Page 1 Institute of Certified Public Accountants of Kenya ICPAK IAS 12 - Income taxes by Simon Fisher 31 March 2011

Page 2 Institute of Certified Public Accountants of Kenya This slide presentation has been prepared for general guidance only, and does not constitute professional advice. You should not act upon the information contained in these slides without obtaining specific professional advice. Accordingly, to the extent permitted by law, RSM Ashvir (and its employees and agents) accept no liability, and disclaim all responsibility, for the consequences of anyone acting, or refraining from acting, in reliance on the information contained in these slides or for any decision based on it, or for any consequential, special or similar damages even if advised of the possibility of such damages. Income taxes

Page 3 Institute of Certified Public Accountants of Kenya Course objectives By the end of today you should: know the components making up tax expense have a good understanding of the basic concepts of IAS 12 understand the main exemptions within IAS 12 be able to compute deferred tax on commonly encountered assets and liabilities know what disclosures are required under IAS 12 be able to prepare a ‘tax reconciliation’ be aware of differences between full IFRS and the IFRS for SMEs. This course does not cover the computation of taxable profit. Income taxes

Page 4 Institute of Certified Public Accountants of Kenya Tax expense … … is the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax (12.5). Income taxes

Page 5 Institute of Certified Public Accountants of Kenya Agenda/Contents Section 1: Accounting for current tax Section 2: Accounting for deferred tax

Page 6 Institute of Certified Public Accountants of Kenya Agenda/Contents Section 1: Accounting for current tax Section 2: Accounting for deferred tax

Page 7 Institute of Certified Public Accountants of Kenya Current tax Current tax is the amount of income tax payable/recoverable in respect of the taxable profit/loss for the period (12.5). Current tax for current and prior periods should, to the extent unpaid, be recognised as a liability (12.12). Accounting for current tax

Page 8 Institute of Certified Public Accountants of Kenya Agenda/Contents Section 1: Accounting for current tax Section 2: Accounting for deferred tax

Page 9 Institute of Certified Public Accountants of Kenya Deferred tax We will be looking at: Basic concepts Measurement -the rule -the exceptions to the rule Recognition Presentation and disclosure. Accounting for deferred tax

Page 10 Institute of Certified Public Accountants of Kenya Basic concepts What is deferred tax? Why do we need it? How is it calculated? Accounting for deferred tax

Page 11 Institute of Certified Public Accountants of Kenya What is deferred tax accounting ….. Accounting for the tax consequences of the future recovery/settlement of the carrying amount of assets/liabilities in a company’s balance sheet. IAS 12 (effective from 1998) uses the balance sheet liability method (as opposed to the deferral method) and focuses on ‘temporary differences’ existing at the balance sheet date (not ‘timing differences’) Accounting for deferred tax

Page 12 Institute of Certified Public Accountants of Kenya Basic concepts What is deferred tax? Why do we need it? How is it calculated? Accounting for deferred tax

Page 13 Institute of Certified Public Accountants of Kenya Measurement – the rule Accounting for deferred tax

Page 14 Institute of Certified Public Accountants of Kenya The IAS 12 approach to calculating deferred tax For every asset and liability in the balance sheet, and for tax losses carried forward: Carrying amount of asset/liabilityX Less: tax base of asset/liability(X) Temporary tax rateX% Deferred tax asset/liabilityX Accounting for deferred tax

Page 15 Institute of Certified Public Accountants of Kenya What is a temporary difference? Temporary difference = [the carrying value of an asset or liability] - [its tax base]: Carrying amount of asset/liabilityX Less: tax base of asset/liability(X) Temporary differenceX Accounting for deferred tax

Page 16 Institute of Certified Public Accountants of Kenya The tax base is ….. …… “the amount attributed to that asset or liability for tax purposes” (12.5) The tax base of an asset is the amount that will be deductible for tax purposes … when the entity recovers the carrying amount of the asset (12.7). ie Tax base = future deductible amount Note: if the future recovery of the asset is not taxable, the tax base is equal to the carrying amount. Accounting for deferred tax

Page 17 Institute of Certified Public Accountants of Kenya Examples 1, 2 and 3 Accounting for deferred tax

Page 18 Institute of Certified Public Accountants of Kenya The tax base is ….. …… the amount attributed to that asset or liability for tax purposes The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods (12.8). Note: in the case of 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. Accounting for deferred tax

Page 19 Institute of Certified Public Accountants of Kenya Examples Examples 4, 5 & 6 Accounting for deferred tax

Page 20 Institute of Certified Public Accountants of Kenya Revaluations ….. Revaluations of property, plant and equipment increase the carrying amount of an asset without affecting the tax base. They therefore create additional temporary differences on which deferred tax must be recognised (12.20). Accounting for deferred tax

Page 21 Institute of Certified Public Accountants of Kenya Consolidation Compare the group carrying value with the tax base. Temporary differences may be affected by: Elimination of inter-company items Fair value adjustments – eg on acquisition of a subsidiary Unification of accounting policies. Accounting for deferred tax

Page 22 Institute of Certified Public Accountants of Kenya Question 1 Accounting for deferred tax

