IAS 12 Tax Accounting – the process 2

Calculate temporary differences

The concept of temporary differences is central to deferred tax accounting. This means that the difference will eventually reverse. Temporary may not mean short-term: it may take many years until the accruals are completely reversed.

Temporary differences arise when the carrying amount of an asset or liability differs from its tax base.

A deductible temporary difference generates a deferred tax asset

(which will reduce future payments) and a

taxable temporary difference gives rise to a deferred tax liability

(which will increase future payments).

Taxable temporary differences occur when tax is charged in a period after the accounting period suffers the expense in the financial accounts.

Taxable temporary differences arise when:

-an asset's carrying amount is greater than its tax base; or when

-a liability's carrying amount is less than its tax base.

Many taxable temporary differences arise because the transaction is recognised in different periods for tax and accounting purposes.

EXAMPLE- Deductible Temporary Difference interest revenue is included in pre-tax accounting profit on a time-apportionment basis but may be taxable on a cash basis.
	I/B	DR		CR
Cash	B	300
Interest revenue	I			100
Deferred interest revenue	B			200
Tax expense @ 24%	I	24
Deferred tax asset	B	48
Current tax liability	B			72
Receipt of cash and tax payment -period 1 Partial recognition of revenue and tax
Deferred interest revenue	B		100
Interest revenue	I			100
Tax expense @ 24%	I		24
Deferred tax asset	B			24
Interest revenue and tax expense recognition -period 2 (Same for period 3)

EXAMPLE- Taxable Temporary Difference i) interest revenue is included in pre-tax accounting profit when accrued but may be taxable on a cash basis.
	I/B	DR		CR
Interest receivable	B	700
Interest revenue	I			700
Deferred tax liability	B			168
Tax expense @ 24% (deferred tax)	I	168
Recognition of revenue and application of deferred tax- period 1
Cash	B		700
Interest receivable	I			700
Tax expense @ 24%	I		144
Cash – tax payment	B			144
Deferred tax liability	B		144
Tax expense	I			144
Receipt of cash and tax payment- period 2

EXAMPLE- Taxable Temporary Difference ii) revenue from the sale of goods is included in pre-tax accounting profit when goods are delivered, but may be included in taxable profit when cash is collected. Goods sold for 100 delivered in year 1, cash collected and taxed in year 2.
	I/B	DR	CR
Accounts receivable	B	100
Revenue	I		100
Deferred tax liability	B		24
Tax expense (deferred tax) @ 24%	I	24
Receipt of cash and tax recognition -period 1
Cash	B	100
Accounts receivable	B		100
Deferred tax liability	B	24
Current tax liability	B		24
Receipt of cash and tax liability recognition -period 2

EXAMPLE- Taxable Temporary Difference iii) accumulated accounting depreciation may differ from cumulative tax depreciation because depreciation is accelerated for tax purposes; Accounting depreciation is 100 and for tax purposes it is 150.
	I/B	DR	CR
Depreciation	I	100
Accumulated depreciation	B		100
Current tax (reduction) 150 @ 24%	B	36
Tax income	I		24
Deferred tax liability	B		12
Depreciation and higher tax credit -period 1
Depreciation	I	100
Accumulated depreciation	B		100
Current tax (reduction) 50 @ 24%	B	12
Tax income	I		24
Deferred tax liability	B	12
Depreciation and lower tax credit -period 2

EXAMPLE- Taxable Temporary Difference iv) development costs have been capitalised for accounting purposes and will be amortised to the income statement, but may have been deducted as an expense in determining taxable profit in the period in which they were incurred. Amortised over 4 years starting from the year after they were incurred.
	I/B	DR	CR
Development costs (capitalised)	B	100
Cash	B		100
Current tax (reduction) @ 24%	B	24
Deferred tax liability	B		24
Development costs capitalised but allowed for tax credit -period 1
Depreciation – development costs	I	25
Accumulated depreciation	B		25
Deferred tax liability	B	6
Tax income @ 24%	I		6
Depreciation and adjustment for tax -period 2

EXAMPLE- Taxable Temporary Difference v) prepaid expenses for accounting purposes may have been deducted on a cash basis in determining the taxable profit.
	I/B	DR	CR
Cash	B		100
Prepaid expenses	B	100
Current tax (reduction) @ 24%	B	24
Deferred tax liability	B		24
Payment of cash and tax credit -period 1
Expense	I	100
Prepaid expenses	B		100
Deferred tax liability	B	24
Tax income (deferred tax)  @ 24%	I		24
Cost and tax income recognition -period 2

The tax laws of the undertaking's operations will determine the temporary differences.

Deductible temporary differences occur when tax is charged in a period after the accounting period suffered the expense in the financial accounts.

Deductible temporary differences arise when:

-an asset's carrying amount is less than its tax base; or when

-a liability's carrying amount is greater than its tax base.

Like taxable temporary differences, many deductible temporary differences arise from differences in the timing of recording the underlying transaction for accounting and tax purposes.

Deductible temporary differences examples:

EXAMPLE- Deductible Temporary Difference i) accumulated depreciation differs from cumulative tax depreciation as depreciation may be accelerated for accounting purposes. Accumulated depreciation is 150 but cumulative tax depreciation is 100.
	I/B	DR	CR
Depreciation	I	100
Accumulated depreciation	B		100
Current tax (reduction) 50 @ 24%	B	12
Tax income	I		24
Deferred tax asset	B	12
Depreciation and lower tax credit -period 1
Depreciation	I	100
Accumulated depreciation	B		100
Current tax (reduction) 150 @ 24%	B	36
Tax income	I		24
Deferred tax asset	B		12
Depreciation and higher tax credit -period 2

EXAMPLE- Deductible Temporary Difference ii) employee expenses, or pension payments, are recorded when incurred for accounting purposes and but only for tax purposes when paid in cash.
	I/B	DR	CR
Pension expense	I	100
Accrual	B		100
Deferred tax asset	B	24
Tax income (deferred tax) @ 24%	I		24
Accrual of pension costs
Cash	B		100
Accrual	B	100
Current tax (reduction) @ 24%	B	24
Deferred tax asset	B		24
Cost and tax income recognition -period 2

EXAMPLE- Deductible Temporary Difference iii) an impairment loss recorded for accounting purposes will not affect the current tax liability until disposal of the property.
	I/B	DR	CR
Impairment of property	I	10m
Accumulated depreciation of property	B		10m
Tax income (deferred tax) @ 24%	I		2,4m
Deferred tax asset	B	2,4m
Recording impairment charge and (deferred) tax charge

EXAMPLE- Deductible Temporary Difference iv) research costs are expensed in the period for accounting purposes, but may only be deducted in a later period for tax purposes.
	I/B	DR	CR
Research cost	I	10m
Cash	B		10m
Tax income (deferred tax) @ 24%	I		2,4m
Deferred tax asset	B	2,4m
Research cost and deferred tax asset -period 1
Current tax liability (reduction)	B	2,4m
Deferred tax asset	B		2,4m
Tax income -later period

EXAMPLE- Deductible Temporary Difference v) the recognition of income is deferred for accounting purposes, but may be included in taxable profit in the current period.
	I/B	DR	CR
Cash	B	500
Deferred revenue	B		500
Deferred tax asset @ 24%	B	120
Current tax liability	B		120
Receipt of cash and tax payment -period 1
Deferred revenue	B	500
Revenue	I		500
Tax expense (deferred tax) @ 24%	I	120
Deferred tax asset	B		120
Revenue and tax expense recognition -period 2