CPA INTERMEDIATE LEVEL

FINANCIAL REPORTING AND ANALYSIS

IAS 12: INCOME TAXES

Objective of IAS 12
The objective of IAS 12 is to prescribe the accounting treatment for income taxes.
In meeting this objective, IAS 12 notes the following:
(a) It is inherent in the recognition of an asset or liability that that asset or liability will be recovered or
settled, and this recovery or settlement may give rise to future tax consequences which should be
recognised at the same time as the asset or liability
(b) An entity should account for the tax consequences of transactions and other events in the same way it
accounts for the transactions or other events themselves.

Key definitions
Carrying amount Amount attributable to an asset or liability at the balance sheet date.
(Amount reported in the SFP)

Tax base The tax base of an asset or liability is the amount attributable to an asset or
liability for tax purposes

Permanent differences Differences between the carrying amount of an asset or liability in the
statement of financial position and its tax bases that will NOT reverse in the
future. E.g. Donations are disallowable.

Temporary differences Differences between the Carrying Amount of an asset or liability in the
statement of financial position and its Tax Bases that will reverse in the
future.

Taxable temporary Temporary differences that will result in taxable amounts in determining
differences taxable profit (tax loss) of future periods when the carrying amount of the
asset or liability is recovered or settled

Deductible temporary Temporary differences that will result in amounts that are deductible in
differences determining taxable profit (tax loss) of future periods when the carrying
amount of the asset or liability is recovered or settled

Deferred tax liabilities The amounts of income taxes payable in future periods in respect of taxable
temporary differences

Deferred tax assets The amounts of income taxes recoverable in future periods in respect of:
(a) Deductible temporary differences
(a) The carry forward of unused tax losses, and
(b) The carry forward of unused tax credits

Current Tax
➢ Current tax is the amount of income tax payable(recoverable) in the current year as a result of
taxable profits.

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➢ Current tax for the current and prior periods is recognised as a liability to the extent that it has not yet
been settled, and as an asset to the extent that the amounts already paid exceed the amount due.
➢ The benefit of a tax loss which can be carried back to recover current tax of a prior period is
recognised as an asset.

Measurement of Current Tax Assets and Liabilities

Current tax assets and liabilities are measured at the amount expected to be paid to or recovered from tax
authorities, using the tax rates/laws that have been enacted or substantively enacted by the balance sheet
date.
Formulae
Current Tax = Taxable Profit x Tax rate

Deferred Tax
Deferred tax is the amount of income tax payable(recoverable) in the future periods as a result of temporary
differences i.e. Accounting profit ≠ Taxable profit.

Reasons/Need for providing deferred tax

1) Helps to establish the relationship between shareholder's funds and other sources of finance.
2) It ensures compliance with the fundamental accounting concept of accrual basis
3) It reports a tax liability which is likely to arise in the future.
4) It provides the post-tax profits/profit after tax that can be used to assess a suitable dividend
declaration.
5) The figures used to calculate stock market indicators such EPS and P/E ratio require the computation
of profit-after tax.

Calculation of deferred taxes

Formulae

Deferred tax assets and deferred tax liabilities can be calculated using the following formulae:

Temporary difference = Carrying amount - Tax base

Deferred tax asset or liability = Temporary x Tax rate

difference

The following formula can be used in the calculation of deferred taxes arising from unused tax losses or
unused tax credits:

Deferred tax asset = Unused tax loss or unused tax x Tax rate
credits

Tax bases
The tax base of an item is crucial in determining the amount of any temporary difference, and effectively
represents the amount at which the asset or liability would be recorded in a tax-based balance sheet.
IAS 12 provides the following guidance on determining tax bases:
1. Assets - The tax base of an asset is the amount that will be deductible against taxable economic
benefits from recovering the carrying amount of the asset. Where recovery of an asset will have no
tax consequences, the tax base is equal to the carrying amount.

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2. Revenue received in advance - The tax base of the recognised liability is its carrying amount, less
revenue that will not be taxable in future periods.

3. Other liabilities - 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.

4. Unrecognised items - If items have a tax base but are not recognised in the statement of financial
position, the carrying amount is nil.

5. Tax bases not immediately apparent - If the tax base of an item is not immediately apparent, the
tax base should effectively be determined in such as manner to ensure the future tax consequences of
recovery or settlement of the item is recognised as a deferred tax amount.

6. Consolidated financial statements - In consolidated financial statements, the carrying amounts in

the consolidated financial statements are used, and the tax bases determined by reference to any
consolidated tax return (or otherwise from the tax returns of each entity in the group).

Examples
The determination of the tax base will depend on the applicable tax laws and the entity's expectations
as to the recovery and settlement of its assets and liabilities.
The following are some basic examples:
(a) Property, plant and equipment - The tax base of property, plant and equipment that is
depreciable for tax purposes that is used in the entity's operations is the unclaimed tax
depreciation (Capital allowance) permitted as deduction in future periods.