Page 23 Institute of Certified Public Accountants of Kenya Temporary differences can be ….. taxable differences - giving rise to deferred tax liabilities; or deductible differences - giving rise to deferred tax assets (12.5) Accounting for deferred tax

Page 24 Institute of Certified Public Accountants of Kenya Measurement – the exceptions to the rule Accounting for deferred tax

Page 25 Institute of Certified Public Accountants of Kenya Specific Exemption - Initial recognition The tax effect of all temporary differences arising on initial recognition of an asset or liability which: is not a business combination at the time of the transaction, affects neither accounting profit nor taxable profit/loss, should not be recognised (12.15). Accounting for deferred tax

Page 26 Institute of Certified Public Accountants of Kenya Initial recognition of assets and liabilities Related to a business combination? At the time of the transaction, affects accounting profit or taxable profit (tax loss)? Don’t recognise DTA/DTL Recognise DTA/DTL Yes No Accounting for deferred tax Yes

Page 27 Institute of Certified Public Accountants of Kenya Initial recognition ….. Question 2 Saloon Car Accounting for deferred tax

Page 28 Institute of Certified Public Accountants of Kenya Saloon car – part 2 Accounting for deferred tax

Page 29 Institute of Certified Public Accountants of Kenya Revaluations ….. Revaluations of property, plant and equipment increase the carrying amount of an asset without affecting the tax base. The resulting change in the temporary difference has not arisen on initial recognition. Therefore the deferred tax must be recognised (12.20). Accounting for deferred tax

Page 30 Institute of Certified Public Accountants of Kenya Specific Exemption - Goodwill No deferred tax liability shall be recognised in respect of goodwill arising in a business combination for which impairment is not deductible for tax purposes (12.15(b)). Accounting for deferred tax

Page 31 Institute of Certified Public Accountants of Kenya Measurement – Applicable rate Accounting for deferred tax

Page 32 Institute of Certified Public Accountants of Kenya The applicable rate ….. Accounting for deferred tax Carrying amount of asset/liabilityX Tax base of asset/liability(X) Temporary tax rateX% Deferred tax asset/liabilityX

Page 33 Institute of Certified Public Accountants of Kenya Expected manner The measurement of deferred tax assets and liabilities should reflect the tax consequences that follow from the manner in which the enterprise expects to recover or settle the respective asset or liability (12.51). Accounting for deferred tax

Page 34 Institute of Certified Public Accountants of Kenya Rate to be applied ….. Deferred tax assets and liabilities should be computed at the rate expected to apply in the period when the asset is realised or the liability settled, based on rates enacted or substantively enacted at the balance sheet date (12.46). Accounting for deferred tax

Page 35 Institute of Certified Public Accountants of Kenya Example of origination and reversal of temporary differences - PPE A B Carrying value = A Tax base= B Taxable temporary ___ difference= C === C1 Provide via profit and loss account at income tax rates Value Carrying value Tax base Time Cost C2 C3 Accounting for deferred tax

Page 36 Institute of Certified Public Accountants of Kenya Examples Examples 7 & 8 Accounting for deferred tax

Page 37 Institute of Certified Public Accountants of Kenya Measurement - discounting Deferred tax assets and liabilities should not be discounted (12.53). Accounting for deferred tax

Page 38 Institute of Certified Public Accountants of Kenya Question 3 Accounting for deferred tax

Page 39 Institute of Certified Public Accountants of Kenya Recognition Accounting for deferred tax

Page 40 Institute of Certified Public Accountants of Kenya Recognition ….. All deferred tax liabilities should be recognised, except on goodwill and temporary differences subject to the initial recognition exception (12.15). Deferred tax assets should be recognised to the extent that it is probable that taxable profit will be available against which the deductible temporary difference (including carry forward tax losses) can be utilised (12.24). Annual reassessment is required (12.37). Accounting for deferred tax

Page 41 Institute of Certified Public Accountants of Kenya Recognition ….. Tax losses The existence of tax losses is strong evidence that future taxable profit may not be available – there therefore has to be convincing evidence that it will be available (12.35). Accounting for deferred tax

Page 42 Institute of Certified Public Accountants of Kenya Question 4 and 5 Accounting for deferred tax

Page 43 Institute of Certified Public Accountants of Kenya Presentation and disclosure Accounting for deferred tax

Page 44 Institute of Certified Public Accountants of Kenya Presentation …. Deferred tax should be recognised in the profit and loss account except where the transaction giving rise to the asset or liability is recognised directly in equity, or from a business combination (12.58): eg prior year adjustments revaluation surpluses “excess” depreciation. Accounting for deferred tax

Page 45 Institute of Certified Public Accountants of Kenya Offsetting …. Deferred tax assets and liabilities may be offset only if: The entity has a legally enforceable right to set off current tax assets against current tax liabilities The deferred tax assets and liabilities relate to income taxes levied by the same tax authority on the same taxable entity (12.74). Accounting for deferred tax

Page 46 Institute of Certified Public Accountants of Kenya Disclosure in the notes to the profit and loss account….. Definition: Tax expense is the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax (12.5). The components of the tax expense should be disclosed eg current tax deferred tax movement prior period under/over provision deferred tax asset not previously recognised (12.79). Accounting for deferred tax

