income taxes

Everything is uncertain but Death and Taxes
Sunday, January 22, 2012 Hammad Ahmad (CA-Module D, MA-Eng Literature part II) 1

Controlled by an entity

ASSET Raised from past event

Future economic benefits will
flow in


⁼
An asset represents the value of its future benefits


CA FB FB FB FB

Present value of future benefits (FB)


XYZ (pvt) Ltd.
Statement of Financial position
As at---------------

PPE xxx

Deferred tax liability xxx


XYZ (pvt) Ltd.
Statement of Comprehensive income
For the year ended--------------

Sales xxx
Cost of goods sold (xxx)

Gross profit xxx
Operating expenses (xxx)

Net profit before tax xxx

TAX
• Current (xxx)
• Deferred expense (xxx)

Net profit after tax xxx

Present obligation

LIABILITY Raised from past event

Future economic benefits will
flow out


=

A liability represents the value of its future outflows


CA FoF FoF FoF FoF

Present value of future outflows (FoF)


XYZ (pvt) Ltd.
Statement of Financial position
As at---------------

Accrued expenses xxx

Deferred tax asset xxx


XYZ (pvt) Ltd.
Statement of Comprehensive income
For the year ended--------------

Sales xxx
Cost of goods sold (xxx)

Gross profit xxx
Operating expenses (xxx)

Net profit before tax xxx

TAX
• Current (xxx)
• Deferred income xxx

Net profit after tax xxx

Tax base of Assets

Assets Tax base Reason

PPE CA- Acmltd The depriciation has already been deducted for
depriciation current and prior periods

Interest Nil The related interest revenue is taxed on cash basis
receivable

Trade Full The related revenue has already been included in
receivables amount taxable profit / loss

Dividends Full Dividends are not taxable
receivable amount

Loan Full The repayment of loan will have no tax
receivable amount consequences


Tax base of Liabilities

Liabilities Tax base Reason

Accrued Nil The related revenue will deducted for tax purposes
expenses on cash basis

Advance Nil The related interest revenue is taxed on cash basis
interest
revenue
Accrued Full The related expense has already been deducted for
expenses amount tax purposes

Accrued fines Full Fines & penalties are not deductible for tax
& penalties amount purposes

Loan payable Full The repayment of loan will have no tax
amount consequences


Recognition of Current tax liability and Current tax asset

Current tax unpaid Current tax liability

Current tax paid in advance Current tax asset

Tax loss Tax asset

Tax recoverable xxx
Tax income xxx


Current Tax Accounting

Normal Calculation Mechanics
Accounting Profit XXX
Add:
Accounting Depreciation xxx
Provision for expenses xxx
In admissible expenses xxx
Less:
Tax depreciation (xxx)
Provisions settled during the year (xxx)
Exempt income (xxx)
Taxable Profit XXX
@ Tax Rate = Current Tax expense XXX


Current Tax
Illustration 1
An extract from financial records of Green Limited for its first year is given below:
Rs 000
Building-Cost 35,000
Other Fixed Assets-Cost 22,000
Product research cost 15,000
Product development cost 12,000
Profit before tax 10,000

i. Depreciation is charged on buildings and other fixed assets at the rate of 15%. The rate of
tax depreciation is 30%.
ii. Half of the research and development costs are allowable for tax purposes in the first
year. The balance amount shall be permanently disallowed.
iii. The company amortizes intangible assets over a period of three years. Current year
amortization has already been accounted for.
iv. The company’s profit is subject to tax at the rate of 35%.
v. Interest of Rs. 1.25 million was paid on a short term loan received from directors, which
is not an allowable expense under the tax laws.
vi. Profit includes a tax exempt gain of Rs 2 million on sale of shares of a listed company.
Required: Prepare journal entry for current taxation


Current Tax
Illustration 1 Rs 000

Profit Before Taxation (a) 10,000
Add:
Accounting Depreciation- Building 5,250
Accounting Depreciation- Other Fixed Assets 3,300
Research Cost 15,000
Amortization of Development cost 4,000
Interest on loan from director 1,250
(b) 28,800
Less:
Tax Depreciation- Building (10,500)
Tax Depreciation- Other Fixed Assets (6,600)
Research Cost (half) (7,500)
Development Cost (half) (6,000)
Capital gain (2,000)
(c) (32,600)
Taxable Income sum (a ,b, c) 6,200
@ 35% 2,170


Deferred Tax- Recognition

The reason that an entity is required to recognize deferred tax is because:
 A deferred tax liability will ultimately translate itself into an actual
liability by, for example, resulting in a larger tax liability in future
periods;
 The matching of items recognized in an entity’s financial statements is
consistent with the requirements of IAS 1 on the preparation of an
entity’s financial statements; and
 Ignoring deferred tax may lead to the reported profit in a period being
misinterpreted.


