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ACCA Paper F 7 Financial Reoirting F7FR Session17 d08
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OVERVIEW Objective ¾ To describe the rules for recognition and measurement of taxes.
DEFERRED TAX DETAILED RULES BASICS ¾
APPENDIX COMPREHENSIVE EXAMPLE ¾
COMPLICATIONS ¾ Rates
the deferred tax balance
¾ Accounting for the movement on
¾ Recognition of deferred tax assets
¾ Recognition of deferred tax
Calculation of the asset or
for deferred tax the financial statements will be as follows
CURRENT TAX ¾
After the company has accounted
Analysis − balance sheet approach ¾
Underlying problem ¾ Scenario ¾
INTRODUCTION WITHHOLDING TAX ¾
Deferred taxation calculations 1 INTRODUCTION
1.1 Overview ¾
In financial reporting, the financial statements need to reflect the effects of taxation on a company. Guidance is provided by the fundamental accounting concepts of accruals and prudence. Tax rules determine the cash flows; these must be matched to the revenues which gave rise to the tax and tax liabilities must be recognised as they are incurred, not merely when they are paid.
¾ The consistency must be applied in the presentation of income and expenditure.
1.2 Scope ¾
IAS 12 should be applied in accounting for income taxes including current tax tax on distributions deferred tax.
1.3 Definitions ¾ Accounting profit is profit or loss for a period before deducting tax expense. ¾
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).
¾ Tax expense (tax income) is the aggregate amount included in the
determination of profit or loss for the period in respect of current tax and deferred tax.
¾ Current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period.
¾ Deferred tax liabilities are the amounts of income taxes payable in future period in respect of taxable temporary differences.
¾ Deferred tax assets are the amounts of income taxes recoverable in future
periods in respect of: deductible temporary differences the carry forward of unused tax losses, and the carry forward of unused tax credits.
¾ Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base.
Temporary differences may be either
taxable temporary differences which 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, or
deductible temporary differences which 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.
¾ The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.2 RECOGNITION OF CURRENT TAX LIABILITIES AND CURRENT TAX ASSETS
IAS 12 says that
Current tax for current and prior periods should, to the extent unpaid, be recognised as a liability. If the amount already paid in respect of current and prior periods exceeds the amounts due for those periods, the excess should be recognised as an asset.
The benefit relating to a tax loss that can be carried back to recover current tax of a previous period should be recognised as an asset.
¾ A company is a separate legal entity and is therefore liable to income tax.
Income tax is based upon company’s profits for period (usually a year)
Example 1 Year 1
Enid Inc starts trading with operating profits of $100,000 and an estimated tax charge of $40,000.
Required: Show the relevant ledger accounts and profit or loss extracts.
Solution Year 1
Accounts Profit or loss extracts
Income tax payable $
$ $ PBT Tax
______ ______ ______ PAT
______ ______ ______
The income tax included in profit or loss is an estimate. Any over/under provisions are cleared in the following period’s profit or loss and do not give rise to a prior period adjustment.
Example 2 Year 2
Enid Inc’s tax charge for year 1 is settled at $43,000. Operating profits for the current year are $105,000 with an estimated tax charge of $44,000.
Required: Show the relevant ledger accounts and profit or loss extracts.
Solution Year 2
Accounts Profit or loss extracts
Income tax payable $ $
$ $ PBT Cash B/d 40,000 Tax
– current year – – underprovn ______ ______ ______ ______
PAT ______ ______ ______ ______ ______3 WITHHOLDING TAX
3.1 Introduction ¾
In some jurisdictions the government eases its cash flow by making companies account for tax when they make interest payments, or dividend payments.
3.2 Accounting Payments ¾
Companies make payments net of tax, e.g. dividends. Income tax is deducted at source and paid to the tax authorities according to specified local rules.
Dr Profit or loss 500 Cr Cash 350 Cr Income tax withheld 150 This records the amount that the company must pay to the authorities.
Companies are themselves taxed on their taxable profit. If they have received interest net of a deduction then they will have already suffered taxation on this piece of income which will then be taxed again in the tax computation for the year. Therefore they need to account for the fact that they have been taxed in order to reduce the future liability.
Dr Cash (net) 400 Dr Income tax asset 100 Cr Profit or loss 500
¾ If company has an income tax payable at the year end, include in payables. ¾
If company has income tax recoverable, i.e. company has net income tax suffered for year deduct from income tax payable include any excess debit balance in receivables.
Rogers Inc operates in an economy where tax is withheld on payment of interest and royalties. Rogers pays a year’s interest on 10% $1 million debentures at the year-end and on the last day of the year is paid a royalty of $1 per unit on 60,000 units sold by a customer. Income tax is at the rate of 24%.
Set out the journals to record the above and calculate the balance owed to or receivable from the tax authorities.
Journal for debenture interest
Journal for royalties
¾ Tax authority
$ $ ——— ——— ——— ———4 DEFERRED TAXATION — INTRODUCTION4.1 Underlying problem
The current tax charge for the period will be based on the tax authorities view of the profit, not the accounting view. This will mean that the relationship between the accounting profit before tax and the tax charge will be distorted. It will not be the tax rate applied to the accounting profit figure but the tax rate applied to a tax comp figure.
