ADVANCED

FINANCIAL
REPORTING
7
https://www.ifrsbox.com/ias-12-income-taxes/
 What is Deferred Tax
Taxable profits vs. Accounting profits
• Taxable profits (calculated by tax authorities) could be different from
Accounting profits (calculated by company) due to certain items of
incomes and expenses
• These differences could either be:
• Permanent
• Temporary
• Permanent differences leads to difference in aggregate tax
calculations. They originate in the current period and never reverses
in subsequent periods. i.e. Any expense disallowed by tax authorities
will increase the profit and eventually the amount of tax.
i.e. Tax as per company= $10
Tax as per Tax dept.= $12
• Permanent differences are IGNORED for the purpose of this standard
• Permanent differences: These occur when certain
items of revenue or expense are excluded or added
back for the computation of taxable profits (for
example, entertainment expenses may not be
allowable for tax purposes).
• Temporary differences: These occur when items of
revenue or expense are included in both accounting
profits and taxable profits, but not for the same
accounting period.
• Deferred tax is the tax attributable to temporary
differences
 What is Deferred Tax
• Temporary differences are actually timing differences which do not
change the aggregate amount of tax.
i.e. Tax as per tax dept.= $10 (1st year= $10)
Tax as per Company.= $10 (1st year= $7 2nd year= $3)
• These differences could arise due to the following reasons:
• The company follows accrual basis of accounting, however tax
dept. may use a hybrid system (Cash + accrual)
• Difference in rates of depreciation or amortization
• Common areas for such differences might include:
• Depreciation / Amortization
• Income received in advance
• Income receivable
• Expenses prepaid
• Expenses payable
• Provisions etc.
 What is Deferred Tax
• Reconciliation of Tax calculated by Company VS Tax
as per tax rules is known as Deferred taxation
• So, this adjustment is simply an “Accrual of tax”
• Tax as per tax profits is adjusted upwards or
downwards to match with tax as per Accounting profit.
This result in creation of deferred tax Asset or liability.
So adjustment is made by the company in their
respective statements of comprehensive income and
financial position.
 Reconciliation of Tax calculated by Company VS Tax
calculated by Tax dept. is known as Deferred taxation
Difference between Current and Deferred Tax
 Deferred Tax Asset & Liability
A debit balance on deferred tax account reflects that Tax
dept. has charged higher tax (i.e.$100) than actual tax
incurred (i.e.$90). This extra charge must be postponed
(deferred). Similar to prepayments
Entry: Deferred tax asset 10
Taxation expense 10

A credit balance on deferred tax account reflects that Tax

dept. has charged lower tax (i.e.$80) than actual tax incurred
(i.e.$100). This difference will be charged in future. So, a
liability is created. Similar to payables
Entry: Taxation expense 20
Deferred tax liability 20
Identification of deferred Tax Asset or Liability
Short-cut Approach
• Step 1
Record tax as per tax rules

• Step 2
Tax EXPENSE= tax as per accounting profit
• Unpaid tax in respect of the current or prior periods is
to be recognized as a liability. Excess tax paid in
respect of current or prior periods is an asset.
In 2015, Marvel plc had taxable profits of 120,000. The
estimated tax liability for 2014 was 30,000. Income tax
rate is 30%. What will be the tax charge for 2015, if tax
due for 2014 is agreed to be 35,000 by the Income Tax
Authorities?
Tax due on 2015 profit (120,000 x 30%) = 36,000
Underpayment for 2014 (35,000 – 30,000) = 5,000
Tax liability for the year 2015 41,000
IAS 12 also requires recognition as an asset of the
benefit relating to any tax loss that can be carried back
to recover current tax of a previous period. This is
acceptable because it is probable that the benefit will
flow to the entity and it can be reliably measured.
In 2014, Marvel paid 50,000 on its profits. In 2015, the
company made tax loss of 24,000. The rules allow loss
to be carried back for one year. Tax rate is 30%.
Tax repayment due to loss = 30% of 24,000 = 7,200
Tax Receivable (Debit) 7,200
Tax Repayment (P&L – Credit) 7,200
Current tax is recognized as income or expense and
included in the net profit or loss for the period, except in
two cases:
(a) Tax arising from a business combination is treated
differently (tax assets or liabilities of the acquired
subsidiary will form part of the goodwill calculation).
(b) Tax arising from a transaction or event which is
recognized directly in equity (in the same or a
different period).
If a transaction or event is charged or credited directly to
equity, rather than to P&L, then the related tax should be
also charged to equity.
 Deferred Tax Asset & Liability
• An entity shall book deferred tax asset or liability whenever the
settlement or recovery of carrying amount of an asset or
liability would make future payments larger or smaller than
they would be if such recovery or settlement were to have no
tax consequences
• Deferred tax is calculated using LIABILITY METHOD, in which
deferred tax is calculated by reference to the tax base of an
asset or liability compared to its carrying amount
Carrying amount of Non-current asset X
Tax base X
Temporary difference X

