IAS-12 Taxation Terms Scope Need for standard Differences Permanent differences Description Accounting for income taxes

and not applicable for govt. grants. To cater for the need to adjust the variation in tax expense Temporary Differences Permanent Differences The differences that will not reverse in future i.e. exempt income or expenses not allowed under tax laws. Exempt income: I.T income of exports, capital gains, agriculture income, Expenses: fine or penalties, payments through cash exceeding prescribed limits. The difference between the carrying amount of an asset or liability in the balance sheet and its tax base. Income received in advance Prepaid expenses Accelerated depreciation/amortization Provisions Taxable differences The temporary differences that will result in taxable amounts in determining taxable profit (loss) of future periods when the carrying amount of the assets/liability is settled. It means they will result in more tax payment in future. It results in deferred tax liability. The temporary differences that will result in amounts that will be deductible in determining taxable profit /(loss) of future periods when the carrying amount of the assets/liability is settled. It results in deferred tax assets. Profit before charging of any taxes i.e. operating profit Profit/loss calculated on the basis of tax provisions/rules is termed as taxable profit. i.e. profit on which tax is paid. Tax payable or recoverable in respect of current period

Temporary Differences

Deductible differences

Accounting profit Taxable profit Current tax

Deferred tax liabilities

Amount of income tax payable in future periods in respect of taxable temporary differences

Deferred tax assets

Amount of income tax recoverable in future periods in respect of deductible temporary differences carry forward of unused tax losses carry forward of unused tax credits it means it will result in reduction in tax expenses. It comprises of current tax income/expense and deferred tax income/expense The amount attributed to an asset/liability for tax purposes. In case of permanent difference the tax base and carrying amount is equal. The tax base of an asset is the amount that would be deductable for tax purposes against any taxable economic benefits when that benefit will flow to entity. If those benefits are not taxable the tax base is equal to carrying amount. If machine has a carrying amount of 100 and related revenue is taxable. Depreciation is also allowed for tax. The tax base is 100. Interest receivable has a carrying amount of Rs. 100. the related revenue is taxed on cash basis. The tax base of interest receivable is zero. Trade receivable has carrying amount of Rs. 100. the related revenue has already been included for tax purposes the tax base of trade receivable is Rs. 100. Dividend has carrying amount of Rs. 100. dividend are not taxable, the tax base is Rs. 100 Loan receivable has a carrying amount of Rs. 100. repayment will not be taxed. The tax base is Rs.

Tax expense/income Tax base

100 When carrying amount of asset is higher than tax base it results in taxable temporary differences i.e. deferred tax liability. Tax base of liability is its carrying amount, less any amount that will be deductable for tax purposes in future The tax base of resulting liability for revenue received in advance is tax base less any amount that will not be taxed. Current liability include accrued expenses for Rs. 100 the related expense will be deductible for tax purposes on a cash basis. The tax base is nil. Current liability include revenue received in advance for Rs. 1000. the revenue will be tax on cash basis the tax base is nil. Current liability include accrued expenses for Rs. 100 the related expense has already been taxed. The tax base is 100. Fines and penalties of Rs. 1000 included in current liabilities. these are not allowed as expense the tax base is Rs. 1000. Loan payable for Rs. 100 the repayment of loan will not have any tax consequences the tax base is Rs. 100 The current tax for current and prior periods should be recognized as liability in the current period to the extent unpaid. The excess amount should be recognized as assets. The benefit relating to a tax loss that can be carried back to recover current tax of a previous period shall be recognized as an asset. Deferred tax is basically recognition of accrual of taxes. Deferred tax liability should be recognized for all taxable temporary differences except to the extent that the deferred tax liability arises from i. Initial recognition of goodwill

Current tax assets and liabilities

Recognition of deferred tax assets/liability

Business combination and goodwill Fair value of assets Initial recognition of assets/liability

Initial recognition of an asset or liability in a transaction which is neither business combination nor at the time of transaction affects accounting or taxable profits. Explain recognition of goodwill. De-recognition and recognition of taxable differences due to goodwill Additional benefits due to use or sale. If all or part is not deductible for tax purposes. e.g. asset cost Rs. 1000 depreciation is not taxable nor the capital gain or loss.

ii.

