Chapter 15
Taxation in Financial Statements
Presented by Group 1
IVacc-2 IVacc- 14
Hsu Lin Latt Thae Su Ko Ko
IVacc- 6 Members IVacc- 18
Phyo Theint Theint Htet
Ei Phoo Wai
of
Group-1
IVacc- 10 IVacc-21
Nao Shin Shin San Shin Mint Thant Lwin
Introduction
• Treatment of taxation in financial statements
• IAS 12, Income taxes, sets out rules for the accounting treatment of “current
tax” and “deferred tax”
• Solely concerned with accounting for taxation and not concerned with
actual calculation of tax liabilities
• Assumes tax calculations have already been done and the problem is how to
account for taxation in the financial statements
• Deals with any taxes payable on the profits of an entity (doesn’t matter what
those taxes might be called in different countries)
Objectives
• To define the term “current tax” and account for current tax in accordance with
requirements of IAS12 Income taxes
• To define the term “temporary differences” and distinguish between taxable
temporary differences and deductible temporary differences
• To explain the meaning of the “tax base” of an asset or liability
• To calculate the deferred tax assets and liabilities arising from deductible and
taxable temporary differences
• To account for deferred tax in accordance with the requirements of IAS12
Current Tax
• “the amount of income taxes payable (recoverable) in respect of the
tax profit (tax loss) for a period”
• “Income Tax”, any tax which is payable on an entity’s profits
Main requirements of IAS12 with regard to current
tax
a) The amount of current tax should be recognised as an expense (income in
the case of tax recoverable) and should be included in the calculation of
profit or loss
• IAS1 requires that tax expense should be presented separately in the statement of
comprehensive income. However,
1. Any current tax arising from an item which 2. Any current tax arising from an item
is recognised in “other comprehensive which is recognised directly in the statement
income” in the statement of comprehensive of changes in equity should be recognised in
income should be recognised in other the SOCIE
comprehensive income. Eg. Adjustment to opening balance of retained
Eg. Revaluation surplus (Property, plant and earnings resulting from the retrospective
equipment or intangible assets), certain foreign application of an accounting policy or the
exchange differences correction of a prior period errors
Main requirements of IAS12 with regard to
current tax
b) Any current tax that remains unpaid at the end of the period should be
recognised as a liability
• If the amount already paid exceeds the amount due, the excess should be
recognised as an asset
• Benefit relating to a tax loss that can be carried back to recover current tax
of a previous period should be recognised as an asset
• Current tax assets and liability should not be offset in the SOFP unless there
is a legally enforceable right and the entity intends to do so
Main requirements of IAS12 with regard to current
tax
c) Current tax should be measured using tax rates and tax laws “that have
been enacted or substantively enacted by the end of the reporting period”
• Tax rates and laws announced after the end of reporting period are dealt with
as non-adjusting events in accordance with the requirements of IAS10
d) Any adjustments necessary so as to reflect underestimates or
overestimates of current tax in previous periods should be included in the tax
expense for the current period
• If material, disclosed separately which is in accordance with requirements of
IAS8
Example 1 (Solution)
• The new tax rates can be regarded as substantively enacted, so that current tax
for the year is £750,000. But the statement of comprehensive income will show
a net current tax expense of only £720,000, so as to adjust for the previous
year's overestimate.
• Payments on account of £390,000 reduce the current tax liability shown in the
statement of financial position to £360,000 (£750,000 - £390,000). The current
tax ledger account for the year might appear as follows:
Tax Deducted at Source (UK)
• UK companies may receive certain forms of income net of UK income tax,
although this is now rare.
• When companies receive income with tax already deducted at source, they
must reclaim this tax from the tax authorities.
• UK companies may occasionally make payments net of income tax.
• Any income tax withheld from these payments is remitted to the tax authorities.
• The overall tax effect is nil and so there is no impact on the tax expense for
the year.
• The company's financial statements should show the relevant income and
payments gross (i.e. at the amount before income tax was deducted).
Deferred Tax
• Deferred tax arises because Accounting profit ≠ Taxable profit
• Two Types of Differences:
1. Permanent Difference
2. Temporary Difference
1. Permanent Difference
Some of the income shown in the financial statements may not be chargeable to
tax and some of the expenses shown in the financial statements may not be
deductible for tax purposes.
E.g. Some Entertaining Expenses
Permanent differences cause no accounting problems and can be ignored.
