Chapter 15

Taxation

Major accounting issues

• Determining Current tax &
Deferred tax
• Taxable temporary differences
• Deductible temporary differences
• Measurement and recognition of
deferred tax
• Taxation in company accounts
 IAS 12 Summary diagram
Taxation

Current tax Deferred tax

Revaluations of Losses that can

Depreciating
Recognition non-current be carried
assets
assets forward

Presentation
 Which party related to this issue?

• How the financial

records are compiled & • Accounting Standards
How to produce the
PROFIT?

• How much tax to pay

• Tax rules & regulations
to the government?
 Income statement vs Tax
computation
Example 1: A computer costs $30,000 was used for 3 years. Depreciation
$10,000 p.a. Tax authority allows full deduction when purchase.

Income Statement Tax computation

Income 100,000 Profits before tax 60,000

(accounting profit)
Rental (11,500) Add: depreciation 10,000
Salary (18,000) Less: Computer cost (30,000)
Depreciation (10,000) Assessable profit 40,000
(taxable profit)
Others (500) Tax payable – 10% 4,000
Net profit 60,000
Tax thereon 10% 6,000
 Income statement vs Tax
computation
• Tax computation for 3 years
Year 1 Year 2 Year 3 Total

Accounting profit 60,000 60,000 60,000 180,000

Depreciation 10,000 10,000 10,000 30,000

Less: computer addition (30,000) (30,000)

Taxable profit 40,000 70,000 70,000 180,000

Currrent tax payable (10%) 4,000 7,000 7,000 18,000

Effective tax rate (= current 7% 12% 12% 10%

tax/accounting profit)

For the 1st Year:

• Effective tax rate = 4,000/60,000 = 7%
• To reflect the delay payment of tax, we have to provide deferred tax
 Deferred tax liabilities (DTL)?
• Year 1: • Year 2:
- Current tax: - Current tax:
Dr Tax charge: 4,000 Dr Tax charge: 7,000
Cr Tax payable: 4,000 Cr Tax payable: 7,000
- Deferred tax: - Deferred tax:
Dr Tax charge: 2,000 Dr Deferred tax liability: 1,000
Cr Deferred tax liability: 2,000 Cr Tax charge: 1,000
- Income statement: - Income statement:
PBT: 60,000 PBT: 60,000
Tax charge: Tax charge:
+ Current tax: 4,000 + Current tax: 7,000
+ Deferred tax: 2,000 + Deferred tax: (1,000)
PAT: 54,000 PAT: 54,000
- Balance sheet: - Balance sheet:
CL: tax payable: 4,000 CL: tax payable: 7,000
NCL: DTL 2,000 NCL: DTL 1,000
 ment vs Tax computation
• Example 2: An entity accrued $30,000 pension per year for 3 years. But
only paid up the total amount of $90,000 in year 3 to a reliable pension
provider. Tax authority allows deduction when payment is made.
Income Statement (Yr 3) Tax computation

Income 160,000 Profits before tax 100,000

(accounting profit)
Rental (11,500) Add: accrued pension 30,000
Salary (18,000) Less: paid pension (90,000)
Accrued pension (30,000) Assessable profit 40,000
(taxable profit)
Others (500) Tax payable – 10% 4,000
Net profit 100,000
Tax thereon 10% 10,000

• Effective tax rate = 4,000/100,000 = 4%

 Income statement vs Tax
computation
• Tax computation for 3 years

Year 1 Year 2 Year 3 Total

Accounting profit 100,000 100,000 100,000 300,000

Accrued pension cost 30,000 30,000 30,000 90,000

Less: Paid pension - - (90,000) (90,000)

Taxable profit 130,000 130,000 40,000 300,000

Current tax payable (10%) 13,000 13,000 4,000 30,000

Effective tax rate (= current 13% 13% 4% 10%

tax/accounting profit)
 Deferred tax liabilities (DTL)?
• Year 1: • Year 2:
- Current tax: - Current tax:
Dr Tax charge: 13,000 Dr Tax charge: 13,000
Cr Tax payable: 13,000 Cr Tax payable: 13,000
- Deferred tax: - Deferred tax:
Dr Deferred tax asset: 3,000 Dr Deferred tax asset: 3,000
Cr Tax charge: 3,000 Cr Tax charge: 3,000
- Income statement: - Income statement:
PBT: 100,000 PBT: 100,000
Tax charge: Tax charge:
+ Current tax: 13,000 + Current tax: 13,000
+ Deferred tax: (3,000) + Deferred tax: (3,000)
PAT: 90,000 PAT: 90,000
- Balance sheet: - Balance sheet:
CL: tax payable: 13,000 CL: tax payable: 13,000
NCA: DTA 3,000 NCL: DTA 6,000
 Definitions – Deferred tax

