Income taxes basics (ias 12) - Current vs deferred tax prese...

Learning Outcomes

Upon completing this article, you will be able to explain the difference between current and deferred tax under IAS 12, identify temporary differences that create deferred tax assets and liabilities, and correctly present income tax in the financial statements. You will practise applying the principles of tax base, temporary differences, and tax charge presentation to ACCA exam scenarios.

ACCA Strategic Business Reporting (SBR) Syllabus

For ACCA Strategic Business Reporting (SBR), you are required to understand the concepts and accounting treatments relating to income taxes under IAS 12. Focus your revision on the following syllabus areas:

• The recognition and measurement of current and deferred tax assets and liabilities
• Calculation of temporary differences and understanding tax bases
• Presentation and disclosure of current tax and deferred tax in the statement of profit or loss and the statement of financial position
• Identification of situations where deferred tax is not recognised
• Treatment of deferred tax relating to revaluations, business combinations, and share-based payments

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. Which of the following gives rise to a deferred tax liability under IAS 12?
   1. Depreciation is faster for tax than for accounting purposes.
   2. Inventory write-downs are not deductible for tax until sale.
   3. An expense is disallowed for tax purposes.
   4. Customer receipts received in advance are taxed immediately but not recognised as revenue.

2. A company has an asset with a carrying amount of $6,000 and a tax base of $4,000. The tax rate is 20%. What is the deferred tax implication?

3. True or false? Deferred tax assets are always recognised for all deductible temporary differences.

4. Briefly explain the difference between current tax and deferred tax in financial statements.

Introduction

Accounting for income taxes under IAS 12 ensures that the tax impact of transactions is reported in the same period as the corresponding income or expense. Tax expense in the financial statements combines both current tax, based on taxable profit for the reporting period, and deferred tax arising from temporary differences between carrying amounts and tax bases of assets and liabilities. Understanding the distinction between current and deferred tax is essential for accurate and faithful reporting, as well as for passing the ACCA SBR exam.

Current Tax

Current tax represents the amount of income tax payable (or recoverable) in respect of taxable profits determined under tax law for the period.

Key Term: current tax
The amount of income tax expected to be paid to (or recovered from) tax authorities for the current and prior periods based on taxable profit.

The current tax amount is calculated using rates and laws enacted at the reporting date. It is recognised in the statement of profit or loss unless it relates to other comprehensive income or equity transactions, in which case it is allocated accordingly.

Presentation

Current tax is presented as a liability (or asset if there has been an overpayment) in the statement of financial position. In the statement of profit or loss, the current tax expense forms part of the total tax charge for the period.

Deferred Tax

Deferred tax adjusts for the effects of temporary differences—differences between accounting carrying amounts and their tax bases—that reverse over time.

Key Term: deferred tax
The tax expected to be paid or recovered in future periods due to temporary differences between the carrying amount of assets or liabilities and their tax base.

Key Term: temporary difference
The difference between the carrying amount of an asset or liability in the statement of financial position and its tax base.

Key Term: tax base
The amount attributed to an asset or liability for tax purposes.

Temporary differences can be:

• Taxable temporary differences: Lead to deferred tax liabilities (future taxable amounts)
• Deductible temporary differences: Lead to deferred tax assets (future tax deductions)

Common Examples

• Property, plant and equipment: If tax allowances (e.g., capital allowances) differ from accounting depreciation, this creates temporary differences.
• Revaluation gains: Recognising asset gains in accounting before tax creates deferred tax liabilities.
• Provisions: Some may be recognised for accounting but not deductible for tax until paid.
• Revenue receipts: Receipts in advance taxed immediately but not recognised in revenue may create deferred tax assets.

Recognition

Deferred tax liabilities are recognised for all taxable temporary differences, except in cases such as the initial recognition of goodwill or an asset/liability in specific transactions not affecting accounting or taxable profit. Deferred tax assets are recognised for deductible differences only when it is probable that future taxable profits will be available for offset.

Measurement and Presentation

Deferred tax is measured using rates expected to apply when the asset is realised or the liability settled, based on laws enacted by the reporting date. Deferred tax assets and liabilities are presented as non-current items in the statement of financial position.

In the profit or loss statement, deferred tax expense or income reflects the change in deferred tax assets and liabilities between opening and closing periods, adjusted for amounts charged/credited outside profit or loss (e.g., other comprehensive income).

Worked Example 1.1

A company purchases equipment for $10,000 on 1 January. Depreciation is $2,000 per year in the accounts (5-year life), while tax authorities allow a 25% annual reducing balance capital allowance. The tax rate is 30%.

Requirement: Calculate the deferred tax liability at the end of year 1.

Answer:
Carrying amount after 1 year: $8,000 ($10,000 – $2,000)
Tax base after year 1: $7,500 ($10,000 – $2,500)
Temporary difference: $500 ($8,000 – $7,500)
Deferred tax liability: $500 × 30% = $150

Worked Example 1.2

Entity writes down inventory by $1,000 for accounting purposes, but tax authorities allow deduction only when the inventory is sold. Tax rate is 25%.

Requirement: What is the deferred tax implication?

Answer:
Carrying amount: lower by $1,000 (due to the write-down)
Tax base: no deduction yet allowed—remains higher by $1,000
Temporary difference: deductible ($1,000) (accounting less than tax base)
Deferred tax asset: $1,000 × 25% = $250

Presentation of Income Taxes in the Financial Statements

The income tax expense in profit or loss includes both current and deferred tax. Both are generally presented as a single line, with notes disclosing the components.

Statement of Financial Position

• Current tax liability/asset: shown within current liabilities/assets
• Deferred tax assets and liabilities: presented as non-current

Statement of Profit or Loss

• The total income tax expense includes:
  • Current tax charge (for the period)
  • Adjustments to prior periods’ current tax
  • Deferred tax charge/credit (arising from changes in temporary differences)

Disclosure

IAS 12 requires disclosure of:

• Major components of tax expense (current/deferred)
• Reconciliation between accounting profit and tax expense
• Amounts recognised directly in other comprehensive income or equity

Exam Warning

Always analyse the tax base carefully when calculating deferred tax. The most common exam mistake is confusing the carrying amount and tax base, especially for provisions or income received in advance.

Summary

• Current tax is based on taxable profit for the period and is recognised when incurred.
• Deferred tax arises from timing differences between the accounting and tax values of assets/liabilities and is recognised for most temporary differences.
• Deferred tax ensures that tax effects are matched to the related income or expense in the financial statements.
• Both current and deferred tax are presented in the statement of profit or loss and in the statement of financial position, with detailed notes as required under IAS 12.

Key Point Checklist

This article has covered the following key knowledge points:

• Explain the difference between current tax and deferred tax
• Define and identify temporary differences and tax bases
• Recognise when to record deferred tax assets and liabilities
• Calculate current and deferred tax charges for financial statements
• Present income tax in the statement of profit or loss and financial position

Key Terms and Concepts

• current tax
• deferred tax
• temporary difference
• tax base