Deferred Tax
2. Temporary Differences
Some of the income or expenses shown in the financial statements for an
accounting period may be dealt with for tax purposes in a different accounting
period.
Eg.
• Depreciation ( shown in financial statements but disregarded for tax purposes
and replaced by standardized depreciation charges known as
capital allowances)
• (Total Depreciation Charges = Total Capital Allowances) over the entire
lifespan of the entity
• But, a significant difference in any one period
Temporary differences a significant distortion ( profit after tax, entity
performance, and earning per ratio)
Example 2
A company with an issued share capital of 2ordinary shares has the following results for
the three years to 31 December 2020:
2018 (£000) 2019 (£000) 2020 (£000)
Profit Before tax 1600 1600 1600
Depreciation 400 400 400
charged in the year
Depreciation for tax 800 300 100
purposes
Assuming that there are no other permanent or temporary differences and that the rate of
tax is 19% throughout, compute the company's profit after tax for each of the three years.
Also calculate the earnings per share ratio for each year. (This ratio is equal to the profit
after tax divided by the number of issued ordinary shares).
The Tax expense for each year is calculated as follows.
2018 (£000) 2019 (£000) 2020 (£000)
Profit before tax 1600 1600 1600
Add: Depreciation charged in the year 400 400 400
Profit before depreciation 2000 2000 2000
Less: Depreciation for tax purposes (800) (300) (100)
Taxable Profit 1200 1700 1900
Tax expense (19% of taxable profit) 228 323 361
The profit after tax calculation for each year
Profit before tax 1600 1600 1600
Tax expense (228) (323) (361)
Profit after tax 1372 1277 1239
No. of ordinary shares 2000 2000 2000
Earnings per share 0.686 0.6385 0.6195
• These figures give the impression that profit after tax and earnings per
share are on a downward trend (which may deter investors) when in fact
the company's profits have been identical in each of the three years.
• Total Depreciation Charges = Total Capital Allowances =£1200,000
• but temporary differences have caused the reported figures for profits after
tax and earnings per share to be misleading.
Accounting for Deferred Tax
• IAS 12: Accounting Profit // Taxable Profit
(Income Tax) // (Current Tax)
(Temporary Difference – Deferred)
• Deferred Tax = Temporary Difference x Tax Rate (%)
• IAS 1: Presentation of Financial Statements – Deferred Tax account should be
shown as Non-current Liability (Asset) in SOFP.
Accounting for Deferred Tax
• Temporary Difference = Accounting Profit // Taxable Profit
• Accounting Profit > Taxable Profit (Deferred Tax Liability)
• Accounting Profit < Taxable Profit (Deferred Tax Asset)
Format of Income Tax (Short – Cut)
Current Tax
xx
• Under SOPL: Income Tax (Expense) (+/-) Deferred Tax for the year xx/
(xx)
Income Tax
xx
NCL : Deferred Tax Closing
• Under SOFP: NCL and CL
xx
( Opening DT + DT for the year)
CL : Current Tax
xx
Example 3: Deferred Tax
• Given: Year 2018 (£000) 2019 (£000) 2020 (£000)
Profit Before Tax 1600 1600 1600
Tax Expense (228) (323) (361)
Profit After Tax 1372 1277 1239
EPS 68.6 p 63.85 p 61.95 p
• Show the necessary transfer to and from the company’s deferred tax account.
Solution
• 2018: Accounting Profit 1600 > Taxable Profit 1200 = 400
Deferred Tax = 400 * 19% = 76 (DTL)
• 2019: Accounting Profit 1600 < Taxable Profit 1700 = 100
Deferred Tax = 100 * 19% = 19 (DTA)
• 2020: Accounting Profit 1600 < Taxable Profit 1900 = 300
Deferred Tax = 300 * 19% = 57 (DTA)
Solution
Year 2018 (£000) 2019 (£000) 2020 (£000)
Profit Before Tax 1600 1600 1600
Income Tax
Current Tax 228 323 361
(+/-) DT FTY 76 (19) (57)
304 304 304
Profit After Tax 1296 1296 1296
EPS 64.8 p 64.8 p 64.8 p
• This is a much fairer presentation of the company’s results than the presentation
which was given in Example 2.
The Tax Base Concept
• IAS 12: Tax base of each asset and liability at year end should be calculated
and compared with its “carrying amount”.
• Deferred = C.V of Asset or Liability // Tax Base of Asset or Liability
• Tax Base of an Asset or Liability – the amount attributed to that asset or liability for
tax purpose.