Recognition of deferred tax assets

An asset should be recognized to the extent it is probable that taxable profits would be available against which this can be utilized, unless asset arises from a transaction that: Is not a business combination and At the time of recognition affects neither accounting nor taxable profits. Examples: Product warranty cost Retirement benefit plans Research costs If same taxable profits are available against same taxable authority and taxable entity. The benefits are expected to reverse: i. In same period or ii. In periods into which a tax loss arising from deferred tax asset can be carried back. i. ii. Ignore future deductible differences Tax planning opportunities are available that will create taxable profits in future

Recognition of deferred tax

liability

Example 1 depreciable assets. An entity buys equipment for rs 10,000 and depreciates on a straight line basis over its expected useful life for five years. For tax purpose the equipment is depreciated at 25% per annum on a straight line basis. Tax losses may be carried back against tax profits of the previous five years. In year 0 the entity taxable profit was Rs 5000/the tax rate is 40%. The entity will recover carrying amount of the equipment by using it to manufacture goods for resale. Therefore the entitys current tax computation is as follows: YEAR 1 2 3 4 Taxable income 2000 2000 2000 2000 Depreciation for tax purpose 2500 2500 2500 2500 Taxable profit (losses) (500) (500) (500) Current tax expense @ 40% (200) (200) (200) The entity recognizes a current tax asset at the end of year one to four because it recovers the benefit of the tax loss against the taxable profits of year 0. Temporary difference associated with the equipment and the resulting deferred tax asset and liability and deferred tax expense and income are as follow: YEAR 1 2 3 4 5 Carrying 8000 6000 4000 2000 0 Tax base 7500 5000 2500 0 0 Taxable temporary difference 500 1000 1500 2000 0 Opening deferred tax liability 0 200 400 600 800 Deferred tax expense(income) 200 200 200 200 (800) Closing deferred tax liability 200 400 600 800 0

The entity recognizes the deferred tax liability in year 1 to 4 because the reversal of the taxable temporary difference will create taxable income in subsequent years. The entitys income statement is as follows: YEAR 1 2 3 4 5 Income 2000 2000 2000 2000 2000 Depreciation 2000 2000 2000 2000 2000 Profit before tax 0 0 0 0 0 Current tax expense (income) (200) (200) (200) (200) 800 Deferred tax expense (income) 200 200 200 200 (800) Total tax expense (income) 0 0 0 0 0 Net profit for the period. 0 0 0 0 0 Example-2 Deferred tax assets and Liabilities The example deals with an entity over the two year period , X5 X6. In x5 the enacted income tax rate was 40% of taxable profit. In x6 the enacted income tax rate was 35% of taxable profits. Charitable donations are recognized as an expense when hey are paid and are not deductible for tax purpose. In x5 the entity was notified by relevant authorities that they intent to pursue an action against the entity with respect to sulphur emissions. Although as at December x6 the action had not yet come to court the entity recognized a liability of 700 in x5 being its best estimate of the fine arising from the action. Fines are not deductible for tax purpose. In x2 the entity incurred 1,250 of cost in relation to the development of a new product. Theses costs were deducted for tax purpose in x2. For accounting purpose the entity capiatlised this expenditure and amortized it on the straight line basis over 5 years, the un amortizes balance of these products development cost was 500. In x5 the entity entered into an agreement with its existing employee to provide health care benefits to retirees. the entity recognizes as an expense the cost of this plan as employee provide service. No payment to retirees were made for such benefits. Current tax expense X5 X6

Accounting profit 8,740 Add Depreciation for accounting purposes 8,250 Charitable donations 350 Fine for environmental pollution Product development costs 250 Healthcare benefits 1,000

8,775 4,800 500 700 250 2,000

17,025 18,590 Deduct Depreciation for tax purposes (8,100) (11,850) Taxable profit 8,925 6,740 Current tax expense at 40% 3,570 Current tax expense at 35% 2,359 Carrying amounts of property, plant and equipment Cost Building Motorvehicles Total Balance at 31/12/x4 50,000 10,000 60,000 Additions X5 6,000 6,000 Balance at 31/12/X5 56,000 10,000 66,000 Elimination of accumulated depreciation on revaluation at 1/1/X6 (22,800) (22,800) Revaluation at 1/1/X6 31,800 31,800 Balance at 1/1/X6 65,000 10,000 75,000 Additions X6 15,000 15,000 65,000 25,000 90,000 Carrying amounts of property, plant and equipment

