1. Accounting for income taxes Chapter 18
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

2. Learning objectives
Recognise differences between income for accounting and taxation purposes
Understand how a temporary difference can arise
Understand how the tax base of assets and liabilities is determined.
Understand how deferred tax assets and deferred tax liabilities arise
Understand that changes in tax rates will impact existing deferred tax balances
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

3. Learning objectives
Account for taxation losses and understand how taxation losses can lead to the recognition of assets in the form of deferred tax assets
Understand how transfer of tax losses to other entities within the group are accounted for
Understand how the revaluation of non-current assets should be treated for deferred tax purposes
Know the disclosure requirements for income taxes
Critically evaluate the balance sheet approach to accounting for taxation and the associated asset, deferred tax asset, and deferred tax liability.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

4. Introduction to accounting for income taxes
Taxation income
Income for taxation purposes is known as taxable income.
Determined in accordance with New Zealand income tax legislation
not according to general accounting rules.
Differences between accounting principles of revenue and expense recognition and taxation principles.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

5. Introduction to accounting for income taxes
Tax income:
Accounting profit is thus not the same as taxable profit.
Tax expense for accounting purposes (income statement) calculated after applying relevant accounting standards.
Income tax payable to Inland Revenue (balance sheet) based on taxable profit derived by the entity applying the rules of taxation law.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

6. Balance sheet approach to accounting for taxation
Accounting for income taxes NZ IAS 12
Applies the ‘balance sheet’ method
recognition of assets and liabilities in the balance sheet based on the differences between accounting and tax values of assets and liabilities.
Focuses on comparing the carrying value of an entity’s assets and liabilities (determined by accounting rules) with the tax base for those assets and liabilities.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

7. Balance sheet approach to accounting for taxation
Carrying amount vs. tax base of asset or liability
Carrying amount is the amount the asset or liability is recorded at in the accounting records.
Tax base:
is the amount attributed to an asset or liability for tax purposes
represents the amount an asset or liability would be recorded at if the balance sheet were prepared applying taxation rules.
Where carrying amount of an asset or liability is different from the tax base a ‘temporary difference’ arises.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

8. Balance sheet approach to accounting for taxation
Two types
An assessable temporary difference:
Results in an increase (decrease) in income tax payable (recoverable) in future periods when the carrying amount of the asset or liability is recovered or settled
Creates a liability — deferred tax liability
A deductible temporary difference:
Results in a decrease (increase) in income tax payable (recoverable) in future periods when the carrying amount of the asset or liability is recovered or settled
Creates an asset — deferred tax asset
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

9. Balance sheet approach to accounting for taxation
Deferred tax liability
The carrying amount of the asset exceeds the tax base.
Taxation payments have effectively been deferred to future periods.
Tax is reduced or ‘saved’ in early years, but additional tax will need to be paid later.
Example:
Carrying amount of a non-current depreciable asset exceeds the tax base in early years, as depreciation allowable as a deduction for tax purposes is greater than depreciation for accounting purposes.
This will be reversed in later years when no depreciation is allowable for tax purposes.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

10. Balance sheet approach to accounting for taxation
Justification for deferred tax liability
Inherent in recognition of an asset that its carrying amount is recovered in the form of economic benefits that flow to the entity in future periods
When carrying amount exceeds its tax base, the amount of taxable economic benefits will exceed the amount that allowed as a deduction for tax purposes
This difference is a taxable temporary difference and the obligation to pay the resulting income taxes in future periods is a deferred tax liability
As the entity recovers the carrying amount of the asset, the taxable temporary difference will reverse and the entity will have taxable profit
This makes it probable that economic benefits will flow from the entity in the form of tax payments
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

11. Balance sheet approach to accounting for taxation
Income tax expense
The sum of the tax attributable to taxable income, plus or minus any adjustments relating to temporary differences.
Defined in NZ IAS 12 as “the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax”.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