• Tax Base of Asset -The value of asset according to the tax authorities
• Tax Base of Liability -The amount of the liability that will be subject to tax
(Carrying value – Any amount that will be deductible for tax purposes in the future)
The Tax Base Concept
• Temporary Difference – The difference between the carrying amount of an asset
or a liability and its tax base.
• Temporary Difference (2 Kinds)
1) Taxable Temporary Difference Deferred Tax Liability Resulted Difference
2) Deductible Temporary Difference Deferred Tax Asset Resulted Difference
The Tax Base Concept
• Deferred tax liability
• Accounting Profit > Taxable Profit (Deferred Tax for the year)
• C.V of Asset > Tax Base of Asset (Deferred Tax closing)
• C.V of Liability < Tax Base of Liability (Deferred Tax closing)
• Deferred tax asset
• Accounting Profit < Taxable Profit (Deferred Tax for the year)
• C.V of Asset < Tax Base of Asset (Deferred Tax closing)
• C.V of Liability > Tax Base of Liability (Deferred Tax closing)
The tax base of an asset
o Entities hold assets to generate future economic benefits
Selling the asset (e.g. inventories)
Using the asset (e.g. property, plant and equipment)
Realising the asset (e.g. trade receivables)
o Benefits obtained might or might not be taxable.
o The deduction allowed is the same as the carrying value of the asset concerned,
the tax system and the accounting system are in harmony and there is no
deferred tax problem.
o If not the same, the difference will give rise to a deferred tax adjustment.
o If the benefits obtained from an asset are not taxable, there is no deferred tax
problem.
EXAMPLE 4
Consider each of the following assets which appear in a company's statement of financial position as
at 31 March 2020.
(a) A machine which cost £40,000 is shown at its written down value of £16,000. For tax purposes, its
written down value is £11,200. The machine's residual value at the end of its useful life is
expected to be £nil.
(b) Trade receivables are shown at £75,000. The revenue to which these relate was included in taxable
profit for the year to 31 March 2020.
(c) Interest receivable is shown at £3,000. This interest has been included in accounting profit but will
not be taxed until it is actually received. It will then be fully taxable.
For each of these assets:
(i) Compute the tax base of the asset and determine whether a temporary difference exists with
respect to it. If so, state whether this is a taxable temporary difference or a deductible temporary
difference.
(ii) Assuming a tax rate of 19%, calculate the amount of the deferred tax liability or asset which
should be shown in the statement of financial position in relation to the asset.
Solution
This solution relies heavily on the IAS12 definitions given above and should be read with those definitions
firmly in mind.
(a) (i) Use of the machine in future periods will generate taxable revenue. Deductions totalling £11,200
will be allowed against that revenue for tax purposes, so the tax base of the machine is £11,200. The
carrying amount is £16,000 and this is the amount that will be deductible when computing accounting
profits in future periods as the machine is used. Since only £11,200 will be deducted for tax purposes,
there is a taxable temporary difference of £4,800.
(ii) The deferred tax liability is £912 (19% x £4,800).
(b) When the receivables are realised, the amount received will not be taxable, so the tax base of the
receivables is the same as their carrying amount (i.e. £75,000). There is no temporary difference and so
there are no deferred tax implications.
(c) (i) When the interest is received, taxable revenue of £3,000 will occur. There will be no deduction
from this revenue for tax purposes so the tax base is £nil. There is a taxable temporary difference of
£3,000.
(ii) The deferred tax liability is £570 (19% x £3,000)
The tax base of a liability
oSettlement of a liability
• No effect on accounting profit
• No effect on taxable profit
• Not to cause deferred tax problems
oIn settlement of a liability might in some cases trigger a deduction from taxable
profits.
oIn these circumstances, the amount of the deduction will give rise to a deferred tax
adjustment.
Example 5
Consider each of the following liabilities which appear in a company's statement
of financial position as at 31 March 2020.
(a) Current liabilities include accrued expenses of £5,000. These expenses have
already been deducted when computing both accounting profit and taxable profit.
(b) Current liabilities include further accrued expenses of £8,000. These expenses
have been deducted when computing accounting profit but will not be deducted for
tax purposes until they are actually paid.
For each of these liabilities:
(i) Compute the tax base of the liability and determine whether a temporary
difference exists with respect to it. If so, state whether this is a taxable
temporary difference or a deductible temporary difference.
