Deffered Tax

Muhammad Khurshid Ashraf
thekhurshid@gmail.com
This article is dedicated to Rahimia Institute of Quranic Sciences, Lahore
http://rahimia.org/taruf.htm
Salam to all finance & account dudes;
In spite of the shortage of time, I have tried my best to explain the core of
the IAS 12. Pray for me. If I find time, Ill try to brought such other work to
you people.
Just required yours prays.
Love my and your Pakistan
Allah Hafiz
URL: http://rahimia.org/taruf.htm
Disclaimer by Rahimia Institute;
The explanation of IAS12 is not the ideology of Rahimia Institute
DEFERRED TAX (IAS-12)
OBJECTIVE
This standard basically deals with the Accounting for Income Taxes. Accounting for
Income Taxes means that it explains the accounting treatment of Income Taxes in the
books of accounts.
Broadly speaking, Accounting for Income Taxes under this standard covers following
three major topics.
The tax consequences arising from:
1. the future recovery / settlement of carrying amount (CA) of assets / liabilities
which the entity has recognized in its balance sheet
2. the transactions and other events of current period that are stated in the financial
statements
3. the unused tax losses and unused tax credits
To deal with the above mentioned tax consequences, this standard recommends the
recognition of deferred tax liability or deferred tax liability.
Future Recovery of Carrying Amount of Assets
The future recovery of carrying amount of assets means the income that will be generated
or economic benefit that will be received by the entity by using the assets in future
periods.
Settlement of Carrying Amount of Liabilities
The settlement of carrying amount of liabilities means the payment / adjustment of
liabilities in future will rise to tax consequences.
The transactions and other events
The transactions and other events which are given in the balance sheet and profit and loss
account
Unused Tax Losses
Tax losses as determined under tax laws and will be used against the taxable profit of
future periods.
Unused Tax Credits
Tax Credits as determined under tax laws and will be used against the taxable profit of
future periods.
SCOPE
This standard only covers the Accounting for Income Taxes. Income Taxes include all
taxes while determining taxable profit under:
1. Domestic laws (Income Tax Ordinance 2001, Income Tax Rules 2002, and other
applicable SROs)
2. Foreign laws (Income tax law of Foreign country) [IAS 12.1 & 12.2]
This standard does NOT cover Accounting for:
1. Government Grants
2. Investment Tax Credits
3. Any other Tax (Sales tax, Excise duty etc) [IAS 12.4]
DEFINITONS
Accounting Profit (Profit before taxation (PBT) in Profit and loss account) [IAS 12.5]
It means the profit determined under accounting methods (Accounting standards,
principles, procedures etc)
Taxable Profit (Tax Loss) [IAS 12.5]
The profit/loss determined under the tax laws (Income Tax Ordinance 2001, Income Tax
Rules 2002, and other applicable SROs). It is the amount on which the income tax is
payable/receivable for a period.
Tax Expense (Tax Income) [IAS 12.5 & 12.6]
It is the total amount of:
1. Current Tax
a. Prior year tax
b. Current year tax
2. Deferred Tax Expense / Deferred Tax Income
The tax expense is deducted from accounting profit (PBT) to reach at profit or loss for a
period or profit after tax (PAT).
(Tax income/refund arises when tax paid is more than the actual amount of tax)
Profit Before Taxation xxx
Tax Expense
Prior year tax xxx
Current year tax expense xxx
Current year tax income (xxx)
Deferred Tax Expense xxx
Deferred Tax Income (xxx) (xxx)
Profit after Taxation xxx
Current Tax [IAS 12.5]
Current tax is the amount of income tax payable or income tax receivable for a period. It
is computed from taxable profit by applying tax rate of that period. If there is tax loss, the
minimum tax under section 113 shall be the amount of current tax.
Entry for recognizing current tax:
DR Current Income tax expense xxxx
CR Current Income tax payable xxxx
(Generally for taxable profit (tax loss), inadmissible expenses and admissible incomes
are added to the profit before tax (PBT). Admissible expenses and inadmissible incomes
are deducted from PBT.)