Accounting profit Taxable profit

Differences

Permanent Differences Temporary Differences

No difference between Tax Difference between Tax

expense & Current tax expense & Current tax

Eg. Fines for violation Eg. Capital allowance

of regulation, is different from
dividend receipt, etc depreciation, etc.
 Definitions
• Temporary difference (TD) is calculated by comparing the
carrying amount of an asset or liability in the statement of
financial position to its tax base.
• The carrying value of an asset or liability is its value in the
statement of financial position at the reporting date.
• 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 the entity when it recovers the carrying value of the
asset. Where those economic benefits are not taxable, the tax
base of the asset is the same as its carrying amount.
Tax base of asset = future tax deduction
 Examples – tax base of assets
1. A machine costs $10,000 is usable for 5 years and depreciated
on a straight-line basis for accounting purpose but on a double
declining balance method for tax purposes. Determine the
carrying amount and the tax base at the end of 1st year if:
a. Revenue generated is taxable
b. Revenue generated is tax exempt
2. Interest receivable has a carrying amount of $2,000. Interest
revenue will be taxed on a cash basis.
3. Trade receivables have a carrying amount of $10,000. The
related revenue has been included in taxable profit.
4. A loan receivable has a carrying amount of $1m. The repayment
of loan has no tax impact.
 Definitions
• Tax base of a liability will be its carrying amount, less any amount
that will be deducted for tax purposes in relation to the liability in
future periods. For revenue 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.
Tax base of liability = Carrying amount – future tax deductions
 Example – tax base of liabilities
• Examples:
1. Current liabilities include accrued expenses with a carrying amount of
$1,000. The related expense will be deducted for tax purposes on a cash
basis.
2. Current liabilities include interest revenue received in advance, with a
carrying amount of $10,000. The related interest revenue was taxed on
a cash basis.
3. Current liabilities include accrued expenses with a carrying amount of
$2,000. The related expense has already been deducted for tax
purposes.
4. Current liabilities include accrued fines and penalties with a carrying
amount of $100. Fines and penalties are not deductible for tax purposes.
5. A loan payable has a carrying amount of $1m. The repayment of the
loan will have no tax consequences.
 Temporary difference
• Temporary differences (TD) = CA of an asset or a liability – tax
base of it
• There are 2 types of temporary differences: taxable temporary
differences and deductible temporary differences.
• Taxable temporary differences describe the situation where
because of a temporary difference in the accounting and tax
treatment of an item the entity will end up paying more tax in the
future. Taxable temporary differences give rise to deferred tax
liabilities (DTL).
• Deductible temporary differences describe the situation where
because of a temporary difference in the accounting and tax
treatment of an item the entity will end up paying less tax in the
future. Deductible temporary differences result in a deferred tax
asset (DTA).

CA of asset > Tax base of asset Taxable temporary difference DTL

CA of liability > Tax base of it Deductible temporary difference DTA
 Examples of temporary difference
Consider the following transactions.
(a) Interest receivable has a carrying amount of $300. The
related interest revenue will be taxed on a cash basis.
(b) Current liabilities include accrued expenses with a carrying
amount of $100. The related expense will be deducted for
tax purposes on a cash basis.
Required
1. Calculate the carrying amount and tax base and consider
whether there is a temporary difference in these values?
2. Calculate the amount of the temporary difference and state
whether this would give rise to a deferred tax asset or liability.
 Examples – depreciation difference
Leisure Tours buys a coach on 1 January 20X1 for $60,000.
The coach has a useful life of four years and will be scrapped at
the end of its life.
The company pays tax at 25% and tax depreciation is available
at 50% of cost in Year 1 and 25% on cost less tax depreciation
in Year 2 onwards. Leisure Tours has a profit before tax of
$100,000 in each of the years from 20X1 to 20X4. Applicable
tax rate is 25%.
Required
Using the information for Leisure Tours above, show how
the company would provide for deferred tax on the
temporary difference.
 Examples – depreciation difference
20X1 20X2 20X3 20X4
$ $ $ $
Profit before tax 100,000 100,000 100,000 100,000
Depn expense 15,000 15,000 15,000 15,000
Capital allowance (30,000) (7,500) (5,625) (16,875)
Taxable profit 85,000 107,500 109,375 98,125
Current tax (25%) 21,250 26,875 27,344 24,531

CA of asset 45,000 30,000 15,000 0

Tax base 30,000 22,500 16,875 0
TD 15,000 7,500 (1,875) 0
DTL (25%) 3,750 1,875 (469) 0
 Examples – depreciation difference
Extracts from SOFP 20X1 20X2 20X3 20X4
$ $ $ $
Deferred tax liability 3,750 1,875 (469) 0