(ii) Assuming a tax rate of 19%, calculate the amount of the deferred tax liability
or asset which should be shown in the statement of financial position in relation
to the liability.
Solution
Once again, this solution relies heavily on the IAS12 definitions given above and
should be read with those definitions firmly in mind.
(a)When these accrued expenses are paid, the payment will not be deductible for
tax purposes. Therefore their tax base is the same as their carrying amount (i.e.
£5,000). There is no temporary difference and so there are no deferred tax
implications.
(b)(i) When these accrued expenses are paid, the payment will be deductible for
tax purposes. Therefore their tax base is £nil (£8,000 - £8,000) and there is a
deductible temporary difference of £8,000.
• (ii) The deferred tax asset is £1,520 (19% x £8,000).
Example 6
A company with an issued share capital of 2,000,000 ordinary shares has the
following results for the three years to 31 December 2020:
The applicable tax rate is 19% throughout.
Now use the tax base concept to rework this example and to calculate the necessary
transfers to and from the company's deferred tax account. Assume that the
depreciation charges relate to an asset acquired for £1,200,000 on 1 January 2018 and
depreciated on the straight-line basis over three years, with an estimated residual
value of £nil.
Solution
At the end of 2018, the asset has a carrying value of £800,000 but its tax base is
only £400,000 (cost £1,200,000 - depreciation £800,000 for tax purposes). There
is a taxable temporary difference of £400,000, giving rise to a deferred tax
liability of £76,000 (19% x £400,000). Setting up this liability increases the tax
expense for 2018 by £76,000.
At the end of 2019, the asset's carrying value is £400,000 but its tax base is only
£100,000 (cost £1,200,000 depreciation £1,100,000 for tax purposes). The
taxable temporary difference is £300,000, giving rise to a deferred tax liability of
£57,000 (19% x £300,000). This is £19,000 less than the liability which was set
up in 2018, so £19,000 must be trans- ferred from the deferred tax account,
reducing the tax expense for 2019 by £19,000.
At the end of 2020, the asset's carrying value and tax base are both £nil. There is no
temporary difference so the £57,000 deferred tax liability from 2019 is no longer
required. Transferring this £57,000 back from the deferred tax account reduces the
tax expense for 2020 by £57,000.
Note:
As expected, the results obtained by using the tax base concept are identical to those
which were obtained originally in the solution to Example 3.
Unused tax losses
The tax law of the country in which an entity resides may allow trading and other
losses to be carried forward and deducted from future taxable profits, so reducing
the tax due on those profits.
In these circumstances, IAS12 states that a deferred tax asset should be recognized
to the extent that it is probable that future taxable profits will be available against
which the losses can be utilized.
IAS12 Requirements with regard to deferred tax
A deferred tax liability must be recognised for all taxable temporary differences.
A deferred tax asset must be recognised for all deductible temporary differences to the
extent that it is probable that taxable profits will be available in the future against
which these deductible temporary differences can be utilised.
The carrying amount of deferred tax assets must be reviewed at the end of each
reporting period and reduced to the extent that it is no longer probable that taxable
profits will arise against which they can be utilised.
A deferred tax asset or liability must be measured at the tax rates that are expected to apply to
the period in which the asset is realised or the liability is settled.
Deferred tax assets and liabilities must not be discounted, even though they might not be
realised or settled for many years. IAS12 regards it as inappropriate to require or permit
discounting because of the uncertain timing of the reversal of each temporary difference.
Transfers to or from the deferred tax account should generally be recognised in the calculation
of profit or loss. However, a deferred tax transfer that arises from an item which is recognised
in other comprehensive income or directly in equity should also be recognised in other
comprehensive income or directly in equity.
Deferred tax assets and liabilities should not be offset in the statement of financial position
unless the entity has a legally enforceable right to do so.
Disclosure Requirements
(a) The tax expense shown in the calculation of profit or loss for the
accounting period must be analysed into its main components. These
may include:
the current tax expense (or income) for the period
any adjustments relating to underestimates or overestimates of current
tax in previous accounting periods
the amount of any transfers to or from the deferred tax account
relating to the origination or reversal of temporary differences.
(b) The following must also be disclosed separately:
the amounts of current and deferred tax relating to items that are recognised in other
comprehensive income or directly in equity
an explanation of the relationship between the accounting profit for the period and
the tax expense for the period
for each type of temporary difference, the amount of the deferred tax asset or
liability recognised in the statement of financial position and the amount of the
deferred tax expense or income recognised in the period.