 r that 2,500 Rand if I want to look at this conceptually future economic benefits carrying amount of 2,500 is greater than zero future tax reductions therefore 2,500 Grand represents future taxable income and that is what we call a taxable temporary difference okay that temporary difference of 25,500 when times by 28% will give me the future tax consequences of that future taxable income I.E a 700 Grand future tax obligation we expect to pay 700 grand tax in the future extra therefore it's a liability so the movement thereof is what I'm after I need to go PPE balance on day one to PPE balance at the end of 2010 and likely I need to do the thir tax balance of zero on the first a to a the third tax balance of 700 Grand at the end of the period the movement is what I'm worried about so to journalize that movement I will go debit deferred tax profit and loss and I've increased from a0 to a 700 Grand liability liabilities get bigger on the credit side credit deferred tax financial position both of them 700 Grand great similar process for the next year in the next year 2011 my PPE has moved to a zero carrying amount fully depreciated tax base is still sitting at zero temper difference zero and I should have no deferred tax balance pleas you he me deferred tax balance is zero so in this scenario now I've gone from a 700 Grand deferred tax liability to a zero the referred tax balance therefore the movement for 2011 well let's think I had a liability balance which is a credit balance I need to make the balance sheet side back to zero so I'm going to go debit the thir tax financial position credit the thir tax expense profit and loss 700 okay and those are your journals you'll pass just to make sure that we've got our proof correct let's go back to our current tax computation and you'll see the journals at the bottom that we were doing a couple of minutes ago well we call the tax expense now we're just going to erase that and I'm going to call it the third tax expense profit and loss same amount and the same on the other side the credit is going to a deferred tax profit and loss expense 700 the check that I always use is taking my movement in temporary difference in my current tax comp I look at that 2,500 I know negative here means that I've decreased taxable income this year therefore when it reverses in the future years it will increase taxable income and therefore increase tax expense therefore it's a taxable temper difference well I go back and I look at the movement in my temper differences I went from zero to a taxable temp difference balance of 2,500 my taxable temp difference movement is therefore perfectly in align with my current tax computation perfect moving on from the calculations now we've done these journals the first year I've raised a current tax expense of 27300 and a current tax liability of 27300 the Deferred tax expense side I've just shown you that journal yeah 2010 we increased the expense by 700 and created a liability through a liability movement of 700 debit the expense credit the liability in 2011 the current tax was based on the increased taxable income and the Deferred tax expense well here we reversed out that deferred tax liability so I needed to debit the liability I make a liability smaller by debiting it and the other side goes to theer tax expense profit and loss a credit an income to finish off let's have a look at what the disclosure in the notes to the financial statements very simplified would look like the first note that you always need to do is your income tax expense and the income tax expense note is made up of two items the major components of tax expense as well as your tax rate reconciliation because there's no reconciliation reconciliation require required for this illustration I'm only going to do the major components major components split up between my current tax expense and my deferred tax expense there could be multiple elements to each of these two components here very simplified the current tax expense we can go back and look at Journal one for each of the 2010 and 2011 years there's my debit current tax expense 27300 debit current tax expense 28700 the trick comes in with the Deferred tax expense here I often can have a credit tax expense or a debit tax expense in 2010 I went debit the F tax profit and loss credit the F tax financial position and created a deferred tax liability in 2011 it's the other way around I reversed out that deferred tax liability and I credited deferred tax profit and loss making the Deferred tax expense smaller I add them up together and please note that I land up with my perfect 28,000 Rand tax expense now this is a very simplified example there's no capital gains tax effects here there is no reconciling items no change in tax rates no unrecognized tax loss again this is to illustrate the basic principles and how these things fit together please don't forget the rest of your um income tax needs to also include this concept of other comprehensive income this illustration did not cover other comprehensive income tax rate reconciliation separates the men's the men from the boys there is always something complex in a real life situation that results in your deferred tax well your total tax expense apologies okay mean meaning that your effective tax rate is not necessarily equal to the statutory tax rate that could be items such as capital gains non- taxable income non-deductible expenses Etc and what everyone also forgets to teach teach is that there's also a defer tax financial position note where we need to list all the items that are on your deferred tax balance calculation here we also should be splitting it between the different tax rates being used but again for a future lecture great thanks very much for your time um I hope you found this useful and uh yeah keep tuning in we will be giving you some more advice in the future thank [Music] you