Deferred Tax= Temporary difference x Tax rate

The tax base of an asset or liability is the amount
attributed to that asset or liability for tax purposes.
• A machine cost $10,000 and has a carrying amount of
$8,000. For tax purposes, depreciation of $3,000 has
already been deducted and the remaining cost will be
deductible in future periods, either as depreciation or
through a deduction on disposal. Revenue generated
by using the machine is taxable, any gain on disposal
of the machine will be taxable and any loss on
disposal will be deductible for tax purposes.
• The tax base of the machine is $7,000. The temporary
difference is $1,000.
• Interest receivable has a carrying amount of $1,000.
The related interest revenue will be taxed on a cash
basis.
• The tax base of the interest receivable is nil. The
temporary difference is $1,000.
• Trade receivables have a carrying amount of $10,000.
The related revenue has already been included in
taxable profit (tax loss) for current year.
• The tax base of the trade receivables is $10,000. No
temporary difference.
• Current liabilities include accrued expenses with a
carrying amount of $1,000. The related expense will
be deducted for tax purposes on a cash basis.
• The tax base of the accrued expenses is nil. The
temporary difference is $1,000.
• Current liabilities include interest revenue received in
advance, with a carrying amount of $10,000. The
related interest revenue was taxed on a cash basis in
prior year.
• The tax base of the interest received in advance is nil.
The temporary difference is $10,000.
• Current liabilities include accrued expenses with a
carrying amount of $2,000. The related expense has
already been deducted for tax purposes in current
year
• The tax base of the accrued expenses is $2,000. No
temporary difference.
• Current liabilities include accrued fines and penalties
with a carrying amount of $100. Fines and penalties
are not deductible for tax purposes.
• The tax base of the accrued fines and penalties is
$100. No temporary difference (permanent difference)
• Permanent differences: These occur when certain
items of revenue or expense are excluded from the
computation of taxable profits (for example,
entertainment expenses may not be allowable for tax
purposes).
• Temporary differences: These occur when items of
revenue or expense are included in both accounting
profits and taxable profits, but not for the same
accounting period.
• Deferred tax is the tax attributable to temporary
differences
Deferred Tax Asset
Deferred Tax Liability
TAXABLE temporary differences DEDUCTIBLE temporary differences

Deferred tax Liability (Entity's FS) Deferred tax Asset (Entity's FS)

Higher CA of asset Lower CA of asset

Higher Income Lower Income

Lower expenses Higher expenses

• Taxable temporary differences: will result in higher tax
charge in future. They give rise to deferred tax liability.
• When an asset is recognized, it is expected that its
carrying amount will be recovered in the form of economic
benefits that flow to the entity in future.
• If the carrying amount of the asset is greater than its tax
base, then taxable economic benefits will also be greater
than the amount that will be allowed as a deduction for tax
purposes.
• (Higher CA Lower dep.  Higher tax by company)
• The difference is therefore a taxable temporary difference
and the obligation to pay the resulting income taxes in
future is a deferred tax liability.
• Under IAS 16 assets may be revalued. This changes
the carrying amount of the asset but the tax base of
the asset is not adjusted. Consequently, the taxable
flow of economic benefits to the entity as the carrying
value of the asset is recovered will differ from the
amount that will be deductible for tax purposes.
• The difference between the carrying amount of a
revalued asset and its tax base is a temporary
difference and gives rise to a deferred tax liability or
asset.
• All deductible temporary differences give rise to a
deferred tax asset.
• Retirement benefit costs (pension costs) are deducted
from accounting profit as service is provided by the
employee. They are not deducted in determining
taxable profit until the entity pays either retirement
benefits or contributions to a fund.
• Accumulated depreciation of an asset in the financial
statements is greater than the accumulated
depreciation allowed for tax purposes up to the end of
the reporting period.
 Test yourself
A company receives rental income of $10,000 in 2018
that relates to 2019 and then receives $110,000 rental
income in 2019 (all earned in 2019). The company does
not have any other source of income. Tax is charged on
earlier of receipt or earning @30%.

