11 Chapter 6 Income taxes

CopyRight 2011 By 周冬华 博士 CPA  Exam guide  Be prepared for a whole question on deferred tax, as happened on the pilot paper. When you were asked to discuss the conceptual basis for its accounting treatment and to calculate the deferred tax provision after making adjustments. 2

CopyRight 2011 By 周冬华 博士 CPA 3 Current tax revised Fast forward Taxation consists of two components: Current tax and deferred tax Definitions:

CopyRight 2011 By 周冬华 博士 CPA 4 Definitions  Accounting profit. Net profit or loss for a period before deducting tax expense.  Taxable profit (tax loss). The profit (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable).  Tax expense (tax income). The aggregate amount included in the determination of net profit or loss for the period in respect of current tax and deferred tax.  Current tax. The amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period.

CopyRight 2011 By 周冬华 博士 CPA 5 recognition of Current tax liabilities and assets  IAS 12 requires any unpaid tax in respect of the current or prior periods to be recognized as a liability.  IAS 12 requires recognition as an asset of the benefit relating to any tax loss that can be carried back to recover current tax of previous period.  Page 151

CopyRight 2011 By 周冬华 博士 CPA 6 Deferred tax Deferred tax is an accounting measure used to match the tax effects of transactions with their accounting impact. It is quite complex. Exam focus point Students invariably find deferred tax very confusing. It is an inherently difficult topic and as such it likely to appear frequently in its most complicated forms in paper P2. you must understand the contents of the rest of this chapter.

CopyRight 2011 By 周冬华 博士 CPA 7 Definitions Key terms on page 153  Deferred tax liabilities  Deferred tax assets  Temporary differences  Taxable temporary differences  Deductible temporary differences

CopyRight 2011 By 周冬华 博士 CPA 8 Test your understanding 1  As at 30 September, Grace has non-current assets with a carrying value of $1,100,000 but a tax written down value of $700,000.  The brought forward balance on the deferred tax account is $300,000.  Assume a tax rate of 30%.  Compute the effect of deferred tax on the financial statements for the year end 30 September.

CopyRight 2011 By 周冬华 博士 CPA 9 Solution The double entry will be: Dr Deferred tax $180,000 Cr tax charge $180,000

CopyRight 2011 By 周冬华 博士 CPA 10 Section summary  Deferred tax is an accounting device. It does not represent tax payable to the tax authorities.  The tax base of an asset or liability is the value of that asset or liability for tax purposes.  You should understand the difference between permanent and temporary differences.  Deferred tax is the tax attributable to temporary differences.

CopyRight 2011 By 周冬华 博士 CPA 11 Taxable temporary differences Exam focus point The rule to remember here is that: 'All taxable temporary differences give rise to a deferred tax liability.'

CopyRight 2011 By 周冬华 博士 CPA 12 Deferred tax liabilities  IAS 12 requires:  a deferred tax liability to be recognised for all taxable temporary differences, with minor exceptions  a taxable temporary difference arises where the carrying value of an asset is greater than its tax base  the liability to be calculated using full provision  no discounting of the liability.

CopyRight 2011 By 周冬华 博士 CPA 13 Timing differences  Interest received which is accounted for on an accruals basis, but which for tax purposes is included on a cash basis.  Accelerated depreciation for tax purposes.  Capitalised and amortized development costs.

CopyRight 2011 By 周冬华 博士 CPA 14 Deductible temporary differences Exam focus point The rule to remember here is that: 'All deductible temporary differences give rise to a deferred tax asset.'

CopyRight 2011 By 周冬华 博士 CPA 15 Deferred tax assets  IAS 12 requires that:  deferred tax assets should be recognised for all deductible temporary differences  a deductible temporary difference arises where the tax base of an asset exceeds its carrying value  to the extent that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised  no discounting is permitted.

CopyRight 2011 By 周冬华 博士 CPA 16 Test your understanding 2  Richard of York is a Shakespearean costumier company. The following is an extract from the trial balance of the above at 31 December 20X5:  A taxable temporary difference of $125,000 has accumulated at the year end. Income tax at 20% is estimated at $30,000.  (a)Prepare the deferred tax note.  (b)Prepare the income statement and tax note.

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CopyRight 2011 By 周冬华 博士 CPA 18 Application to scenarios  Revaluation of non-current assets  Deferred tax should be recognised on revaluation gains even where there is no intention to sell the asset or rollover relief is available on the gain.  The revaluation of non-current assets results in taxable temporary differences, and so a liability. This is charged as a component of other comprehensive income (alongside the revaluation gain itself). It is therefore disclosed either in the statement of comprehensive income or in a separate statement showing other comprehensive income.

CopyRight 2011 By 周冬华 博士 CPA 19  Tax losses  Where unused tax losses are carried forward, a deferred tax asset can be recognised to the extent that taxable profits will be available in the future to set the losses against.  If an entity does not expect to have taxable profits in the future it cannot recognise the asset in its own accounts.  If, however, the entity is part of a group and may surrender tax losses to other group companies, a deferred tax asset may be recognised in the consolidated accounts.  The asset is equal to the tax losses expected to be utilised multiplied by the tax rate

CopyRight 2011 By 周冬华 博士 CPA 20 Changes in tax rates  (a) The deferral method assumes that the deferred tax account is an item of 'deferred tax relief' which is credited to profits in the years in which the timing differences are reversed. Therefore the tax effects of timing differences are calculated using tax rates current when the differences arise.  (b) The liability method assumes that the tax effects of timing differences should be regarded as amounts of tax ultimately due by or to the company. Therefore deferred tax provisions are calculated at the rate at which it is estimated that tax will be paid (or recovered) when the timing differences reverse.

CopyRight 2011 By 周冬华 博士 CPA Deferred taxation and business combinations  p165 21