Cost Building Motorvehicles total Accumulated depreciation 5% 20% Balance at 31/12/X4 20,000 4,000 24,000 Depreciation X5 2 800 2,000 4,800 Balance at 31/12/X5 22,800 6,000 28,800 Revaluation at 1/1/X6 (22,800) (22,800) Balance at 1/1/X6 6,000 6,000 Depreciation X6 3,250 5,000 8,250 Balance at 31/12/X6 3,250 11,000 14,250 Carrying amount 31/12/X4 30,000 6,000 36,000 31/12/X5 33,200 4,000 37,200 31/12/X6 61,750 14,000 75,750 Tax base of property, plant and equipment Cost Building Motorvehicles Total Balance at 31/12/X4 50,000 10,000 60,000 Additions X5 6,000 6,000 Balance at 31/12/X5 56,000 10,000 66,000 Additions X6 15,000 15,000 Balance at 31/12/X6 56,000 25,000 81,000 Accumulated depreciation 10% 25% Balance at 31/12/X4 40,000 5,000 45,000 Depreciation X5 5,600 2,500 8,100 Balance at 31/12/X5 45,600 7,500 53,100

Depreciation X6 5,600 6,250 11,850 Balance 31/12/X6 51,200 13,750 64,950 Tax base 31/12/X4 10,000 5,000 15,000 31/12/X5 10,400 2,500 12,900 31/12/X6 4,800 11,250 16,050 Deferred tax assets, liabilities and expense at 31/12/X4 Carryingamount Taxbase Temporarydifferences Accounts receivable 500 500 Inventory 2,000 2,000 Product development costs 500 500 Investments 33,000 33,000 Property, plant & equipment 36,000 15,000 21,000 TOTAL ASSETS 72,000 50,500 21,500 Current income taxes payable 3,000 3,000 Accounts payable 500 500 Fines payable Liability for healthcare benefits Long-term debt 20,000 20,000 Deferred income taxes 8,600 8,600 TOTAL LIABILITIES 32,100 32,100 Share capital 5,000 5,000 Revaluation surplus Retained earnings 34,900 13,400 TOTAL LIABILITIES/EQUITY 72,000 50,500 TEMPORARY DIFFERENCES 21,500

Deferred tax liability 1,500 at 40% 8,600 Deferred tax asset Net deferred tax liability 8,600 Deferred tax assets, liabilities and expense at 31/12/X5 Carryingamount Taxbase Temporarydifferences Accounts receivable 500 500 Inventory 2,000 2,000 Product development costs 250 250 Investments 33,000 33,000 Property, plant & equipment 37,200 12,900 24,300 TOTAL ASSETS 72,950 48,400 24,550 Current income taxes payable 3,570 3,570 Accounts payable 500 500 Fines payable 700 700 Liability for healthcare benefits 2,000 (2,000) Long-term debt 12,475 12,475 Deferred income taxes 9,020 9,020 TOTAL LIABILITIES 28,265 26,265 (2,000) Share capital 5,000 5,000 Revaluation surplus Retained earnings 39,685 17,135 TOTAL LIABILITIES/EQUITY 72,950 48,400 TEMPORARY DIFFERENCES 22,550 Deferred tax liability 24,550 at 40% 9,820 Deferred tax asset 2,000 at 40% (800)

Net deferred tax liability 9,020 Less: Opening deferred tax liability (8,600) Deferred tax expense (income) related to the origination and reversal of temporary differences 420

Deferred tax assets, liabilities and expense at 31/12/X6 Carryingamount Taxbase temporarydifferences Accounts receivable 500 500 Inventory 2,000 2,000 Product development costs Investments 33,000 33,000 Property, plant & equipment 75,750 16,050 59,700 TOTAL ASSETS 111,250 51,550 59,700 Current income taxes payable 2,359 2,359 Accounts payable 500 500 Fines payable 700 700 Liability for healthcare benefits 3,000 (3,000) Long-term debt 12,805 12,805 Deferred income taxes 19,845 19,845 TOTAL LIABILITIES 39,209 36,209 (3,000) Share capital 5,000 5,000 Revaluation surplus 19,637 Retained earnings 47,404 10,341 TOTAL LIABILITIES/EQUITY 111,250 51,550