2Record
018 tax entries for 2018 and 2019.
2019
Tax expense 3,000 Tax expense 36,000
Tax P/A 3,000 Deferred tax 3,000
Tax P/A 33,000
Deferred tax 3,000
Tax expense 3,000
 Test yourself
Profit before tax by company and Tax dept. is $20,000 both in
years of 2018 & 2019 before electricity bill. Electricity bill of $8,000
for Jan 2019 is paid in Dec 2018 and tax dept. wants to settle this
expense in 2018. The company paid current tax of 2018 in 2019
@30% on profits. There are no other temporary or permanent
differences.
201 201
8Record tax entries for 2018 and 2019.
9
Tax expense 3,600 Tax expense 6,000
Tax P/A 3,600 Tax P/A 6,000

Tax expense 2,400 Deferred tax 2,400

Deferred tax 2,400 Tax expense 2,400

Tax P/A 6,000

• Taxable temporary differences: will result in higher tax
charge in future. They give rise to deferred tax liability.
• For example: Interest Revenue received in arrears,
included in accounting P&L on accrual basis, included
in taxable profit on cash basis.
Accounting Profit 2014 2015
Interest Income 50,000 50,000
Tax Expense at 25% 12,500 12,500
Taxable Profit
Interest Income 0 100,000
Tax Payable at 25% 0 25,000
 JOURNAL ENTRIES
2014:
Tax Expense 12,500
Deferred tax liability 12,500

2015
Tax Expense 12,500
Deferred tax liability 12,500
Provision for taxation 25,000
Accounting Profit 2014 2015
Interest Income 50,000 50,000
Tax Expense at 25% 12,500 12,500
Taxable Profit
Interest Income 0 100,000
Tax Payable at 25% 0 25,000

Tax expense 12,500 25,000

Tax expense reversal (12,500)
Deferred Tax Liability 12,500
Deferred Tax Liability Reversal (12,500)
Current Tax Liability 25,000
Rs. 45 million was charged against profit in respect of
depreciation. The tax computation showed capital
allowances of Rs. 50 million. Tax rate = 30%.

Capital allowances 50,000,000

Depreciation (45,000,000)
5,000,000 x 30% = 1,500,000
This will be deferred tax liability (more tax payable in
future years)
Interest receivable of Rs. 50,000 was reflected in profit
for the period. However, only Rs. 45,000 of interest was
actually received during the year. Interest is not taxed
until it is received. Tax rate = 30%.

Interest (B/Sheet) 50,000

Interest (tax P&L) (45,000)
5,000, x 30% = 1,500
This will be deferred tax liability (more tax payable in
future years)
Interest payable of Rs. 32,000 was treated as an
expense for the period. However, only Rs. 28,000 of
interest was actually paid during the year. Interest is not
an allowable expense for tax purposes until it is paid.
Tax rate = 30%.

Interest (B/Sheet) 32,000

Interest (tax P&L) (28,000)
4,000, x 30% = (1,200)
This will be deferred tax asset (less tax payable in future
years).
During the year Francesca incurred development costs
of Rs. 500,600, which it has capitalized. Development
costs are an allowable expense for tax purposes in the
period in which they are paid. Tax rate = 30%.

Development cost as allowable expense = 500,600 x

30% = 150,180
This will be deferred tax liability (more tax payable in
future years).
 Test yourself
The financial statements of Bell ltd. are presented below:
2015 2016 2017
Profits before dep. & tax12,000 12,000 12,000
Depreciation (2,000) (2,000) (2,000)
PBT 10,000 10,000 10,000
Tax depreciation 2,400 2,100 1,500

P&M was purchase at $6,000 and having a useful life of 3 years

with nil salvage value. Tax rate is 30%.
Required;
A) Prepare Income statement under using general & specific
framework
B) Prepare statement of financial position
 Accounting profit 2015 2016 2017
PBT 10,000 10,000 10,000
Tax@30% (3,000) (3,000) (3,000)
PAT 7,000 7,000 7,000