Page 47 Institute of Certified Public Accountants of Kenya Also ….. Tax relating to discontinued operations (12.81(h)). Accounting for deferred tax

Page 48 Institute of Certified Public Accountants of Kenya And ….. ….. a reconciliation of: the tax expense, to the accounting profit multiplied by the applicable tax rate The “proof of tax” (12.81(c)). Accounting for deferred tax

Page 49 Institute of Certified Public Accountants of Kenya Proof of tax Accounting for deferred tax Tax computation Accounting profitX Add back: items not tax deductible in period(X) Sub totalX Deduct: non-taxable income and allowancesX Taxable profitX

Page 50 Institute of Certified Public Accountants of Kenya Proof of tax Accounting for deferred tax Tax computation Tax effect Accounting profitX Adjustment for permanent differencesX Sub totalX Origination and reversal of temporary differencesX Taxable profitXA?

Page 51 Institute of Certified Public Accountants of Kenya Proof of tax Accounting for deferred tax Tax computation Tax effect Accounting profitX Adjustment for permanent differencesX Sub totalXC? Origination and reversal of temporary differencesXB? Taxable profitXCurrent tax

Page 52 Institute of Certified Public Accountants of Kenya Proof of tax Accounting for deferred tax Tax computation Tax effect Accounting profitXD Adjustment for permanent differencesXE Sub totalXTax expense Origination and reversal of temporary differences XDeferred tax mvt Taxable profitXCurrent tax

Page 53 Institute of Certified Public Accountants of Kenya Proof of tax Accounting for deferred tax Tax computation Tax effect Accounting profitXD Adjustment for permanent differencesXE Sub totalXTax expense Origination and reversal of temporary differencesXDeferred tax mvt Taxable profitXCurrent tax Proof of tax

Page 54 Institute of Certified Public Accountants of Kenya Question 6 Accounting for deferred tax

Page 55 Institute of Certified Public Accountants of Kenya Example ….. Accounting for deferred tax Accounting profit1,200,000 Tax at applicable rate of 30%360,000 Tax effect of: Expenses not allowed for tax purposes60,000 Income not subject to tax(80,000) Effect of change of tax rate on deferred tax liability (20,000) Prior period over-provision(10,000) Tax expense310,000

Page 56 Institute of Certified Public Accountants of Kenya And in the notes to the balance sheet ….. The movement of gross deferred tax assets and liabilities analysed by category of temporary difference (12.81(g)) The evidence supporting recognition of deferred tax assets if the entity is making losses (12.82) The amount of temporary differences and unused tax losses for which no deferred tax asset is recognised (12.81(e)). Accounting for deferred tax

Page 57 Institute of Certified Public Accountants of Kenya Case study Accounting for deferred tax

Page 58 Institute of Certified Public Accountants of Kenya Exposure draft – Income Tax Issued on 31 March 2009 … … has been abandoned, but unfortunately was ‘borrowed’ for the IFRS for SMEs Accounting for deferred tax

Page 59 Institute of Certified Public Accountants of Kenya IFRS for SMEs – Income tax No initial recognition exemption, other than for goodwill, but Section 29.3(c): “the tax basis of assets and liabilities is determined by the consequences of sale of the assets …” Section 29.24: “an entity shall measure current and deferred tax … using the probability-weighted average amount of all the possible outcomes, assuming that the tax authorities will review the amounts reported and have full knowledge of all relevant information” all deferred tax assets should be recognised and then a valuation allowance is used, if necessary. Accounting for deferred tax

Page 60 Institute of Certified Public Accountants of Kenya IFRS for SMEs – Income tax Conflict: Section 29.3(c): “the tax basis of assets and liabilities is determined by the consequences of sale of the assets …” Section 29.20: “the measurement of deferred tax … shall reflect the consequences that would follow from the manner in which the entity expects … to recover … the carrying amount of the related assets …” Accounting for deferred tax

Page 61 Institute of Certified Public Accountants of Kenya IFRS for SMEs – Income tax Gobbledegook: Section 29.32(b): an entity shall disclose “an explanation of the significant differences in amounts presented in the statement of comprehensive income and amounts reported to tax authorities” Which amounts – Revenue? Expenses? Surely what was meant was: “an explanation of the significant differences between the effective tax rate and the applicable statutory tax rate”? Accounting for deferred tax

Page 62 Institute of Certified Public Accountants of Kenya Amendment to IAS 12 – Recovery of underlying assets Issued 20 December 2010 Effective for accounting periods beginning on or after 1 January 2012 Introduces the presumption that the carrying value of an investment property carried at fair value is recovered entirely through sale The presumption is rebutted if the investment property is held within a business model whose objective is to consume substantially all of the economic benefits embodied in the investment property over time, rather than through sale. Accounting for deferred tax

Page 63 Institute of Certified Public Accountants of Kenya Conclusion IAS 12 is a rule based standard: Rule 1: Deferred tax = (carrying amount - tax base) x applicable tax rate. Accounting for deferred tax

Thank you!