Deferred Tax Expense and Deferred Tax Liability [IAS 12.5]
Deferred tax expense is the amount of income tax expense on the income of current
period but due to taxable temporary differences, such income taxes will be paid in future
periods.
Entry for Deferred Tax Expense and Deferred Tax Liability:
DR Deferred tax expense xxxx
CR Deferred tax liability xxxx
Let us suppose, there is no tax deferred tax expense/income in future period(s)
In accounting, the (deferred) tax expense is recognized in current period and it will be
reversed in future.
Entry in such case:
DR Deferred tax liability xxxx
CR Deferred tax income (credit) xxxx
Under accounting, there will be deferred tax expense in current period and deferred tax
income (credit) in future period(s).
Under tax laws,
In current period, less current tax expense is computed and
In future period(s), the difference that is not recognized in current period will become
part of current tax of future period. In simple words more current tax expense of future
period will be computed.
Deferred Tax Income and Deferred Tax Asset [IAS 12.5]
Deferred tax income is the amount of income tax expense of future period but it has been
recognized as current tax expense of current period which should not be recognized in
current period. Therefore, deferred tax income will be recognized to reduce tax expense
of current period and these amounts shall be recoverable (adjustable) in future period(s)
due to:
1. the deductible temporary difference;
2. the carryforward of unused tax losses; and
3. the carryforward of unused tax credits
Entry Deferred Tax Income and Deferred Tax Asset:
DR Deferred tax assets xxxx
CR Deferred tax income xxxx
Let us suppose, there is no tax deferred tax expense/income in future period(s)
In accounting, the (deferred) tax income is recognized in current period and it will be
reversed in future.
Entry in such case:
DR Deferred tax expense xxxx
CR Deferred tax asset xxxx
Under accounting, there will be deferred tax income in current period and deferred tax
expense in future period(s).
Under tax laws,
In current period, more current tax expense is computed and
In future period(s), the excess difference that is recognized in current period will not
become part of current tax of future period. In simple words less current tax expense of
future period will be computed.
(Deferred tax expense/income is not recognized by tax authorities. In accounting, we
recognize it because it because the incomes and expenses are taken on accrual basis.
Those incomes and expenses which form the part of current period, their relevant income
tax should also be charged to the current period which we do in the shape of deferred tax
expense/income. Whereas they form the part taxable profit on cash basis under tax laws
except those which are allowed to be recognized on accrual basis by Income tax
Ordinance 2001, relevant rules and SROs.)
Temporary Difference [IAS 12.5]
Temporary difference is the amount of difference between the carrying amount of an
asset or liability in the balance sheet of the current period and its tax base. There are two
types of differences that arise between the carrying amount (CA) and tax base. These are:
1. Taxable temporary differences
2. Deductible temporary differences
Taxable temporary differences [IAS 12.5]
When the taxable profit or tax loss of future period(s) will be determined, those
temporary differences (the differences between carrying amount of an asset or liability
and its tax base) that will give rise to taxable amounts in taxable profits (tax loss) are
called taxable temporary differences when the carrying amount of an asset is recovered or
the carrying amount of liability is settled.
In other words, the amount of difference between carrying amount and tax base of an
asset or liability that will be taxable in taxable profit (tax loss) of future period(s) is called
taxable temporary differences. When the taxable profit (tax loss) of the future period will
be determined, the amount of taxable temporary differences will already be included in
this taxable profit (tax loss).
Deductible temporary difference [IAS 12.5]
When the taxable profit or tax loss of future period(s) will be determined, those
temporary differences (the differences between carrying amount of an asset or liability
and its tax base) that will give rise to deductible amounts from taxable profit (tax loss) are
called deductible temporary differences when the carrying amount of an asset is
recovered or the carrying amount of liability is settled.
In other words, the amount of difference between carrying amount and tax base of an
asset or liability that will be deductible from taxable profit (tax loss) of future period(s) is
called deductible temporary differences. When the taxable profit (tax loss) of the future
period will be determined, the amount of deductible temporary differences will already
be included in this taxable profit (tax loss).