TEMPORARY DIFFERENCES 56,700 Deferred tax liability 59,700 at 35% 20,895 Deferred tax asset 3,000 at 35% (1,050) Net deferred tax liability 19,845 Less: Opening deferred tax liability (9,020) Adjustment to opening deferred tax liability resulting from reduction in tax rate 22,550 at 5% 1,127 Deferred tax attributable to revaluation surplus 31,800 at 35% (11,130) Deferred tax expense (income) related to the origination and reversal of temporary differences 822

Example-3 business combination: On 1 January x5 entity A acquired 100% of the shares of entity B at a cost of 600. At the acquired date, the tax base in As tax jurisdiction of As investment in B is 600.reductions in the carrying amount of goodwill are not deductible for tax purpose and the cost of goodwill is also not deductible if B were to dispose off its underlying business. Tax rate in As tax jurisdiction is 30% and tax rate in Bs tax jurisdiction is 40%. The fair value of identifiable assets acquired and liabilities assumed by A is set out in the following table, together with there tax base in Bs tax jurisdiction and the resulting temporary difference. COST OF ACQUISITION TAX BASE TEMPORARY DIFF. Property, plant and equipment 270 155 115 Accounts receivable 210 210 Inventory 174 124 50 Retirement benefit obligation (30) (30) Accounts payable (120) (120) Fair value of identifiable assets acquired 504 369 135

And liabilities assumed, excluding deferred tax. The deferred tax arising from the retirement benefits obligation is offset against the deferred tax liabilities arising from the property plant and equipment and inventory. No deduction is available ion Bs tax jurisdiction for the cost of goodwill. Therefore the taxbase of goodwill ib Bs tax jurisdiction is nil. A recognizes no deferred tax liability for the taxable temporary difference associated with the goodwill in Bs tax jurisdiction. The carrying amount in As consolidated financial statement of its investment in B is made up as follows: Fair value of identifiable ass acquired and liabilities assumed, 504 excluding deferred tax Deferred tax liability (135@ 40%) (54) Fair value of identifiable assets acquired and liabilities assumed 450 Goodwill 150 Carrying amount 600 Because at the acquisition date, the tax base in As tax jurisdiction, of As investment in B is 600, no temporary difference is associated in As tax jurisdiction with the investment. During x5, Bs equity changed as follow: At 1 January x5 450 Retained profit for x5 70 At 31 December x5 520 A recognizes a liability for any withholding tax or any other tax that it will incur on the accrued dividend receivable of 80. At 31 december x5, the carrying amount of As underlying investment in B excluding accrued dividend receivable is as follows: Net assets of B 520 Goodwill 150 Carrying amount 676 The temporary difference associated with As underlying investment is 70. This amount is equal to the cumulative retained profit since the acquisition date. If A has determined that it will not sell the investment in the foreseeable future and that B will not distribute its retained profits in the foreseeable future, no deferred tax liability is rcognized in relation to As investment in B. A disclose the amount of the temporary difference for which no deferred tax is recognized, ie 70.

If A expects to sell the investment in B or that B will distribute its retained profit in the foreseeable future, A recognizes a deferred tax liability to the extent the temporary difference is expected to reverse. The tax rate reflect the manner in which Aexpects to recover the carrying amount of its investment. A credits or charge the deferred tax to equity to the extent that the deferred tax results from foreign exchange transaction difference have been charged to credit directly to equity. A discloses separately: a) The amount of deferred tax which has been charged or credited directly to equity and b) The amount of any remaining temporary difference which is not expected to reverse in the foreseeable future and for which, therefore, no deferred tax is recognized.

Carrying amounts of property, plant and equipment Cost Building Motorvehicles total Accumulated depreciation 5% 20% Balance at 31/12/X4 20,000 4,000 24,000 Depreciation X5 2 800 2,000 4,800 Balance at 31/12/X5 22,800 6,000 28,800 Revaluation at 1/1/X6 (22,800) (22,800) Balance at 1/1/X6 6,000 6,000 Depreciation X6 3,250 5,000 8,250 Balance at 31/12/X6 3,250 11,000 14,250 Carrying amount