Tax profit 2015 2016 2017

PBT- Accounting 10,000 10,000 10,000
Solution
Accounting dep. 2,000 2,000 2,000
Tax dep. (2,400) (2,100) (1,500)
PBT- Tax 9,600 9,900 10,500
Tax@30% (2,880) (2,970) (3,150)
PAT 7,120 7,030 6,850

Deferred tax liability 120 30 (150)

Income tax 2,880 2,970 3,150

Deferred tax 120 30 (150)
Tax expense 3,000 3,000 3,000
Temporary difference
Carrying amount 4,000 2,000 -
Tax base 3,600 1,500 -
Temporary difference 400 500 -
Increase/ decrease 120 150 (150)

Statement of financial position

Non-current liabilities
Deferred tax 120 150 -

Current liabilites
Income tax 2,880 2,970 3,150
 Tax Entries
2015 2016
Tax expense 2,880 Tax expense 2,970
Tax P/A 2,880 Tax P/A 2,970

Tax expense 120 Tax expense 30

Dtax
Dtax liability 120 liability 30

2017
Tax expense (3150-150) 3,000
Dtax liability 150
Tax P/A 3,150
Land and buildings with a net book value of Rs.
4,900,500 were revalued to Rs. 6,000,000.
Tax rate = 30%.

Revaluation 6,000,000
Carrying Value (4,900,500)
1,099,500 x 30% = 329,850
This will be deferred tax liability (more tax payable in
future years).
 Test Yourself (Initial Allowance)
A machine having life of 4 years was purchased on
1.1.14 for 10,000. Residual value = Nil. Initial Allowance
is 25% on P&M, and depreciation rate = 15% on
Reducing balance method. Tax Rate is 20%.
2014 2015
Accounting Depreciation 2,500 2,500
Tax Depreciation 3,625 956
(1,125) 1,544
Deferred Tax @ 20% (225) 309
If profit for the year (before tax) is 40,000.
2014 2015
Profit before tax 40,000 40,000
Add: Accounting depreciation 2,500 2,500
Less: Tax Depreciation (3,625) (956)
38,875 41,544
Tax Charge @ 20% 7,775 8,309
Deferred Tax adjustment 225 (309)
Income Tax charge in P&L 8,000 8,000
 Revaluation of Assets
• Under IAS 16 assets may be revalued. This changes
the carrying amount of the asset but the tax base of
the asset is not adjusted. Consequently, the taxable
flow of economic benefits to the entity as the carrying
value of the asset is recovered will differ from the
amount that will be deductible for tax purposes.
• The difference between the carrying amount of a
revalued asset and its tax base is a temporary
difference and gives rise to a deferred tax liability or
asset.
 Question (without revaluation)
Joshua purchased a plant for $500,000 on Jan 1st, 2018.
On Dec 31st, 2018, the carrying amount and tax base are
$470,000 & $420,000 respectively.
The tax rate is 20%.

Solution:
1) Temporary diff= CA- Tax base= 470,000-420,000= 50,000
2) Deferred tax adjustment= 50,000 @20%= 10,000
3) Entry:
Tax expense 10,000
Deferred tax liability 10,000
 Question (with revaluation)
Joshua purchased a plant for $500,000 on Jan 1st, 2018
On Dec 31st, 2018, the carrying amount and tax base are
$470,000 & $420,000 respectively. However, the company follows
a revaluation model and on this day the revalued amount of plant
was $800,000.
The tax rate is 20%.

Solution:
1)Temporary diff= CA- Tax base= 800,000-420,000= 380,000
2) Deferred tax adjustment= 380,000 @20%= 76,000
Entry:
3) Surplus on revaluation= 800,000- 470,000= 330,000
4) Tax Tax- (IS) 330,000 10,000
on surplus= @20%= 66,000
5) Net Tax-
other(OCI) / Surplus 66,000
comprehensive income (revaluation surplus)
Deferred
=330,000- 66,000= tax liability 76,000
264,000
Test Yourself (Opening balances of Def tax a/c + Revaluation)

TD Tax
Difference between CA & tax base of asset 1900 475
Revaluation difference 1500 375 OCI
100
Opening balance 75
25 P&L

Tax expense 25
Revaluation reserve 375
Deferred tax liability 400

Record the Journal entry assuming tax rate is 25% & opening deferred tax
Cr. balance is $75 .
 Test Yourself
• Temporary
Total On 1 difference
st
Jan 27000@25%
2017, Taylor ltd.
6,750 revalued itsBalance landsheet
and the value has
increased
Revaluation from $65,000 3,750
surplus 15000@25% to $80,000.
Non-current assets
3,000 Land 80,000
Opening balance tax dept. assessed
• Income 2,600 tax liability of $19,400 for the year
Chargeable to P&L 400 Revaluation surplus 11,250
ending Dec 31 , 2017. st