The taxable profit (tax loss) will be less than the amount of profit before tax (PBT) by the
amount of deductible temporary difference.
General Note
Whereas in accounting, tax on taxable temporary differences or deductible temporary
difference is recognized in the financial statements of current period to give true and fair
view. By doing this the financial statements give true picture of profit for the year or
profit after tax (PAT).
If such treatment is not made in the financial statements, the profit will be over or
understated. Therefore, the financial statements will not true picture of profit for the year
or profit after tax.
TAX BASE
For the purpose of tax, the amount attributed to the asset or liability under tax laws. [IAS
12.5]
Tax Base of Assets [IAS 12.7]
1. When related expense is deductible for tax purpose
Every asset that is used in business will generate or help in generating economic benefits
(revenues) for the entity. These economic benefits (revenues) will be taxable under tax
laws. There is an amount that is attributed to an asset under tax laws or it may be called
cost of an asset determined under tax laws. Such amount of an asset will be transferred to
a related expense in each future period. When the amount (total of all related expenses) is
deductible for tax purpose from the taxable economic benefits (revenue) in future
periods, it will be called tax base of an asset.
The cost of a fixed asset is apportioned into depreciation for charging against the revenue
of different future periods under tax laws. If we add the amounts of depreciation that will
be charged to revenues of each future period, the total of amounts of depreciation will be
called the tax base of that fixed asset.
Example by IAS12
A machine cost 100. For tax purposes, depreciation of 30 has already been deducted in
the current and prior periods and the remaining cost will be deductible in future periods,
either as depreciation or through a deduction on disposal. Revenue generated by using the
machine is taxable, any gain on disposal of the machine will be taxable and any loss on
disposal will be deductible for tax purposes. The tax base of the machine is 70.
As explained by this example, for determining the tax base of machine the related
expenses (depreciation or deduction on disposal) will be deductible for tax purpose and
the related economic benefits (revenue) will be taxable.
2. When related expense is not deductible for tax purpose
When related expense is not deductible for tax purpose, there will be no tax consequence
and then tax base is equal to carrying amount.
3. When related economics benefit is not taxable
If related economic benefits:
a. are not taxable in future period(s) or
b. have been taxed in current or prior period,
tax base of an asset is equal to its carrying amount.
Example by IAS12
Trade receivables have a carrying amount of 100. The related revenue has already been
included in taxable profit (tax loss). The tax base of the trade receivables is 100.
As the related revenue is not taxable in future period, the tax base is equal to carrying
amount. Carrying amount is 100; the tax base of trade receivable is also 100.
Example by IAS12
Dividends receivable from a subsidiary have a carrying amount of 100. The dividends are
not taxable. In substance, the entire carrying amount of the asset is deductible against the
economic benefits. Consequently, the tax base of the dividends receivable is 100.
As is this example the related revenue (dividend) is not taxable in future period. The tax
base of dividends receivable is equal to its carrying amount. So tax base of this asset is
100.
Example by IAS12
A loan receivable has a carrying amount of 100. The repayment of the loan will have no
tax consequences. The tax base of the loan is 100.
The repayment of loan receivable in future will neither be taxable nor be deductible for
tax purpose. In this case, its tax base will also be equal to its carrying amount.
4. When related economics benefit is taxable
As in IAS 12.7, if related economics benefits are not taxable in future period, the tax base
is equal to carrying amount. We can extract from this statement if economic benefits are
taxable in future period, the tax base is not equal to carrying amount.
If related economic benefits:
c. are taxable in future period(s) or
d. have not been taxed in current or prior period
tax base of an asset is not equal to its carrying amount,
(The tax base is not equal to carrying amount means that it might be nil, less than, or
greater than carrying amount)
Example by IAS12
Interest receivable has a carrying amount of 100. The related interest revenue will be
taxed on a cash basis. The tax base of the interest receivable is nil.