(b) Receivables - If receiving payment of the receivable has no tax consequences, its tax base is
equal to its carrying amount

(c) Goodwill - If goodwill is not recognised for tax purposes, its tax base is nil (no deductions are
available)

(d) Revenue in advance - If the revenue is taxed on receipt but deferred for accounting purposes,
the tax base of the liability is equal to nil (as there are no future taxable amounts). Conversely, if
the revenue is recognised for tax purposes when the goods or services are received, the tax base
will be equal to its carrying amount

(e) Loans - If there are no tax consequences from repayment of the loan, the tax base of the loan is
equal to its carrying amount.
If the repayment has tax consequences (e.g. taxable amounts or deductions on repayments of
foreign currency loans recognised for tax purposes at the exchange rate on the date the loan
was drawn down), the tax consequence of repayment at carrying amount is adjusted against the
carrying amount to determine the tax base (which in the case of the aforementioned foreign
currency loan would result in the tax base of the loan being determined by reference to the
exchange rate on the draw down date).

Recognition and measurement of deferred taxes

Recognition of deferred tax liabilities
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The general principle in IAS 12 is that a deferred tax liability is recognised for all taxable temporary
differences.
There are however three exceptions to this rule as follows:
1. Liabilities arising from initial recognition of goodwill
2. Liabilities arising from the initial recognition of an asset/liability other than in a business
combination
which, at the time of the transaction, does not affect either the accounting or the taxable
profit and at the time of the transaction, does not give rise to equal taxable and deductible temporary
differences.
3. Liabilities arising from temporary differences associated with investments in subsidiaries, branches,
and associates, and interests in joint arrangements, but only to the extent that the entity is able to
control the timing of the reversal of the differences and it is probable that the reversal will not occur
in the foreseeable future.

Example
❖ An entity undertaken a business combination which results in the recognition of goodwill in
accordance with IFRS 3 Business Combinations.
❖ The goodwill is not tax depreciable or otherwise recognised for tax purposes.
❖ As no future tax deductions are available in respect of the goodwill, the tax base is nil.
Accordingly, a taxable temporary difference arises in respect of the entire carrying amount of
the goodwill.
❖ However, the taxable temporary difference does not result in the recognition of a deferred tax
liability because of the recognition exception for deferred tax liabilities arising from goodwill.

Recognition of deferred tax assets

A deferred tax asset is recognised for deductible temporary differences, unused tax losses and unused tax
credits to the extent that it is probable that taxable profit will be available against which the deductible
temporary differences can be utilised, unless the deferred tax asset arises from:
❖ The initial recognition of an asset or liability other than in a business combination which, at the time
of the transaction, does not affect accounting profit or taxable profit.
❖ Deferred tax assets for deductible temporary differences arising from investments in subsidiaries,
branches and associates, and interests in joint arrangements, are only recognised to the extent that it
is probable that the temporary difference will reverse in the foreseeable future and that taxable
profit will be available against which the temporary difference will be utilised.
❖ The carrying amount of deferred tax assets are reviewed at the end of each reporting period and
reduced to the extent that it is no longer probable that sufficient taxable profit will be available to
allow the benefit of part or all of that deferred tax asset to be utilised. Any such reduction is
subsequently reversed to the extent that it becomes probable that sufficient taxable profit will be
available. (Tax planning opportunities)
❖ A deferred tax asset is recognised for an unused tax loss carryforward or unused tax credit if, and
only if, it is considered probable that there will be sufficient future taxable profit against which
the loss or credit carryforward can be utilised.

Measurement of deferred tax

Deferred tax assets and liabilities are measured at the tax rates that are expected to apply to the period when
the asset is realised or the liability is settled, based on tax rates/laws that have been enacted or substantively
enacted by the end of the reporting period.

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The measurement reflects the entity's expectations, at the end of the reporting period, as to the manner in
which the carrying amount of its assets and liabilities will be recovered or settled.
IAS 12 provides the following guidance on measuring deferred taxes:
(a) Where the tax rate or tax base is impacted by the manner in which the entity recovers its assets or
settles its liabilities (e.g. whether an asset is sold or used), the measurement of deferred taxes is
consistent with the way in which an asset is recovered or liability settled
(b) Where deferred taxes arise from revalued non-depreciable assets (e.g. revalued land), deferred taxes
reflect the tax consequences of selling the asset.
(c) Deferred taxes arising from investment property measured at fair value under IAS 40 Investment
Property reflect the rebuttable presumption that the investment property will be recovered through
sale.
(d) If dividends are paid to shareholders, and this causes income taxes to be payable at a higher or lower
rate, or the entity pays additional taxes or receives a refund, deferred taxes are measured using the
tax rate applicable to undistributed profits
Key Note
Deferred tax assets and liabilities cannot be discounted.