Extracts from SOPL 20X1 20X2 20X3 20X4

$ $ $ $
Profit before tax 100,000 100,000 100,000 100,000
Current tax (Scenario 2) 21,250 26,875 27,344 24,531
Deferred tax 3,750 (1,875) (2,344) 469
Profit for the period 75,000 75,000 75,000 75,000
 Exercises
1. A company purchased some land on 1 January 20X7 for $400,000. On 31
December 20X8 the land was revalued to $500,000. Capital gain is only
taxed when it is realized. Income tax rate is 30%
2. During the year ended 31 Mar X4, Epsilon Co correctly capitalised
development costs of $1.6m in accordance with IAS 38. The development
project began to generate economic benefits for Epsilon from 1 Jan X4. The
directors of Epsilon estimated that the project would generate economic
benefits for 5 years from that date. Amortisation is charged on a monthly
prorata basis. The development expenditure was fully deductible against
taxable profits for the year ended 31 Mar X4 and the rate of tax applicable is
25%.
3. Pargatha recognises a liability of $10,000 for accrued product warranty
costs on 31 Dec 20X7. These product warranty costs will not be deductible
for tax purposes until the entity pays the warranty claims. Tax rate is 25%
4. BG is a company which has unused tax losses of $10,000. BG has
recently made positive operational changes and expects to return to
profitability in the next year or two. The income tax rate is 25%.
Required: State the deferred tax implications
 Recognition of deferred tax

• Under IAS 12, a deferred tax liability/asset is recognized for all

temporary differences, unless they arise from:
− Initial recognition of goodwill
− Initial recognition of an asset or liability in a transaction which
(i) is not a business combination
(ii) at the time of the transaction, affects neither accounting
profit nor taxable profit
• Deferred tax assets are only recognized to the extent that it is
probable that taxable profit will be available against which the
deductible temporary difference can be utilized.
• The carrying amount of deferred tax assets should be reviewed at the
end of each reporting period and reduced where appropriate
(insufficient future taxable profits). Such reduction may be reversed
in future years.
 Measurement of deferred tax

• Deferred tax assets and liabilities are measured at the tax rates
expected to apply to the period when the asset is realised or
liability settled, based on tax rates (and tax laws) that have been
enacted (or substantively enacted) by the end of the reporting
period.
• Deferred tax assets and liabilities should not be discounted because
of the complexities and difficulties involved.
Example: Girdo Co has an asset with CA of $80,000 and a tax base of
$50,000. The current tax rate is 30% and the rate is being reduced to
25% in the next tax year. Ginger Co plans to dispose of the asset for
its CA and will do so after the tax rate falls.
Calculate the deferred tax?
 Taxation in company accounts
• As mentioned previously:
– Current tax relates to the tax payable to the tax authorities based
on the taxable profits for the year
– Deferred tax is the tax relating to temporary differences
• The tax expense in the statement of profit or loss has three
component parts:
– Income tax on taxable profits
– Transfers to or from deferred taxation during the period
– Any under provision or over provision of income tax on profits of
previous years
 Taxation in company accounts
Income statement:
- Tax charge (Tax expense): in SOPL consists of 3 components:
1. Current tax: Income tax on taxable profits of this period
Current tax = taxable profit * tax rate
2. Over/under provision of income tax on profits of previous
periods
3. Deferred tax: Movement in deferred tax balances during the
periods

Balance sheet:
1. Unpaid tax (liabilities) or overpaid tax (prepayment)
2. Deferred tax liabilities (DTL) or deferred tax assets (DTA)
 Taxation in company accounts
Jasper’s trial balance at 31 Dec 20X3 shows a debit balance of
$700,000 on current tax and a credit balance of $8,400,000 on
deferred tax. The directors have estimated the provision for
income tax for the year at $4.5m and the required deferred tax
provision is $5.6m.
What is the tax expense recognized in Jasper’ SOPL for the year
ended 31 Dec 20X3?
 Taxation in company accounts
Jasper’s trial balance at 31 Dec 20X3 shows a debit balance of
$700,000 on current tax and a credit balance of $8,400,000 on
deferred tax. The directors have estimated the provision for
income tax for the year at $4.5m and the required deferred tax
provision is $5.6m, $1.2m of which relates to a property
revaluation.
What is the tax expense recognized in Jasper’ SOPL for the year
ended 31 Dec 20X3?
 2 approaches for deferred tax
• A computer at $30,000 and depreciates it over 3 years
• Tax authority allows full deduction in the year of acquisition.
Year 1 Year 2 Year 3 Total

Accounting profit 60,000 60,000 60,000 180,000

Depreciation 10,000 10,000 10,000 30,000

Less: computer addition (30,000) (30,000)

Taxable profit 40,000 70,000 70,000 180,000

Currrent tax payable (10%) 4,000 7,000 7,000 18,000

Effective tax rate (= current 7% 12% 12% 10%

tax/accounting profit)
 2 approaches for deferred tax

Example 1. A computer at $30,000 and depreciates it over 3 years.