In this example, the related revenue will be taxed on a cash basis. It will be taxable in
future period. If it is not taxable in future, the tax base of interest receivable (100) is
equal to its carrying amount (100). As it IS TAXABLE in future period, then tax base is
not equal to carrying amount. It is not 100. It is zero (0). So is NIL. The tax base is NIL
because the revenues do not affect taxable profit until cash is collected
In nut shell, Tax base of an asset
1.When related expenses are deductible for tax purpose
Tax base = amount deductible for tax purpose
2.When related expenses are not deductible for tax purpose
Tax base = carrying amount
3.When related economic benefits are not taxable
4.When related economic benefits are taxable
Tax base ? carrying amount
Tax base > carrying amount
Tax base < carrying amount
Tax base = 0 (nil)
[In brief, we can say that the carrying amount determined under tax laws (not under
accounting standards and principles) is the tax base of an asset.]
Tax base w.r.t Amount deductible for tax purpose
If any amount of asset that will be deductible for tax purpose against taxable economic
benefits could be determined, then such deductible amount will be tax base.
Deductible amount = Tax base
Tax base w.r.t Taxable economic benefit (revenue)
If any amount of an asset that is deductible could not be straightly identified and related
economic benefits (revenue) are ascertainable, then find out whether they will be taxed
or will not be taxed in future.
If they will not be taxed in future period, the tax base is equal to carrying amount.
If they will be taxed in future period, there is a tax base is equal to nil, less and greater
than carrying amount.
Determination of Tax base by another method
The tax base of can also be determined using following formula:
Carrying amount xxxx
Less: taxable amount xxxx
Add: deductible amount xxxx
Tax base xxxx
Ref:
www.pwc.org
Deferred Tax by Kamran Rasheed
Tax Base of Liability [IAS 12.8]
If a service or good is received but payment is not made, then expense is incurred and
amount payable is a liability. If amount is received advance but service is not rendered or
good is not delivered, then advance income will be a liability and it will become income
in future period. So an expense or income is related to a liability. The related expenses
may be deductible for tax purpose and related incomes may be taxable.
[In accounting, advance income will become income of any future period. But under tax
laws, it might become income of current period if it is taken on cash basis (if not taken on
accrual basis).]
Now we find the tax base as given in IAS 12.
1. When related expense is deductible for tax purpose
When the related expense of liability is deductible for tax purpose against the economic
benefits, the tax base of liability is equal to carrying amount less any amount deductible
for tax purpose.
Tax base of liability = Carrying amount of liability Related expense deductible for tax purpose
Example by IAS12
Current liabilities include accrued expenses with a carrying amount of 100. The related expense
will be deducted for tax purposes on a cash basis. The tax base of the accrued expenses is nil.
By analyzing above example, we come to know by the statement given in the example
that the related expense will be deducted for tax purposes on a cash basis but accrued
expense has been recognized on accrual basis. Under tax laws, it will be treated as
expense when cash will be paid and then it will become part of taxable profit (tax loss).
So the related expense deductible for tax purpose is 100. By using the above formula: -
0 = 100 100
2. When related expense is not deductible for tax purpose
When the related expense is NOT deductible for tax purpose, it has already been
deducted, or it has not tax consequences (neither already deducted nor deductible for tax)
then:-
Tax base of liability = carrying amount of liability
Example by IAS12
Current liabilities include accrued expenses with a carrying amount of 100. The related expense
has already been deducted for tax purposes. The tax base of the accrued expenses is 100.
In this example, related expense has already been deducted for tax purpose. It means it will not be
deductible for tax purpose. The related expense deductible for tax will be zero (0).
For more clarification, lets use the formula given in IAS12.
100 = 100 0
Example by IAS12
Current liabilities include accrued fines and penalties with a carrying amount of 100. Fines and
penalties are not deductible for tax purposes. The tax base of the accrued fines and penalties is
100.
In this example, related expenses (fines and penalties) are not deductible for tax purpose. There
will be no tax consequences because fines and penalties. The related expenses (fines and
penalties) deductible for tax will be zero (0).