Recognition of tax amounts for the period in the SoPL

Amount of income tax to recognise in SoPL
The following formula summarises the amount of tax to be recognised in an accounting period:

Tax to recognise for the = Current tax for the + Movement in deferred tax balances
period period for the period

Where to recognise income tax for the period

Consistent with the principles underlying IAS 12, the tax consequences of transactions and other events are
recognised in the same way as the items giving rise to those tax consequences.
Accordingly, current and deferred tax is recognised as income or expense and included in profit or loss for
the period, except to the extent that the tax arises from:
(a) Transactions or events that are recognised outside of profit or loss (other comprehensive income or
equity) - in which case the related tax amount is also recognised outside of profit or loss.

(b) A business combination - in which case the tax amounts are recognised as identifiable assets or
liabilities at the acquisition date, and accordingly effectively taken into account in the determination
of goodwill when applying IFRS 3 Business Combinations.

Example
❖ An entity undertakes a capital raising and incurs incremental costs directly attributable to the
equity transaction, including regulatory fees, legal costs and stamp duties. In accordance with
the requirements of IAS 32 Financial Instruments: Presentation, the costs are accounted for as
a deduction from equity.
❖ Assume that the costs incurred are immediately deductible for tax purposes, reducing the
amount of current tax payable for the period.
❖ When the tax benefit of the deductions is recognised, the current tax amount associated with the
costs of the equity transaction is recognised directly in equity, consistent with the treatment of
the costs themselves.

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IAS 12 provides the following additional guidance on the recognition of income tax for the period:
(a) Where it is difficult to determine the amount of current and deferred tax relating to items recognised
outside of profit or loss (e.g. where there are graduated rates or tax), the amount of income tax
recognised outside of profit or loss is determined on a reasonable pro-rata allocation, or using
another more appropriate method
(b) In the circumstances where the payment of dividends impacts the tax rate or results in taxable
amounts or refunds, the income tax consequences of dividends are considered to be more directly
linked to past transactions or events and so are recognised in profit or loss unless the past
transactions or events were recognised outside of profit or loss.
(c) The impact of business combinations on the recognition of pre-combination deferred tax assets are
not included in the determination of goodwill as part of the business combination, but are separately
recognised.
(d) The recognition of acquired deferred tax benefits subsequent to a business combination are treated as
'measurement period' adjustments if they qualify for that treatment, or otherwise are recognised in
profit or loss.
(e) Tax benefits of equity settled share-based payment transactions that exceed the tax effected
cumulative remuneration expense are considered to relate to an equity item and are recognised
directly in equity.

Presentation
❖ Current tax assets and current tax liabilities can only be offset in the statement of financial position if
the entity has the legal right and the intention to settle on a net basis.
❖ Deferred tax assets and deferred tax liabilities can only be offset in the statement of financial position
if the entity has the legal right to settle current tax amounts on a net basis and the deferred tax
amounts are levied by the same taxing authority on the same entity or different entities that intend to
realise the asset and settle the liability at the same time.
❖ The amount of tax expense (or income) related to profit or loss is required to be presented in the
statement(s) of profit or loss and other comprehensive income.
❖ The tax effects of items included in other comprehensive income can either be shown net for each
item, or the items can be shown before tax effects with an aggregate amount of income tax for groups
of items (allocated between items that will and will not be reclassified to profit or loss in subsequent
periods).

Disclosure
Notes to the financial statements will disclose:
1. Major components of tax expense (tax income) which may include:
✓ Current tax expense (income)
✓ Any adjustments of taxes of prior periods
✓ Amount of deferred tax expense (income) relating to the origination and reversal of temporary
differences
✓ Amount of deferred tax expense (income) relating to changes in tax rates or the imposition of
new taxes
✓ Amount of the benefit arising from a previously unrecognised tax loss, tax credit or temporary
difference of a prior period
✓ Write down, or reversal of a previous write down, of a deferred tax asset
✓ Amount of tax expense (income) relating to changes in accounting policies and corrections of
errors.
2. Aggregate current and deferred tax relating to items recognised directly in equity
3. Tax relating to each component of other comprehensive income

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4. Explanation of the relationship between tax expense (income) and the tax that would be expected by
applying the current tax rate to accounting profit or loss (this can be presented as a reconciliation of
amounts of tax or a reconciliation of the rate of tax)
5. Changes in tax rates
6. Amounts and other details of deductible temporary differences, unused tax losses, and unused tax
credits
7. Temporary differences associated with investments in subsidiaries, branches and associates, and
interests in joint arrangements
8. For each type of temporary difference and unused tax loss and credit, the amount of deferred tax
assets or liabilities recognised in the statement of financial position and the amount of deferred tax
income or expense recognised in profit or loss
9. Tax relating to discontinued operations
10. Tax consequences of dividends declared after the end of the reporting period
11. Information about the impacts of business combinations on an acquirer's deferred tax assets
12. Recognition of deferred tax assets of an acquiree after the acquisition date.

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