IAS 12

What is an Income Tax? An income tax is a tax that governments impose on income generated by businesses and individuals within their jurisdiction. By law, taxpayers must file an income tax return annually to determine their tax obligations. Income taxes are a source of revenue for governments. They are used to fund public services, pay government obligations, and provide goods for citizens.

What is a temporary difference in tax expense? Temporary differences are differences between pretax book income and taxable income that will eventually reverse itself or be eliminatedpretax book income Example: An example of a timing difference is rent income. Accrual accounting will only allow revenue to be recorded when it is earned, but if a company receives an advanced payment of rental income, it must report this under taxable income on its tax return. As such, this revenue will be recorded on the tax return but not the book income. This creates a timing difference in this period. At a future period when the rental revenue is finally earned, the company will record that revenue under book income but not on its tax return, thereby reversing and eliminating the initial difference.

Types of temporary difference Taxable  When Taxable income is lower than pretax accounting income  This give rise to deferred tax liability  Mean you have to pay more tax in future Deductible  When taxable income is higher than accounting income  This give rise to Deferred tax asset  Means you have to pay less tax in future.

Deferred Tax Asset What is deferred tax asset? A deferred tax asset is the amount of income taxes recoverable in future periods due to Deductible temporary differences Unused tax loss carried forward A deferred tax liability or asset is created when there are temporary differences between book tax and actual income tax. An asset on a company statement of financial position that may be used to reduce taxable income. It is presented under the heading of non-current assets. It is totally opposite to deferred tax Liability which increases the value of taxable income. Companies use tax deferrals to lower the income tax expenses of the coming accounting period, provided that next tax period will generate positive earnings.

How deferred tax asset arises? where deferred tax asset arise is where there is a difference between accounting rules and tax rules.. If a business incurs a loss in a financial year, it usually is entitled to use that loss in order to lower its taxable income in following years. In that sense, the loss is an asset. Carrying value < Tax base = Deferred Asset Carrying value > Tax base =Deferred tax liability

Deferred Tax Asset Formula

Recognition IAS 12 requires an entity to review the carrying amount of a deferred tax asset at the end of each reporting date and adjust it according to the reference of probability of sufficient taxable profits being available against which the deferred tax asset may be utilized.

Practical Example Tax authorities do not allow company to deduct expenses that are related to future cost e.g. warranty. Year 1 Income Tax$’000 Revenue5000 Warranty (future)90 Taxable Income4100 Tax Payable (30%)1230 Net Income2870 Year 1 Tax Authority$’000 Revenue5000 Warranty (future)0 Taxable Income5000 Tax Payable1500 Net Income3500

Changes in Carrying Value The carrying amount of a deferred asst or liability may change for reasons other the change in temporary differences itself. Such changes arise as a result of A change in tax rates, laws or Reassessment of the recoverability of deferred tax asset. In such circumstances IAS 12 requires that the change in deferred tax balances be recognized in profit and loss, except to the extent that it relates to items previously recognized outside profit and loss.

Revaluation Model: Cost Accumulated Depreciation Carrying Amount FV Incremental Plant ($)200,000100, ,00050,000 Increase in Revaluation an upward revaluation of assets creates a taxable temporary difference (TTD), leading to deferred tax liability. These are based on new FV of assets. Example 1: At June 2016, Ltd has the following information.

Solution CA- TB = TTD *30% =DTL 150, ,000= 50,000 *30% = $15,000 Dr Income tax expense $15000 Cr Deferred tax liability $15000

Decrease in Revaluation Loss on revaluation leads to temporary differences. Cost Accumulated Depreciation Carrying Amount FV Decrease Plant ($)170,00070,000100,00080,00010,000 Dr Accumulated depreciation $70,000 Dr Loss on Revaluation $10,000 Cr Plant $ 80,000

Items recognized in Equity the deferred tax liability that is recognized from the revaluation of the asset must be charged directly to equity. This is because the accounting for the revaluation itself involves the increment in value being recognized in equity and not in the income statement. Under IFRS the adjustments to the opening balance of retained earning resulting from change in Accounting policy is recorded as retrospectively under IAS 8 Accounting Policy, Change in accounting estimate and Error.