INCOME TAX (IAS 12)

This standard looks at the treatment of statutory liability in the form of income tax.
Companies in almost all jurisdictions are deemed to be artificial persons and hence given
separate identity from the owners or shareholders. In this regard, companies are made to pay
tax on every income they make. The tax payable by the company is a liability and is also
charged in the income statement as expense.

IAS 37 indicates that there are two liabilities namely: legal and constructive liability.

Legal liability is that liability that arises from contractual relations or legislation and so that is
that legal liability arising from legislation and in Ghana specifically the Income Tax Act, Act
896, 2015.

Tax is payable on income and as such companies are also taxed based on the net income
(profit) they make for the year. Profit is calculated using income and expenses. The profit
however calculated using Generally accepted accounting principles (GAAP) can be different
from that calculated by the tax authorities’ using the tax laws. This is because the tax laws
disallow some expenses and exempt some income when those items have already been
incorporated in the calculation of accounting profit

Accounting profit is the profit calculated based on Generally Accepted Accounting Principles
(GAAP)

Taxable profit is the profit calculated based on the tax regulations or legislation.

The difference between accounting profit and taxable profit can be categorized into two or is
caused by two things: permanent difference and temporary difference.

Permanent difference is the difference between accounting and taxable profit caused by
income and expense credited or charged by a company but the tax legislation exempts that
income or disallows that expense. In short it is that income or expense that affects only the
year they arise tax but cannot affect future years’ tax liability.

Temporary or timing difference is the difference between accounting and taxable profit that
arises because of difference in the timing of recognition of items in the income statement and
in calculating the taxable profit or differences in the amounts recognized in the income
statement vis-à-vis that recognized in the taxable profit calculation.
Timing difference is the difference between taxable profit and accounting profit for the year
that is expected to reverse in the future years (income statement focus).

Some temporary difference arises when income or expense is recorded in different periods in
the books of accounts against the tax books. Examples of such timing differences that lead to
differed tax liability are:

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  Interest revenue is included in accounting profit on a time proportion basis but may,
in some jurisdictions be included in taxable profit when cash is collected. The tax
base of any receivable recognized in the statement of financial position is nil because
the revenues do not affect taxable profit until cash is collected.
 Depreciation used in determining taxable profit may differ from the depreciation
(capital allowance) used in the calculation of taxable profit. This difference of the
carrying amount and tax base affect future taxable profit.
 Development costs may be capitalized and amortized in the income statement but may
be deducted in arriving at taxable profit in the year or period that it is incurred. The
tax base of the development cost is nil and the difference between the tax base and the
carrying amount is the temporary difference.

Temporary difference also arises when:

 The identifiable assets acquired and liabilities assumed in a business combination are
recognize at their fair values in accordance with IFRS 3 Business combinations, but
no equivalent adjustment is made for tax purposes\.
 Assets are revalued and no equivalent adjustment is made for tax purposes.
 Goodwill arises in a business combination
 The tax base of an asset or liability on initial recognition differs from its carrying
amount, for example an entity benefits from non-taxable government grants related to
assets.
 The carrying amount of investments in subsidiaries, branches and associates or
interests in joint arrangements becomes different from the tax base of the investment
or interest.

Current tax and Deferred tax

Tax that is in a company’s financial statements can be current tax or deferred tax.
Current tax is the tax payable by a company in respect of a period’s profit. It is usually
expected to be paid within three months following the period’s accounting year and as such it
is always classified as current liability on the statement of financial position.

Deferred tax is the corporation tax on temporary or timing differences and this is the tax
provided by a company to show the probable increase or decrease in tax that companies will
have in the future as a result of timing or temporary differences. When the future tax is
expected to increase as a result of temporary difference that will increase future taxable
profit, there is deferred tax liability.
On the other hand, if the future tax liability is expected to reduce as a result of temporary
difference that is expected to reduce taxable income, there is a deferred tax asset. It is
presented as non-current liability or asset on the statement of financial position.

Deferred tax is basically recognized on all temporary differences between tax books and book
of accounts. However IAS 12 does not permit recognition of deferred tax in the following

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circumstances even though there is a difference that will be created in the two books (book of
accounts and tax books).These are;
 Upon initial recognition of goodwill (as it will increase the value of goodwill since
goodwill is measured as a residual and recognition of deferred tax will increase the
value of goodwill)
 Upon initial recognition of an asset or liability in transaction which:
(i) Is not a business combination
(ii) At the time of the transaction, affects neither accounting profit nor taxable
profit (tax loss).

A typical example of this if a penalty was paid in the process of bringing an

asset to its working condition as intended by the management and hence, it
was capitalised.As per taxation laws, penalty is not allowed as an expense.
Now this penalty affects neither accounting profit (since it was capitalized)
nor taxable profits. Hence, as per the above said exception, no deferred tax
shall be created on this difference.

In the income statement however both current tax and deferred tax (net effect) for the year are
presented or charged as expense. The tax on the profit for the year is what is split or adjusted
into current and deferred tax.

Why must deferred tax be accounted for?

The basic concepts underlying the preparation of accounts support recognition of deferred
tax.