Income statement Non-current liabilities

• The difference between the carrying amount & tax base of net
Income tax expense (19,400+400) 19,800 Deferred tax 6,750
assets (including revaluation) is $27,000 at the year end.
Other comprehensive income Current liabilites
• Opening
Revaluation surplus Cr. balance
15,000 of deferred
Incometax account is $2,600 and19,400
tax payable tax
Deferredrate
tax is 25%. (3,750) Statement of changes in equity
11,250 Revaluationin
Show the impact of these transactions surplus
the financial statement. 15,000
Deferred tax (3,750)
11,250
Comprehensive Questions on revaluation
QUESTION 1 & 2
 Question 1
A plant costing $2,000 was acquired at the start of year 1. It
is being depreciated straight line over four years, resulting in
annual depreciation charges of $500. Tax rate is 25%. This
asset is revalued to $2,500 at the end of year 2. The capital
allowances granted on this asset are as follows.
Years Depreciation Capital allowance
1 $500 $800
2 $500 $600
3 $500 $360
4 $500 $240

Record the entries from year 1 to 4?

 Total Def.
Table 1 (Without revaluation) Table 2 tax
Rev.
Year A/C dep. Tax dep. Tem. Diff Def. tax surplus Def. tax
-
1 500 800 (300) (75) - (75)

2 500 600 (100) (25) 1,500 (375) (400)

3 500 360 140 35 (750) 187.5 222.5

4 500 240 260 65 (750) 187.5 252.5

-
2,000 2,000 - - - -
 Year 2
Solution 1) Dep. 500

Year 1 Acc.dep. 500

1) Plant 2,000
2) Tax expense 25
To cash 2,000
DT liablity 25
(600-
500)*25%
2) Dep. 500

Acc.dep. 500 3) Plant 500

Acc.dep. 1,000
Tax
3) expense 75
Rev. surplus 1,500
DT liablity 75
Tax
(800- 4) (surplus /OCI) 375
500)*25%
DT liablity 375
(1500*25%)
 Year 3

1) Dep. 1,250
Acc.dep. 1,250
(2500/2)

2) DT liability 222.50

Tax expense 35
Tax (surplus/OCI) 187.50

3) Rev. surplus 750

Ret.earnings 750
(1500/2)
 Year 4

1) Dep. 1,250
Acc.dep. 1,250
(2500/2)

2) DT liability 252.50

Tax expense 65
Tax (surplus/OCI) 187.50

3) Rev. surplus 750

Ret.earnings 750
(1500/2)
Year 2018
Question 2
Cost of asset 1,000,000
Useful 5 years
life (straight line)
Tax dep. 25%
Purchased on 1/1/2018

Solution
31/12/2018 CA tax base
800,000 750,000
Rev surplus 200,000
Rev amount / fair value 1,000,000

Temporary diff= 1,000,000 - 750, 000= 250,000 Journal entry

Def tax @30%= 75,000 Tax expense 15,000
Revaluation
surplus= 200,000 (800-750)*30%
Tax on
surplus@30%= 60,000 Tax-OCI 60,000
200,000*30%
Def tax liability 75,000
 Question 2
Year 2019 continued……..
Now assume that company wants to write off revaluation
surplus through incremental depreciation
Dep. On Fair value= (1,000,000/4) 250,000
Dep. On actual cost= (800,000/4) 200,000
Dep.on tax base= (750,000*.25) 187,500
Journal entries
1) Dep.exp. 200,000
Rev. surplus 50,000
Acc. Dep. 250,000

2) Def tax liability 18,750

(62500*.30)
Tax expense 3,750
(12500*.30)
Tax (OCI) 15,000
Test yourself
• Z Co owns a property which has a carrying amount at
the beginning of 2015 of $1,500,000. At the year end it
has entered into a contract to sell the property for
$1,800,000. The tax rate is 30%.
Other Comprehensive Income
Gain on property revaluation 300,000
Income Tax on gain (90,000)
Other comprehensive income for the year 210,000
PPE 300,000
Deferred Tax 90
Revaluation surplus 210