1. CHAPTER 15 Taxation in financial statements Lecturer: Dr. Bashir Abdisamed Printer: Ali Nur Dirie

2. Introduction This chapter is concerned with the treatment of taxation in financial statements. The applicable standard is IAS12 Income Taxes, which sets out rules for the accounting treatment of "current tax" and "deferred tax". Both of these terms are defined in this chapter and the requirements of IAS12 are explained. For example, the corporation tax payable on the profits of UK companies falls within the scope of IAS12.

3. Objectives By the end of this chapter, the reader should be able to: 1. define the term "current tax" and account for current tax in accordance with the requirements of IAS12 Income Taxes 2. define the term "temporary differences" and distinguish between taxable temporary differences and deductible temporary differences 3. explain the meaning of the "tax base" of an asset or liability 4. calculate the deferred tax assets and liabilities arising from deductible and taxable temporary differences 5. account for deferred tax in accordance with the requirements of IAS12.

4. Current Tax IAS12 defines current tax as "the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period". As mentioned earlier, the term "income taxes" refers to any tax which is payable on an entity's profits, regardless of the name given to that tax in the country concerned.

5. The main requirements of IAS12 with regard to current tax 1. The amount of current tax for an accounting period should generally be recognised as an expense (or as income in the case of tax recoverable) and should be included in the calculation of profit or loss. IAS1 requires that the tax expense should be presented separately in the statement of comprehensive income (see Chapter3). 2. Any current tax that remains unpaid at the end of the period should be recognized as a liability. If the amount already paid exceeds the amount due, the excess should be recognized as an asset. The benefit relating to a tax loss that can be carried back to recover current tax of a previous period should also be recognized as an asset.

6. continue 3. Current tax should be measured using tax rates and tax laws "that have been enacted or substantively enacted by the end of the reporting period". Tax rates and tax laws which have been announced but not enacted by the end of the period can be treated as "substantively enacted" if their enactment is regarded as more or less a formality. Tax rates and laws announced after the end of the reporting period are dealt with as non-adjusting events in accordance with the requirements of IAS10 (see Chapter 12). 4 Any adjustments necessary so as to reflect underestimates or overestimates of current tax in previous periods should be included in the tax expense for the current period and then (if material) disclosed separately in the notes. This is in accordance with the requirements of IAS8 (see Chapter 4).

7. EXAMPLE 1 a) The company estimates that current tax for the year to 30 June 2018 is £750,000. This figure takes into account new tax rates which were announced in March 2018 and which are confidently expected to be enacted in August 2018. If the new tax rates were disregarded, the amount due would be £810,000. b) Payments on account totaling £390,000 have been made during the year to 30 June 2018 in relation to the current tax for the year. c) Current tax for the year to 30 June 2017 was overestimated by £30,000. Calculate the amount of the current tax expense which should be shown in the statement of comprehensive income for the year to 30 June 2018 and the amount of the current tax liability which should be shown in the statement of financial position at that date.

8. Solution The new tax rates can be regarded as substantively enacted, so that current tax for the year is £750,000. But the statement of comprehensive income should show a current tax expense of only £720,000, so as to adjust for the previous year's overestimate. Payments on account of £390,000 reduce the current tax liability shown in the statement of financial position to £360,000 (£750,000 – £390,000).

9. The current tax ledger account for the year might appear as follows:

10. Deferred tax The amount of current tax payable by an entity for an accounting period depends upon the entity's taxable profit for that period. However, this taxable profit will often be different from the profit shown in the financial statements (the "accounting profit"). There are two main reasons for this discrepancy: (a) Permanent differences. In a such cases"permanent difference" between the accounting profit and the taxable profit (i.e. a difference that will not reverse itself in a future accounting period). (b) Temporary differences. Some of the income or expenses shown in the financial statements for an accounting period may be dealt with for tax purposes in a different accounting period.

11. Accounting for deferred tax IAS12 solves the problem illustrated above by requiring entities to account for "deferred tax". The broad approach is as follows: (a) In an accounting period in which temporary differences cause taxable profits to be lower than accounting profits, the tax expense which is shown in the statement of comprehensive income is increased by a transfer to a deferred tax account. (b) In an accounting period in which temporary differences cause taxable profits to be higher than accounting profits, the tax expense which is shown in the statement of comprehensive income is reduced by a transfer from the deferred tax account. IAS1 Presentation of Financial Statements (see Chapter 3)

12. The tax base concept IAS12 defines the tax base of an asset or liability as "the amount attributed to that asset or liability for tax purposes". (a) The tax base of an asset is "the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount.". (b) 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".

13. IAS12 requirements with regard to deferred tax IAS12 makes a number of detailed requirements with regard to deferred tax. Broadly, the main points are as follows: (a) A deferred tax liability must be recognized for all taxable temporary differences. (b) A deferred tax asset must be recognized for all deductible temporary differences to the extent that it is probable that taxable profits will be available in the future against which these deductible temporary differences can be utilized. (c) The carrying amount of deferred tax assets must be reviewed at the end of each reporting period and reduced to the extent that it is no longer probable that taxable profits will arise against which they can be utilized.

14. ( d) A deferred tax asset or liability must be measured at the tax rates that are expected to apply to the period in which the asset is realized or the liability is settled. These tax rates should be based upon tax rates and laws that have been enacted or substantively enacted by the end of the reporting period (see earlier in this chapter). (e) Deferred tax assets and liabilities must not be discounted, even though they might not be realized or settled for many years. IAS12 regards it as inappropriate to require or permit discounting because of the uncertain timing of the reversal of each temporary difference. (f) Transfers to or from the deferred tax account should generally be recognized in the calculation of profit or loss. However, a deferred tax transfer that arises from an item which is recognized in other comprehensive income or directly in equity should also be recognized in other comprehensive income or directly in equity. (g) Deferred tax assets and liabilities should not be offset in the statement of financial position unless the entity has a legally enforceable right to do so.

15. Disclosure requirements The disclosure requirements of IAS12 are very extensive. A brief summary of the main disclosures that must be made in the notes to the financial statements is as follows: (a) The tax expense shown in the calculation of profit or loss for the accounting period must be analysed into its main components. These may include: (i) the current tax expense (or income) for the period (ii) any adjustments relating to underestimates or overestimates of current tax in previous accounting periods (iii) the amount of any transfers to or from the deferred tax account relating to the origination or reversal of temporary differences.

16. (b) The following must also be disclosed separately: (i) the amounts of current and deferred tax relating to items that are recognized in other comprehensive income or directly in equity (ii) an explanation of the relationship between the accounting profit for the period and the tax expense for the period (iii) for each type of temporary difference, the amount of the deferred tax asset or liability recognized in the statement of financial position and the amount of the deferred tax expense or income recognized in the period.

17. END Question and comments Ali Faid Question and comments