The differences between the two sets of rules will result in different numbers in the financial statements and in the tax comps. These differences may be viewed from a balance sheet liability perspective, or an income statement liability perspective.
Commentary Of course there is not really a full set of tax accounts but there could be. Tax files in reality merely note those areas of difference between the two systems ¾
It is convenient to envisage two separate sets of accounts one set constructed following IFRS rules and a second set following the tax rules of the jurisdiction in which the company operates. (we will refer to these as the “tax comps”).
In most jurisdictions accounting profit and taxable profit differ, meaning that the tax charge may bear little relation to profits in a period.
Most tax authorities will allow companies to deduct the cost of purchasing non current assets from their profit for tax purposes but only according to a set formula. If this differs from the accounting depreciation then the asset will be written down by the tax authority and by the company but at different rates.
Illustration 1 Many non current assets are depreciated.
Transactions which are recognised in the accounts in a particular period may have their tax effect deferred until a later period.
Differences arise due to the fact that tax authorities follow rules which differ from IFRS rules in arriving at taxable profit.
Thus the tax effect of the transaction (which is based on the tax laws) will be felt in a different period to the accounting effect.5 DEFERRED TAXATION — THE CONCEPT ILLUSTRATED5.1 Scenario
Illustration 2 Tom Inc bought a non current asset on 1 January 2008 for $9,000. This asset is to be depreciated on a straight line basis over 3 years. Accounting depreciation is not allowed as a taxable deduction in the jurisdiction in which the company operates. Instead tax allowable depreciation (capital allowances), under the tax regime in the country of operation is available as follows.
2008 $4,000 2009 $3,000 2010 $2,000 Accounting profit for each of the years 2008 to 2010 is budgeted to be $20,000 (before accounting for depreciation) and income tax is to be charged at the rate of 30%.
Differences arising Difference in the Carrying Tax base Financial Profit or amount position loss
Cost at 1 Jan 2008 9,000 9,000 Charge for the year (3,000) (4,000) (1,000) Cost at 31 Dec 2008 6,000 5,000 1,000
− Charge for the year (3,000) (3,000) Cost at 31 Dec 2009 3,000 2,000 1,000 Charge for the year (3,000) (2,000) 1,000
− − − Cost at 31 Dec 2010 −
At the end of each reporting period the deferred tax liability might be identified from a balance sheet or an income statement view.
In this example the difference in the statement of financial position amounts is the sum of the differences that have gone through the statement of comprehensive income.
The balance sheet view identifies the deferred taxation balance that is required in the statement of financial position whereas the income statement approach identifies the deferred tax that arises during the period.
¾ IAS 12 takes the first approach.5.2 Analysis − balance sheet approach
In summary the process involves a comparison of the accounting balance to the tax authority’s version of the same transaction and applying the tax rate to the difference.
Liability required Profit or loss entry 2008 300 Dr 300 2009 300 NIL 2010 NIL Cr 300
The charge to profit or loss is found by looking at the movement on the liability
Commentary In years to come (i.e. looking forward from the end of 2008) the company will earn profits against which it will charge $6,000 depreciation but will only be allowed $5,000 capital allowances. Therefore taxable profit will be $1,000 bigger than accounting profit in the future. This means that the current tax charge in the future will be $300 (30% × $1,000) bigger than would be expected from looking at the financial statements. This is because of events that have occurred and been recognised at the end of the reporting period. This satisfies the definition and recognition criteria for a liability as at the reporting date.
The $300 is a liability that exists at the end of the reporting period and which will be paid in the future.
The balance sheet approach calculates the liability (or more rarely the asset) that a company would need to set up on the face of its statement of financial position.
Application of the tax rate to the difference will give the deferred tax balance that should be recognised in the statement of financial position.
− − − −
At 31 Dec 2008 6,000 5,000 1,000 300 At 31 Dec 2009 3,000 2,000 1,000 300 At 31 Dec 2010
Tax @ 30%
Balance sheet view of the differences (known as the temporary difference)
Carrying amount Tax base
In 2008 the company will recognise a deferred tax liability of $300 in its statement of financial position. This will be released to the profit or loss in later years.5.3 After the company has accounted for deferred tax the financial statements will be as follows
Accounting for the tax on the differences through profit or loss restores the relationship that should exist between the accounting profit and the tax charge. It does this by taking a debit or a credit to the statement of comprehensive income. This then interacts with the current tax expense to give an overall figure that is the accounting profit multiplied by the tax rate.
Taxable profit 16,000 17,000 18,000 Tax @ 30% 4,800 5,100 5,400
(4,000) (3,000) (2,000) (1,000) 1,000
$ $ $ Accounting profit (after depreciation) 17,000 17,000 17,000 Add back depreciation 3,000 3,000 3,000 Deduct capital allowances
W1 Calculations of tax for the periods 2008 2009 2010
Accruals and provisions for taxation will impact on earnings per share, net assets per share and gearing.
As can be seen from this ex