Tax authority allows full deduction in the year of acquisition.

Year 1 Year 2 Year 3 Total

Accounting profit 60,000 60,000 60,000 180,000

Depreciation 10,000 10,000 10,000 30,000

Less: computer addition (30,000) (30,000)

Taxable profit 40,000 70,000 70,000 180,000

Currrent tax payable (10%) 4,000 7,000 7,000 18,000

Effective tax rate (= current 7% 12% 12% 10%

tax/accounting profit)
 2 approaches for deferred tax
• P/L approach
Accounting Taxable Difference Tax effect Remark
expense expense (change)
Year 1 10,000 30,000 (20,000) (2,000) DTL created
Year 2 10,000 - 10,000 1,000 DTL reverse
Year 3 10,000 - 10,000 1,000 DTL reverse
Total 30,000 30,000 - -

• Balance sheet approach

Accounting Tax base Difference DTL Remark
base asset asset
Year 1 20,000 - 20,000 2,000 DTL balance
Year 2 10,000 - 10,000 1,000 DTL balance
Year 3 - - - -
 2 approaches for deferred tax
Year 1 Year 2 Year 3 Total
Profit before tax 60,000 60,000 60,000 180,000
Tax (4,000) (7,000) (7,000) (18,000)
Deferred tax (2,000) 1,000 1,000 -
Profit after tax 54,000 54,000 54,000 162,000
Effective tax rate 10% 10% 10% 10%

• Year 1: • Year 2:
Current tax Current tax
Dr P/L – taxation: 4,000 Dr P/L – taxation: 7,000
Cr B/S – tax payable: 4,000 Cr B/S – tax payable: 7,000
Deferred tax Deferred tax
Dr P/L – taxation: 2,000 Dr B/S – deferred tax liability:
Cr B/S – deferred tax liability: 1,000
2,000 Cr P/L - taxation: 1,000
 2 approaches for deferred tax
Example 2: An entity accrued $30,000 pension per year for 3 years. But only
paid up the total amount of $90,000 in year 3 to a reliable pension provider.
Tax authority allows deduction when payment is made.
Income Statement (Yr 3) Tax computation

Income 160,000 Profits before tax 100,000

(accounting profit)
Rental (11,500) Add: accrued pension 30,000
Salary (18,000) Less: paid pension (90,000)
Accrued pension (30,000) Assessable profit 40,000
(taxable profit)
Others (500) Tax payable – 10% 4,000
Net profit 100,000
Tax thereon 10% 10,000

• Effective tax rate = 4,000/100,000 = 4%

 2 approaches for deferred tax
• An entity accrued $30,000 pension per year for 3 years. But only
paid up the total amount of $90,000 in year 3 to a reliable pension
provider. Tax authority allows deduction when payment is made.
Year 1 Year 2 Year 3 Total

Accounting profit 100,000 100,000 100,000 300,000

Accrued pension cost 30,000 30,000 30,000 90,000

Less: actual incurred pension cost - - (90,000) (90,000)

Taxable profit 130,000 130,000 40,000 300,000

Currrent tax payable (10%) 13,000 13,000 4,000 30,000

Effective tax rate (= current 13% 13% 4% 10%

tax/accounting profit)
 2 approaches for deferred tax
• P/L approach
Accounting Taxable Difference Tax effect Remark
expense expense (change)
Year 1 30,000 - 30,000 3,000 DTA created
Year 2 30,000 - 30,000 3,000 DTA increased
Year 3 30,000 90,000 (60,000) (6,000) DTA reduced
Total 90,000 90,000 - -

• Balance sheet approach

Accounting Tax base Difference DTA Remark
base liability liability

Year 1 30,000 - 30,000 3,000 DTA balance

Year 2 60,000 - 60,000 6,000 DTA balance
Year 3 90,000 90,000 - -
 2 approaches for deferred tax
Year 1 Year 2 Year 3 Total
Profit before tax 100,000 100,000 100,000 300,000
Tax (13,000) (13,000) (4,000) (30,000)
Deferred tax 3,000 3,000 (6,000) -
Profit after tax 90,000 90,000 90,000 270,000
Effective tax rate 10% 10% 10% 10%

• Year 1: • Year 2:
Current tax Current tax
Dr P/L – taxation: 13,000 Dr P/L – taxation: 13,000
Cr B/S – tax payable: 13,000 Cr B/S – tax payable: 13,000
Deferred tax Deferred tax
Dr B/S - DTA: 3,000 Dr B/S – DTA: 3,000
Cr P/L – taxation: 3,000 Cr P/L - taxation: 3,000