31/12/X4 30,000 6,000 36,000 31/12/X5 33,200 4,000 37,200 31/12/X6 61,750 14,000 75,750 Tax base of property, plant and equipment Cost Building Motorvehicles Total Balance at 31/12/X4 50,000 10,000 60,000 Additions X5 6,000 6,000 Balance at 31/12/X5 56,000 10,000 66,000 Additions X6 15,000 15,000 Balance at 31/12/X6 56,000 25,000 81,000 Accumulated depreciation 10% 25% Balance at 31/12/X4 40,000 5,000 45,000 Depreciation X5 5,600 2,500 8,100 Balance at 31/12/X5 45,600 7,500 53,100 Depreciation X6 5,600 6,250 11,850 Balance 31/12/X6 51,200 13,750 64,950 Tax base 31/12/X4 10,000 5,000 15,000 31/12/X5 10,400 2,500 12,900 31/12/X6 4,800 11,250 16,050 Deferred tax assets, liabilities and expense at 31/12/X4 Carryingamount Taxbase Temporarydifferences Accounts receivable 500 500 Inventory 2,000 2,000 Product development costs 500 500

Investments 33,000 33,000 Property, plant & equipment 36,000 15,000 21,000 TOTAL ASSETS 72,000 50,500 21,500 Current income taxes payable 3,000 3,000 Accounts payable 500 500 Fines payable Liability for healthcare benefits Long-term debt 20,000 20,000 Deferred income taxes 8,600 8,600 TOTAL LIABILITIES 32,100 32,100 Share capital 5,000 5,000 Revaluation surplus Retained earnings 34,900 13,400 TOTAL LIABILITIES/EQUITY 72,000 50,500 TEMPORARY DIFFERENCES 21,500 Deferred tax liability 1,500 at 40% 8,600 Deferred tax asset Net deferred tax liability 8,600 Deferred tax assets, liabilities and expense at 31/12/X5 Carryingamount Taxbase Temporarydifferences Accounts receivable 500 500 Inventory 2,000 2,000 Product development costs 250 250 Investments 33,000 33,000 Property, plant & equipment 37,200 12,900 24,300

TOTAL ASSETS 72,950 48,400 24,550 Current income taxes payable 3,570 3,570 Accounts payable 500 500 Fines payable 700 700 Liability for healthcare benefits 2,000 (2,000) Long-term debt 12,475 12,475 Deferred income taxes 9,020 9,020 TOTAL LIABILITIES 28,265 26,265 (2,000) Share capital 5,000 5,000 Revaluation surplus Retained earnings 39,685 17,135 TOTAL LIABILITIES/EQUITY 72,950 48,400 TEMPORARY DIFFERENCES 22,550 Deferred tax liability 24,550 at 40% 9,820 Deferred tax asset 2,000 at 40% (800) Net deferred tax liability 9,020 Less: Opening deferred tax liability (8,600) Deferred tax expense (income) related to the origination and reversal of temporary differences 420

Deferred tax assets, liabilities and expense at 31/12/X6 Carryingamount Taxbase temporarydifferences Accounts receivable 500 500 Inventory 2,000 2,000

Product development costs Investments 33,000 33,000 Property, plant & equipment 75,750 16,050 59,700 TOTAL ASSETS 111,250 51,550 59,700 Current income taxes payable 2,359 2,359 Accounts payable 500 500 Fines payable 700 700 Liability for healthcare benefits 3,000 (3,000) Long-term debt 12,805 12,805 Deferred income taxes 19,845 19,845 TOTAL LIABILITIES 39,209 36,209 (3,000) Share capital 5,000 5,000 Revaluation surplus 19,637 Retained earnings 47,404 10,341 TOTAL LIABILITIES/EQUITY 111,250 51,550 TEMPORARY DIFFERENCES 56,700 Deferred tax liability 59,700 at 35% 20,895 Deferred tax asset 3,000 at 35% (1,050) Net deferred tax liability 19,845 Less: Opening deferred tax liability (9,020) Adjustment to opening deferred tax liability resulting from reduction in tax rate 22,550 at 5% 1,127 Deferred tax attributable to revaluation surplus 31,800 at 35% (11,130) Deferred tax expense (income) related to the origination and reversal of temporary differences 822

Scheme of lecture Objective Accounting and Taxable profit Payment of current taxes Applicable and effective tax rate Differences Deferred tax assets Deferred tax liabilities Unused tax losses Unused tax credits Permanent differences Disclosures Numeric Under/over estimation of current tax Description Give two examples Example What will result in assets and what in liability. A brief discussion of permanent differences Examples Examples