100 = 100 0
Example by IAS12
A loan payable has a carrying amount of 100. The repayment of the loan will have no tax
consequences. The tax base of the loan is 100.
In this example, the repayment of the loan will have no tax consequences. There will be no
related expense deductible for tax purpose. The related expenses deductible for tax will be zero
(0).
100 = 100 0
3. When related economics benefit is not taxable
Where in a case the related economic benefit (revenue) is NOT taxable with taxable
profit of future period
Tax base of liability = carrying amount not taxable related economic benefit (revenue)
Example by IAS12
Current liabilities include interest revenue received in advance, with a carrying amount of 100.
The related interest revenue was taxed on a cash basis. The tax base of the interest received in
advance is nil.
By analyzing above example, we come to know by the statement given in the example
that the related interest revenue was taxed on a cash basis. It means it is not taxable in
future. So the amount of not taxable economic benefit is 100 and now by putting this 100
in the above formula, we will get: -
0 = 100 100
4. When related economics benefit is taxable
When the related economic benefit (revenue) is taxable with taxable profit of future
period, then: -
Tax base of liability = carrying amount
As, Tax base of liability = carrying amount not taxable related economic benefit (revenue)
If Amount not taxable related economic benefit (revenue) = 0
100 = 100 0
Tax base of liability = carrying amount
100 = 100
Example
Current liabilities include interest revenue received in advance, with a carrying amount of 100.
The related interest revenue will be taxable on accrual basis. The tax base of the interest received
in advance is 100.
Normally, under tax laws revenues are taxable on cash basis. For understanding of this
point, lets suppose it will be taxable on accrual basis. Then amount of not taxable related
economics benefit will be zero (0). So the tax base of liability will be 100.
In nut shell, Tax base of liability
1. When related expenses are deductible for tax purpose
Tax base = carrying amount amount deductible for tax purpose
2. When related expenses are not deductible for tax purpose
3. When related economic benefits are taxable
4. When related economic benefits are not taxable
Tax base = carrying amount not taxable related economic benefit (revenue)
Tax Base Of Items That Are Not Assets And Liabilities [IAS 12.9]
There are certain items which are not the part of balance sheet but they have tax base.
These items become the part of profit and loss account.
Lets analyze the example given in the IAS-12.9. Research costs are recognized as an
expense in determining accounting profit in the period in which they are incurred but may
not be permitted as a deduction in determining taxable profit (tax loss) until a later
period.
In this example, research costs are charged to profit and loss account in the period in
which they incurred but these are allowed by tax authorities to become part of taxable
profit (tax loss) of future period. Because of this treatment, the temporary difference will
rise in the current period. The research costs do not have any carrying amount in current
period. The tax base is 100.
So,
Tax base of expense = 100;
Carrying amount = 0;
Tax base of research cost - carrying amount of research cost = Deductible temporary difference
100 - 0 = 100
In case where the difference is incurred due to expenses, the temporary difference will be
deductible temporary difference because the future taxable profit will be reduced by this
difference or future tax loss will be increased.
In case where the difference is incurred due to income, the temporary difference will be
taxable temporary difference because the future taxable profit will be increased by this
difference or future tax loss will be decreased.
The carrying amount of expenses / income will be NIL as per accounting records as it has
charged to Profit and loss account.
General Note
As the taxable profit is decreased by deductible temporary difference and the tax loss is
increased by deductible temporary difference.
As the taxable profit is increased by taxable temporary difference and the tax loss is
decreased by deductible temporary difference.
Under tax laws, the expense that is not allowed to be deducted for tax purpose in current
period it will be deductible for tax purpose in future period and under accounting, it has
been charged to profit and loss in current period. The tax base of an expense that has been
charged to Profit and loss account will be its amount that has been charged to profit and
loss account of current period.