The accrual concept underlies the preparation of accounts and guide recognition of elements
in the financial statements but tax is determined by legislation.

The matching concept wants all expenses recorded in the year that the income associated is
recorded. Deferred tax is therefore recorded in the year that the transaction arises or not when
the timing difference starts reversing.

Accounting for deferred tax

Deferred tax is provided on only timing and temporal difference. No deferred tax is provided
on permanent difference and the reason is permanent difference affects only the year that it
arises profit and not expected to affect the profits in the future. Timing difference however
will reverse in the future and has an effect on future taxable profit and hence the tax liability
that is why there is a need to account for the implication of the difference now on the
company’s liability.
Even though the reversal will occur in the future but the obligating event (the event that
brings about the timing difference has occurred and means the liability is past and meets the
IASB framework’s definition of liability or asset.

The following methods are usually used in the calculation of deferred tax:

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 (i) The deferral or deferred method
This method calculates deferred tax based on temporary difference but the tax rate that is
used is the rate existing at the date the transaction occurred. This therefore does not make a
good estimation of the company’s liability or a possible asset as the current tax rate which
will determine the company’s tax liability is not used.

(ii) The liability method

This is where deferred tax is calculated on temporary or timing difference and the rate used is
the current tax rate and therefore the deferred tax is recalculated whenever there is a change
in the tax rate. There are two sub-methods under this method:

- Income statement liability method

This is where deferred tax is calculated based on timing difference and hence the focus is on
the income statement (the difference between the amount recorded for the item in accounting
profit against taxable profit).The income statement approach assumes that all incomes and
expenses are accrued in the income statement but failed to recognize that income like
revaluation gain though earned arise but is recorded directly in equity or as reserve. It
therefore does not capture all the differences in book of accounts and the tax books.

- Balance sheet liability method

This is where deferred tax is calculated based on temporary difference (difference between
the tax base of the asset or liability and its carrying amount)
The liability method is preferred because the deferred taxation provision is maintained at an
up-to-date figure. IAS 12 prefers the liability method and specifically the Balance sheet
liability method. The balance sheet approach captures all the difference between book of
accounts and the tax books. Revaluation gain for instance is captured as part of the difference
which the income statement approach fails to recognize.

Determining temporary difference and deferred tax

Temporary difference is the difference between the carrying amount of an asset or liability
and its tax base. The carrying amount is given by the books of accounts whereas the tax base
of the asset or liability is given by the tax books. In short the tax base of the asset can be
determined by drawing a balance sheet for tax purpose. Deferred tax is calculated on the
temporary difference.

To better understand the concept of ‘tax base’, a few examples have been given below:

(1) A machine costs GHS 100 for tax purposes, depreciation of GHS 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. The tax base
of the machine is GHS 70.

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 (2) Dividends receivable from a subsidiary of GHS 100.The dividends are not taxable.
Thus the tax base of the asset is GHS 100 since there is no temporary difference as the
dividend will never affect future taxable profit(carrying amount-tax base=temporary
difference and since carrying amt=GHS 100 and temporary difference =NIL, tax base
= CA-TD =100-0 = GHS 100.(tax base=carrying amount because income is tax-
exempt)\

(3) Similarly loan receivable has a carrying amount of GHS 100.The repayment of the
loan will have no effect on the taxable profit in the future and hence temporary
difference is Nil. Tax base of the asset = CA-TD = GHS 100-GHS 0 =GHS 100.

(4) Current liabilities include interest revenue received in advance of GHS 100.The
related interest revenue was taxed on cash basis.
Income has been received in advance but since the related service has not been done
accounting principles do not allow recognition in the income statement until the
service is rendered. The cash has been received and since tax is charged on cash basis,
tax is paid in the year the interest cash is received. In the future there will not be any
tax on the interest again when it is finally recorded as income in the income statement.
Thus temporary difference is GHS 100.The tax base of the liability =CA-TD =GHS
100-GHS 100 =GHS 0.

(5) Current liabilities include accrued expenses with carrying amount of GHS 100.The
related expense will be deducted for tax purposes on cash basis. The tax base of the
asset is Nil because there is a temporary difference of GHS 100 as taxable profit will
go down in the future by GHS 100 when the expense is paid.
Tax base = CA-TD =GHS 100-GHS 100 =GHS0.There will be a deferred tax asset on
the temporary difference.
(6) Current liabilities include accrued expenses with a carrying amount of GHS100.The
related expense has already been deducted for tax purposes. The tax base of the
accrued expenses is GHS 100 because in both the book of accounts and tax books, the
expense has reflected in the profit and hence has no effect on future taxable profit.
Temporary difference is Nil. Tax base =CA-TD = GHS 100-GHS 0=GHS 100.

(7) Current liabilities include accrued fines and penalties with a carrying amount of GHS
100. Fines and penalties are not deductible for tax purposes. The tax base of the
accrued fines and penalties is GHS 100 since is tax exempt tax base should equal
carrying amount for there to be no temporary difference. Alternatively exempt
expenses ate permanent differences and cannot be temporary differences.