12. Balance sheet approach to accounting for taxation
Income tax payable
The amount of tax generally expected to be paid within the next financial period.
Under the ‘taxes payable method’ would be same as tax expense:
i.e. the amount payable to the IRD is also treated as the tax expense by the organisation
This method not permitted in NZ.
Under balance sheet method income tax payable does not necessarily equate to tax expense
Tax expense affected by temporary differences.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

13. Balance sheet approach to accounting for taxation
Calculation of income tax payable
Income tax payable is based on taxable income, not accounting profit.
Necessary to make adjustments to accounting profit to determine tax profit e.g.:
Add back accounting depreciation
Deduct depreciation for taxation purposes.
Tax rate multiplied by tax profit.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

14. Balance sheet approach to accounting for taxation
Journal entry if temporary differences result in deferred tax asset
To recognise tax expense relating to the temporary difference:
Dr Deferred tax asset (temp. difference × tax rate)
Cr Tax expense
To recognise tax expense relating to the entity’s taxable profit:
Dr Taxation expense
Cr Income tax payable
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

15. Balance sheet approach to accounting for taxation
Journal entry if temporary differences result in deferred tax liability
To recognise tax expense relating to the temporary difference:
Dr Tax expense
Cr Deferred tax liability (temp. difference × tax rate)
To recognise tax expense relating to the entity’s taxable profit:
Dr Taxation expense
Cr Income tax payable
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

16. Balance sheet approach to accounting for taxation
Reversal in future periods
In future periods, timing differences will reverse
Deferred tax asset will be credited
Deferred tax liability will be debited.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

17. Tax base of asset and liabilities: further considerations
Calculation of tax base for assets
Carrying amount + future deductible amount less future assessable amount.
Although assets might be expected to give future assessable amounts that exceed the asset’s carrying amount, NZ IAS 12 focuses on tax consequences of recovering an asset to the extent of its carrying amount only.
Where carrying amount of asset exceeds tax base there is a deferred tax liability
If the carrying amount of the asset is less than the tax base there is will be a deferred tax asset.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

18. Tax base of asset and liabilities: further considerations
Calculation of tax base for assets
Consideration of doubtful debts when examining accounts receivable
Amounts provided for doubtful debts are not deductible for tax purposes
Deductible only when the account receivable is actually written off.
Any provision for doubtful debts will result in a difference between carrying amount and tax base
This results in a deferred tax asset.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

19. Tax base of asset and liabilities: further considerations
Calculation of tax base for liabilities
Carrying amount – future deductible amount + future assessable amount
Exception to the rule:
Tax base of a liability that is in the nature of ‘revenue received in advance’ must be calculated as the liability’s carrying amount less any amount of the revenue received in advance that has been included in assessable amounts in the current or a previous reporting period.
This results in a deferred tax asset.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

20. Tax base of asset and liabilities: further considerations
Tax base of a liability for ‘revenue received in advance’
Tax base of the liability is equal to the carrying amount of the liability where the ‘revenue received in advance’ is taxed in a reporting period subsequent to the reporting period in which received.
The tax base of the liability is equal to zero where ‘revenue received in advance’ is taxed in the reporting period when received.
Carrying amount – amount of revenue received in advance that will not be subject to tax in future periods = tax base.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

21. Deferred tax assets and deferred tax liabilities
Deferred tax liability arises when:
carrying amount > tax base.
Deferred tax asset arises when:
carrying amount < tax base.
Liabilities
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

22. Changes in tax rates
If tax rates change, the estimate of future tax savings or amount owing will change.
NZ IAS 12, para 47 requires deferred tax assets and liabilities to be measured at the tax rates that are expected to apply to the period with the asset is realised or liability settled
Opening balance on deferred tax needs to be restated to reflect the new tax rate.
Effect of change must be recognised in profit and loss.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