Deferred Tax- Recognition and Measurement


Illustration 3 Deferred Tax- Recognition


DT Recognition and Measurement- Further Issues
Revaluations
•The act of revaluing an asset will not generally result in a taxable event. However, the future recovery of the
asset (through continuing use or through disposal), will lead to taxable amounts being generated by the
entity.
•The amount that will be deductible for tax purposes, based on cost, will differ from that for accounting
purposes, based on the revalued amount.
•Consequently, the difference between the CA of a revalued asset and its tax base is a temporary difference.
•An upward revaluation of an asset will therefore give rise to a deferred tax liability.
•Most transactions creating TD relate to transactions recognized in PL, so the related deferred tax is also
recognized in PL. However, where the underlying transaction, such as a revaluation, is recognized in OCI,
the deferred tax impact is also recognized in OCI.
The expected manner of recovery of an Annual review
asset or settlement of liability
•The carrying amount of a deferred tax asset
•The measurement of deferred tax liabilities (and should be reviewed at the end of each reporting
assets) should reflect the tax consequences of how an period to ensure that it continues to be probable
entity intends to settle (and recover) the carrying that it will be recovered against future taxable
amount of its liabilities (or assets). profits.
•For example, different tax rates may apply, depending •If it is no longer probable that sufficient taxable
on whether the entity intends to use an asset to profit will be available to utilize the benefit of the
generate future benefits for the entity on an ongoing deferred tax asset, then its carrying amount
basis or to sell it. The DT amount will therefore be should be written down accordingly. If sufficient
calculated using the tax rate relevant to the entity’s profits later become available, then the amount
expected use. written down should be reversed.
Discounting
IAS 12 does not permit deferred tax assets and liabilities to be discounted


1. Current and deferred tax movements should be recognized directly in the PL for the period, except
where the tax arises from: [IAS 12.58]
 a transaction that is accounted for directly in OCI (such as a revaluation); or
Presentation and Disclosures- Current and deferred tax

 a business combination. ( in that case it adjusts the value of goodwill)
2. The tax expense or income in respect of the PL should be presented in the SCI.
3. The main components of the tax expense, or income, should be disclosed separately in the FS. The
main components of the tax expense or income may include, for example:
i. current tax expense (income);
ii. adjustments recognized in the period for current tax of prior periods;
iii. deferred tax expense (income) relating to temporary differences;
iv. an adjustment to the deferred tax expense (income) relating to changes in tax rates; and
4. Further disclosures requirements include: [IAS 12.81]
i. the amount of income tax relating to each component of OCI;
ii. a reconciliation of the tax expense (income) to the amount calculated as the accounting profit
multiplied by the tax rate. (or with percentages);
iii. the amount of any potential deferred tax asset which has not been recognized because of
uncertainties over its recoverability;
5. Deferred tax assets and liabilities should not be disclosed as part of current assets and liabilities.
Offsetting
 A CT asset and a CT liability should only be offset by an entity where it has a legally enforceable right to
set off the amounts and it intends to settle them on a net basis or to be settled simultaneously. [IAS 12.71]
 DT assets and liabilities should similarly only be offset where the entity has a legally enforceable right to
set off CT assets against CT liabilities and the DT assets and liabilities have arisen on income taxes levied
by the same taxation authority. In addition, the amounts should be in relation to the same taxable entity
or, where they have arisen in respect of different taxable entities, there should be the right to settle the
amounts on a net basis or simultaneously. [IAS 12.74]


Comprehensive Illustration
XYZ Limited submits following details to you for calculation of Current and Deferred Tax.

Accounting Profit before Tax 4,000,000

The profit has been calculated after incorporating following items

Accounting Depreciation for the year 1,000,000

Accumulated Accounting Depreciation at year end 2,000,000

Provision for warranty expenses 800,000
Following information is relevant for tax law purposes

Tax Depreciation 2,000,000

Accumulated Tax Depreciation at year end 4,000,000

Inadmissible expenses 900,000

Exempt income 200,000
Warranty cost is deductible only on paid basis
Other Information
The company first time created provision for warranty expense out of which no payment is made as yet.
The applicable tax rate for current year is 40% and was 30% last year.
The only depreciable asset of the company was acquired at a cost of Rs 5,000,000


Current Tax Calculation
Accounting Profit 4,000,000
Before Tax
Add:
Accounting depreciation 1,000,000
Provision for warranty expenses 800,000
Inadmissible expenses 900,000
Less:
Tax depreciation (2,000,000)
Exempt income (200,000)

Taxable Income 4,500,000
Current Tax @ 40% 1,800,000


Deferred Tax Calculation
Year End
Balances
Description Carrying Tax Base Temporary Type
Amount Difference
Depreciable 3,000,000 1,000,000 2,000,000 Liability
Asset
Provision for 800,000 Nil (800,000) Asset
warranty expense
Net Temporary Difference 1,200,000
Deferred Tax @ 40% 480,000 Liability

Opening Deferred Tax
1,000,000 @ 30% (300,000) Liability

Deferred Tax expense for the year 180,000


Analysis of Deferred Tax Expense for the year
EFFECT OF CHANGE IN RATES Rs.
Opening Temporary Difference 1,000,000
X X
Change in Tax Rate (40% -30%)=10% 100,000

EFFECT OF CHANGE IN TEMPORARY DIFFERENCE

Closing Tax Rate 40%
X x
Change in Temporary Differences (1,200,000- 800,000
1,000,000)=
200,000

Deferred Tax Expense for the year 180,000



Reconciliation of Expected and Actual Tax Expense
Expected Tax Expense
Accounting PBT x Tax Rate 4,000,000 x 40% 1,600,000

In admissible expenses 900,000 x 40% 3,60,000
effect
Exempt income effect 200,000 x 40% (80,000)
Effect of change in tax rate 1,000,000 x 10% 100,000

Actual Tax Expense
(Current + Deferred Tax) (1,800,000+180,000) 1,980,000


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