IAS 12 : Deferred Tax – basic idea 2

EXAMPLE - the cash is received and taxed in year 1, but the income is split between years 1, 2 and 3. This might occur when an advance payment is received for a long-term contract.
	Year 1	Year 2		Year 3
Income	200	200		200
Tax expense @ 24%	-144	0		0
Net profit	56	200		200
The income is the same for each year, but the net profit changes due to the tax payment. The income in years 2 & 3 is taxed in the first year. Deferred tax is used to apportion the tax charge to match the income:
	Year 1		Year 2	Year 3
Income	200		200	200
Tax expense @ 24%	-144		0	0
Deferred tax @ 24%	+96		-48	-48
Net profit	152		152	152
The total tax charge for year 1 will be 48 (144 minus 96), so the Income Statement for each year will be the same. The deferred tax reduces the tax charge in year 1, but increases it in years 2 & 3.

EXAMPLE -expenses attract tax credits (‘tax income’). If a transaction takes place in year 1 and tax is credited in year 2, year 1 will show a transaction without a tax credit, and year 2 will show a tax credit without a transaction:
	Year 1	Year 2
Expense	-100	0
Tax income @ 24%	0	+24
Net profit	-100	+24
The tax income, or benefit of paying less tax due to the expense, is a direct result of the expense in period 1. Readers of financial statements should be made aware that tax will be credited in the following year. Deferred tax is used to accrue future tax credits generated by transactions in the current year.
	Year 1	Year 2
Expense	-100	0
Tax income @ 24%	0	+24
Deferred tax @ 24%	+24	-24
Net profit	-76	0
On the balance sheet, this deferred tax would be shown as an asset at the end of period 1. It will disappear at the end of period 2 by being reversed.

EXAMPLE- tax is credited on payment of the money in period 1, but only treated as an expense in period 2.
	Year 1	Year 2
Expense	0	-100
Tax income @ 24%	+24	0
Net profit	+24	-100
In year 1 there is a tax credit without a transaction. In year 2 there is a transaction without a tax credit. The tax will be shown as a prepayment. Again, we use deferred tax to link the transaction to the tax credit.
	Year 1	Year 2
Expense	0	-100
Tax income @ 24%	+24	0
Deferred tax @ 24%	-24	+24
Net profit	0	-76
In this case, it accrues a tax credit in year 1 to carry forward the tax paid to period 2 to link with the timing of the transaction. It is reversed in year 2.

EXAMPLE- an advance payment on a construction contract. The cash is paid and credited for tax in year 1, but the expense is split between years 1, 2 and 3.
	Year 1	Year 2		Year 3
Expense	-200	-200		-200
Tax income @ 24%	+144	0		0
Net profit	-56	-200		-200
The expense is the same for each year, but the net profit changes due to the tax credit. The expense in years 2 & 3 is credited for tax in the first year. Deferred tax is used to apportion the tax credit by accrual to match the expense:
	Year 1		Year 2	Year 3
Expense	-200		-200	-200
Tax income @ 24%	144		0	0
Deferred tax @ 24%	-96		+48	+48
Net profit	-152		-152	-152
The total tax credit for year 1 will be 48 (144 minus 96), so the Income Statement for each year will be the same, matching the economic reality. The deferred tax reduces the tax credit in year 1, but increases it in years 2 & 3.