Some items have a tax base but are not recognized as assets and liabilities on the statement of
financial position. For example 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 until a latter period. The difference between the

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amount the amount the tax authorities will permit as a deduction in future periods and a nil
carrying amount is a deductible temporary difference.

Where the tax base of an asset is not immediately apparent, an entity is guided by this
principle: an entity recognizes 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.

Temporary differences are of two types:

(1) Taxable temporary differences (deferred tax liability).Taxable temporary differences
that will result in taxable amounts in determining taxable profit or loss of future
periods when the carrying of an asset (non-current assets, expenses prepaid or
income owing) is greater than the tax base of that asset. That is the expenses
deducted in book of accounts are higher than the tax books and the difference will
therefore have to be added back hence increasing taxable profit for it to be taxed. In
the same way if there is a difference in liability(income received in advance,
expenses owing,payables,etc) in the books of accounts and tax books and the
carrying amount is lower than the tax base, it leads to increase in taxable profit and
hence a taxable temporary difference. Taxable temporary difference raises the future
taxable profit and hence the tax liability. It thus leads to deferred tax liability

(2) Deductible temporary differe nces ate temporary differences that will result in
amounts that are deductible in determining taxable profits/loss of future periods when
the carrying amount of the asset or liability recovered or settled. When an asset has a
carrying amount lower than its tax base it results in deductible temporary
difference. For instance a company having a depreciable asset on the balance sheet
that is carrying amount is lower than the tax base, means that the company in future
will have its taxable profit go up as excess depreciation charged by the tax authority
will further reduce the taxable profit and hence a reduced tax liability in the future. A
liability with also a carrying amount higher than the tax base will lead to a reduced
taxable profit An inflow of this economic benefit in the form of reduced tax liability
is recorded as asset specifically non-current asset called deferred tax asset.

Deferred tax asset arise from mainly these:

 Deductible temporary difference
 The carry forward of unused tax losses
 The carry forward of unused tax credits

Deferred tax assets are recognised only when it is probable that the entity will have sufficient
taxable profit available against which the deductible temporary difference can be utilised.

The following deductible temporary differences lead to deferred tax assets:

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  Retirement benefits costs in the form of the actual benefit paid and the contribution as
per the accrual concept that IAS 19 Employee benefits recommends that it is used to
account for retirements benefits has the effect of charging these in an earlier period
not when the cost is actually paid. However for tax purpose it can be deductible when
the benefit is actually paid. The entity involved therefore has a deductible amount
against the taxable profit to reduce in the future and hence recognises a deferred tax.
The temporary difference is the carrying amount of the liability and the tax base of
Nil.
 The research costs when incurred according to IAS 38 is immediately expensed but
allowing for deduction against taxable profit can occur in a later period abd this give
rise to deferred tax asset as the entity has a deductible amount in the future against the
taxable amount. The temporary difference is the difference between the carrying
amount that is Nil and the tax base of the research cost amount eligible for deduction.
 A government grant which is included in the statement of financial position as
deferred income will not be taxable in future periods.
 Income is deferred in the statement of financial position but has already been included
in taxable profit in current or prior periods.
 The cost of inventories sold before the end of the reporting period is deducted in
determining accounting profit when goods are or services are delivered but id
deducted in determining taxable profit when cash is collected
 The net realizable value of an item of inventory, or the recoverable amount of an item
of property, plant or equipment, is less than the previous carrying amount and an
entity therefore reduces the carrying amount of the asset, but that reduction is ignored
for tax purposes until the asset is old.
 When there is a business combination the difference between the fair values of assets
and liabilities against their old values maintained in the tax books cause temporary
difference. When the fair values of assets are lower than the tax base or their original
cost it results in deferred tax asset. Also when a liability is recognised at the
acquisition date but the related costs are not deducted in determining taxable profits
until a later period, it will also lead to a taxable asset.
 Certain assets may be carried at fair value or may be revalued, without an equivalent
adjustment being made for tax purposes. A deductible temporary difference arises if
the tax base of the asset exceeds its carrying amount.

Examples of circumstances that the carrying amount of asset or liability equals the tax
base.
1. Accrued expenses have already been deducted in determining an entity’s current tax
liability for the current or earlier periods.
2. A loan payable is measured at the amount originally received and this amount is the
same as the amount repayable on final maturity of the loan.
3. Accrued expenses will never be deductible for tax purposes
4. Accrued income will never be taxable.

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Deferred tax on items recognized outside profit or loss:
Current tax and deferred tax shall be recognized outside profit or loss if the tax relates to
items that are recognized in the same or a different period, outside profit or loss. Therefore
current tax and deferred tax that relate to items that are recognized in the same or a different
period:

(a) In other comprehensive income shall be recognized in other comprehensive income

(OCI)
(b) Directly in equity, shall be recognized directly in equity i.e in the statement of
changes in equity (SOCIE)

Computations of tax expense

Current tax for the period x

Under (over) provision from previous year x(x)
Deferred tax for the period caused by reversal of temporary differences x(x)
Deferred tax relating to changes in the tax rates x
P& L xx

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