Tax Base Is Not Immediately Apparent [IAS 12.10]
When the tax base of an asset or liability could not be determined immediately, then
standard has referred the following principle and standard has also said that this standard
is also based on this principle. Following is the principle;
an entity shall, with certain limited exceptions, recognize a deferred tax liability (asset)
whenever recovery or settlement of the carrying amount of an asset or liability would
make future tax payments larger (smaller) than they would be if such recovery or
settlement were to have no tax consequences.
According to this principle, an entity shall recognize the deferred tax liability in its books
of accounts where the taxable profit will be increased (tax loss will be decreased) by
future recovery or settlement of asset or liability and an entity shall recognize deferred
tax asset in its books of accounts where the taxable profit will be decreased (tax loss will
be increased) by future recovery or settlement of asset or liability.
This paragraph also discusses that where the tax base of an asset or liability is dependent
upon manner or way under which carrying amount of asset or liability will be recovered
or settled. Then this principle shall be considered. [See para 52 example C]
Tax Base of Items of Consolidated Financial Statement [IAS 12.11]
When consolidated financial statements (CFS) are prepared, the assets and liabilities
appearing in consolidated financial statements represents different entities. The
temporary difference is also required here which is determined by comparing the tax base
and carrying amount each item of CFS. Two main issues arise in this context;
1. If CFS is prepared from financial statements of entities of same jurisdiction or
country, then tax base shall be determined in context with the taxation of that country.
2. If CFS is prepared from financial statements of entities of different jurisdictions or
countries, then tax base shall be determined in context with the taxation of each
country to which each entity represents.
RECOGNITION OF CURRENT TAX LIABILITIES AND CURRENT TAX ASSETS
Current Tax Expense [IAS 12.12]
Current tax expense is amount that is determined by applying the rate on taxable profit
(tax loss). In Pakistan, current tax is not determined by applying the rate on tax loss
instead it is determined under section 113 of the Income Ordinance 2001. Under section
113, where a company sustains a loss during a tax year, it shall have to pay income tax @
0.5 % of the annual turnover of the company. It covers both the prior year tax and current
year tax.
Current Tax Liability [IAS 12.12]
When the amount of income tax is payable, following shall be the entry for recognizing
current tax liability;
DR Current tax expense xxxx
DR Current tax payable xxxx
It shall not be confused with the amount of income tax deducted at source payable. As the
income tax deducted at source is not an income tax on our income. It is tax deducted from
income of other parties (i.e. suppliers of goods and services etc). Income tax deducted at
source by us has nothing to do with IAS 12.
Current Tax Asset [IAS 12.12]
When the amount of income tax is paid in advance, following shall be the entry for
recognizing current tax asset;
DR Advance income tax paid xxxx
DR Current tax income xxxx
Whereas income tax deducted at source by others (our customers or clients) on amounts
payable to us shall be our income tax. Our income tax deducted at source shall be
adjusted in our final tax liability according to applicable tax laws.
Recovery of Current Tax of Previous Period by Using Tax Loss [IAS 12.13 & 12.14]
In current period, when expenses exceed incomes under income tax laws, tax loss
occurred. Generally, these tax losses are adjustable against the income of future taxable
profit. By doing so, the taxable profit of future period will be decreased.
A tax loss that can be carried back to recover current tax of a previous period means
the tax loss that has been incurred in the previous period shall be adjusted against the
taxable profit of current period. It will decrease the current tax expense of current period.
Thus, the current tax expense of previous period is said to be recovered in current period
by its tax loss.
As such tax loss will give us the benefit in future period. We will recognize this benefit as
an asset in the period in which this tax loss is occurred.
FOLLOWING ARE MAIN TOPICS THAT IAS 12 DISCUSSES
Carrying amount of asset > tax base of an asset = Taxable temporary difference
1. Interest revenue receivable
2. Depreciation of assets
3. Development costs
4. Cost of a business combination
5. Assets Carried at Fair Value (revaluation)
6. Goodwill arises in a business combination
7. Initial Recognition of an Asset or Liability
8. Investments in subsidiaries, branches and associates or interests in joint ventures
9. Compound financial instrument

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