1. F7

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3. 3 Designed to give you the knowledge and application of: Section C: Financial Statements C1. Statements of cash flows C2. Tangible non-current assets C3. Intangible assets C4. Inventory C5. Financial assets and financial liabilities C6. Leases C9. Taxation

4. 4  Account for current tax liabilities and assets  Taxable temporary differences on accounting & taxable profits  Calculate & record deferred tax amounts in financial statements Learning Outcomes C9: Taxes on income

5. 5 Current tax Current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period. Example A company’s taxable income for the year 20X6 is $800,000. The tax rate applicable to the company is 30%. For 20X5, the company had provided $200,000 for income tax. The actual liability for 20X5 was decided at $215,000. Tax due for 20X6 ($800,000 x 30%)240,000 under provision for 20X5 (215,000 – 200,000) 15,000 Current tax expense and liability255,000 Use tax rates enacted at that date

6. 6 When calculating tax on profits: 1.When advance tax is paid (i.e. on a dividend distribution) Dr Advance tax SOFP (balance sheet) X Cr bank / cash X Being advance tax paid 2.When expense is recognised Dr Current tax expense X Cr current tax liability X Being tax expense recorded in the books 3.When the current tax asset and liability are adjusted against each other Dr Current tax liability X Cr advance tax X Being adjustment of current tax asset and current tax liability Accounting entries The tax expense will normally be transferred to profit or loss. If the current tax liability is more than the amount paid, the balance will be presented as a current tax liability. If the payment is more than current tax liability, the difference will be presented as a current tax asset. The asset or liability will be transferred to the SOFP.

7. 7 Differences in accounting profits and taxable profits Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base.  The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.  Taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable).  Accounting profit is profit or loss for a period before deducting the expense. IAS 12, Para 5 What are the differences and how do they arise Calculation of taxable profits is based on applicable tax laws Accountants base their figures on generally accepted accounting principles and standards

8. 8 Permanent differences Any expense that will never be allowed as a deduction in the calculation of taxable profits causes permanent difference. Example A penalty of $8,000 is treated as an expense for accounting profits, whereas the amount is not a deductible expense for calculating tax profit according to local tax laws. Temporary differences SOCI (income statement angle): the word ‘temporary’ indicates that the difference arise in one accounting period and reverse in another. Refer to Example on page 385 Permanent Differences

9. 9 Types of temporary differences Taxable temporary differences Deductible temporary differences Deductible temporary differences are temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. Taxable temporary differences are temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. Temporary differences

10. 10 Example (Once again, continuing the previous example of Melco) The cost of an asset is $100,000. For the first year, accounting depreciation is $16,000 while tax depreciation is $25,000. Accounting profit will be $9,000 ($25,000 – 16,000) higher than taxable profit. The carrying amount of an asset is $84,000. In future, the entity will earn taxable income and recover this carrying amount. When it does so, for tax purposes it can deduct only $75,000 ($100,000 – $25,000), the tax base, on which depreciation is yet to be allowed. On the difference of $9,000, it will have to pay tax, i.e. it is a taxable difference. Assets For assets, a taxable temporary difference occurs when depreciation or amortisation is accelerated for tax purposes. The manner of recovery may be by using an asset to generate business income or by selling it Liabilities If a particular liability has been already allowed as a deduction for tax purposes, but it has not been deducted in the accounts, a taxable temporary difference occurs. This situation is seen less frequently in real life. Taxable temporary differences

11. 11 Deductible temporary differences Example: assets Accounting depreciation charged on a machine costing $100,000 is $18,000, and its tax depreciation is $12,000. The carrying value of the asset is $82,000, and its tax base is $88,000. Since the tax depreciation is lower than accounting depreciation, profits for tax purposes are $6,000 higher than accounting profits. This being a reversible difference, there will in future be higher tax depreciation (recovery of asset) than accounting depreciation and therefore $6,000 lower profits for tax purposes than for accounting purposes. This amount will be deductible while calculating taxable profits and is therefore a deductible difference. Example: liabilities situation will arise when a liability has been deducted for accounting purposes but not for tax purposes A company had accrued product warranty costs of $10,000 in its accounts, in respect of claims made by customers against warranties. The taxation laws do not permit the deduction until the company actually pays the claims. Its taxable profits for the current period will be higher by $10,000. In future, it will be lower. Therefore, this is a deductible difference. Reverse of the taxable temporary differences

12. 12 Income Interest of $15,000 is received in advance. Local tax laws treat this as taxable on receipt. However, for accounting purposes, it will be shown as income in future periods when the income accrues. In future, to calculate taxable profit, this amount will be deducted from accounting profit. Therefore, it is a deductible temporary difference. Expenses Research costs of $25,000 are recognised as an expense in the accounts in the year in which they are incurred. Under local tax laws, they are allowed as deductions only in a later year. In future, to calculate taxable profit, this amount will be deducted from the accounting profit. Therefore, it is a deductible temporary difference. Example

13. 13 Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable temporary differences. Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of: 1. Deductible temporary differences; 2. The carry-forward of unused tax losses; and 3. The carry-forward of unused tax credits. IAS 12 Para 5 Compute and record deferred tax amounts in the financial statements Example Imagine an entity with a building whose fair value is $500,000 but whose net book value in the accounts is $200,000. The current tax rate is 20%. The entity decides to revalue the building to $500,000. Now, by doing so, the entity is recognising that in the future it is likely to be able to sell the asset for $500,000. However, it is also likely to have to pay tax on this sale. If the entity knows that it will have to pay this additional tax later on, then it should account for it in some manner. Refer to Example on page 392 Refer to Example on page 393 (why is a deferred tax asset recognised?)

14. 14 RECAP  Account for current tax liabilities and assets  Taxable temporary differences on accounting & taxable profits  Calculate & record deferred tax amounts in financial statements

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