23. Unused tax losses
Deferred tax assets can arise as a result of tax losses
Losses incurred in previous years can generally be carried forward to offset taxable income derived in future years.
Tax losses can generate subsequent benefits in the form of tax payments saved in future profitable periods.
Consistent with the test for deferred tax assets generated by temporary differences, deferred tax assets generated as a result of unused tax losses must also be able to satisfy the ‘probable’ test before they are recognised.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

24. Unused tax losses NZ IAS 12 (par. 34):
A deferred tax asset shall be recognised arising from the carry-forward of unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilised.
As a general principle applicable to all deferred tax assets it is a requirement that they be reviewed at each reporting date to ensure that the assets are not overstated.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

25. Transfer of tax losses
Transfer of tax losses within a group or economic entity is not addressed in NZ IAS 12.
Loss transfer rules in section IC5 of the Income Tax Act 2007 permits, subject to certain requirements, losses incurred by a company within a group of companies to be transferred to other companies within the group.
Guidance is provided by SSAP-12 ‘Accounting for income tax’
The paying company should disclose the payment.
The receiving company should disclose the receipt.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

26. Revaluation of non-current assets
According to NZ IAS 12 (par. 20) revaluations of non-current assets can create temporary differences.
Revaluation increments are not deductible for tax purposes, even though depreciation for accounting purposes will be based on the revalued amount.
The tax base is not affected by the revaluation because depreciation for tax purposes will be based on the original cost of the asset.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

27. Revaluation of non-current assets
Any increase in the carrying value of a non-current asset through a revaluation undertaken to recognise an increase in fair value implies an expected increase in the future flow of economic benefits.
This increase can be taxable and can lead to a deferred tax liability if the carrying amount is greater than the tax base.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

28. Revaluation of non-current assets
Unlike previous examples where the temporary difference is adjusted against income tax expense, asset revaluations give rise to a special case.
NZ IAS 12 requires that, to the extent that the deferred tax relates to amounts that were previously recognised in equity as either direct credits or direct debits, the journal entry to recognise the deferred tax asset or liability must also be adjusted against the equity account.
NZ IAS 12 (par. 61):
Current tax and deferred tax shall be charged or credited directly to equity if the tax relates to items that are credited or charged, in the same or a different period, directly to equity.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

29. Revaluation of non-current assets
As the revaluation is adjusted against equity (revaluation surplus account), the accounting entry to record the recognition of the deferred tax liability is:
Dr Revaluation surplus
Cr Deferred tax liability
Recognition of future tax associated with an asset that has a fair value in excess of its cost as recognised by a revaluation acts to reduce the amount of the revaluation surplus account.
Entry assumes that the revalued amount of the asset will be recovered by the entity’s continued use of the asset.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

30. Revaluation of non-current assets
If there is an expectation that the revalued asset is to be sold:
Journal entries to record the deferred tax liability will be different.
If a non-current asset is sold there is often a ‘tax break’ given to the organisation as the tax base is increased by an index that reflects general price increases.
If the tax that will be assessed in future is to be reduced because of capital gains indexation
the reduction in the amount of tax that would be paid is accounted for by debiting the deferred tax liability and crediting the revaluation reserve.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

31. Revaluation of non-current assets
Result:
the tax base of an asset depends on the manner in which the entity's management expects to recover the benefits inherent in the asset.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

32. Future changes in accounting for tax
The IASB released an exposure draft in 2009.
Anticipated that final standard will be finalised in 2010, applicable from 2011/2012.
No fundamental changes expected.
A simplification expected—basic approach will remain the same.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd

33. Summary There is a difference between accounting and tax profits.
Differences can be great.
NZ IAS 12 uses balance sheet approach to accounting for tax
Differences occur between tax bases and accounting carrying value.
Multiplying by tax rate gives the deferred tax liabilities and assets.
Tax loss transferrals within a group need to be accounted for.
Revaluations result in additional temporary differences.
PowerPoint slides to accompany New Zealand Financial Accounting 5e by Samkin
Slides adapted by Bob Miller, © 2011 McGraw-Hill Australia Pty Ltd