Accounting for Taxes (IAS 12)

Applicable Standard

  • IAS 12: Income Taxes

Basics of Current Tax and Deferred Tax

Current Tax

  • Difference between Tax Expense in Income Statement and Tax Payable on Balance Sheet
    • The Tax Payable (Balance Sheet account) shows the provision made by the company for taxes, and is estimated based on the year’s profit. The actual cash tax charge is finalized by the tax authorities later.
    • The tax charge on the Income Statement captures the aggregate change in the Tax Payable and Deferred Tax (both Balance Sheet accounts) from one period to the next.
  • Accounting entries
    • Dr Taxes (Income Statement)
    • Cr Tax Payable (Balance Sheet)
  • Recognition in OCI
    • If the gain or loss being taxed was recognised in OCI, the taxes should also be recognised in OCI.

Deferred Tax

  • Deferred Tax adjusts for temporary differences (e.g. timing differences of accounting depreciation vs. tax capital allowance), but not for permanent differences (e.g. business entertainment is deductible for accounting purposes but not for tax purposes)
  • Calculation of Deferred Tax (Full Provision Method)
    • Temporary difference = Carrying value – Tax base
      • Carrying value of assets and income are positive, for liabilities and expenses are negative.
      • There is no temporary difference that arises for the “deferred tax” account.
    • For Non-Current Assets
      • Tax base (a.k.a tax written down value) = Cost – Cumulative Capital Allowances
      • Carrying value = Cost – Depreciation
    • Temporary difference > 0
      • Taxable temporary difference
      • Deferred Tax Liability (DTL) = Tax rate * Temporary difference
    • Temporary difference < 0
      • Deductible temporary difference
      • Deferred Tax Asset (DTA) = Tax rate * Temporary difference
    • The Tax Rate used is the tax rate expected to apply in the period when the temporary difference is realised (stipulated by current regulations, not subjective expectations). This is known as the Liability Method.
    • The way to figure out whether something is a taxable or deductible temporary difference is to think whether the entity will need to pay more or less cash taxes in the future due to the timing difference. Most of the time, if you pay less tax now,  you end up needing to pay more tax later on. More cash taxes later mean a liability (i.e. taxable), less mean an asset (i.e. deductible).
  • Accounting entries
    • Dr Taxes (Income Statement)
    • Cr Deferred Tax Liability (Balance Sheet)
  • Recognition in OCI
    • If the gain or loss being taxed was recognised in OCI, the taxes should also be recognised in OCI.
  • Deferred tax asset / liability is not allowed to be discounted to present value because it is too difficult to forecast to be reliable.

Tax Base

  • If an item is not taxed, or not tax deductible, its tax base is equal to its carrying value, so that no temporary differences will arise.
  • E.g. impairment of goodwill is not tax deductible, and does not create a temporary difference.

Taxable Temporary Differences (Deferred Tax Liability)


  • A deferred tax liability should be recognised for all taxable temporary differences except for
    • Initial recognition of goodwill
    • Initial recognition of a transaction that neither affects accounting nor tax profits.

Common Scenarios that Result in Deferred Tax Liability

  • Accrual Income/Expense vs. Actual Cash Flow
    • Interest receivable are accrued and posted to P&L as income, but only taxed when received.
    • Development cost may be capitalised and amortised, reducing future accounting profits, but tax relief was given when the costs were first incurred.
  • Revaluations
    • Tax base is typically unchanged even though an asset is revalued. The gain in value is taxed when the asset is disposed.
    • Since revaluation is recognised in OCI, any tax effects are also recognised in OCI (e.g. increase in deferred tax liability due to increase in carrying value). This impact will flow from OCI to the revaluation reserve, lowering the reserve (in the case of upwards revaluation).
    • Initial accounting entries
      • Dr Non-Current Asset with (Revalued amount – original cost)
      • Dr Accumulated Depreciation with (accumulated deprecation for the revalued asset)
      • Cr OCI (Revaluation Surplus) with (Revalued amount – carrying value)
      • Cr Deferred Tax Liability with (increase in deferred tax liability)
      • Dr OCI (Revaluation Surplus) with (increase in deferred tax liability)
    • Subsequent accounting entries (for transfer from revaluation reserve to retained earnings)
      • Cr Retained Earnings with (excess depreciation due to revaluation)
      • Dr Revaluation Surplus with (excess depreciation due to revaluation)
      • Dr Deferred Tax Liability with (decrease in deferred tax liability)
      • Cr OCI (Revaluation Surplus) with (decrease in deferred tax liability)
      • Hence eventually Revaluation Surplus decreases by (excess depreciation due to revaluation – decrease in deferred tax liability)
    • Note that any increase in deferred tax liability due to the difference between depreciation and capital allowance is still captured in P&L.
    • At disposal, remaining balances on both revaluation surplus and deferred tax are transferred to retained earnings.

Deductible Temporary Differences (Deferred Tax Asset)


  • Recognised only to the extent that it is probable that
    • The temporary difference will reverse in the foreseeable future; and
    • Taxable profit will be available against which the temporary difference can be utilised.
  • Deferred tax asset is also recognised for unused tax losses and unused tax credits that are being carried forward.

Common Scenarios that Result in Deferred Tax Asset

  • Retirement benefit costs
    • Expensed in P&L based on accrual concept but are only tax deductible when cash benefits are paid out.
  • Share-based payments
    • FV of share options are expensed to P&L over vesting period, but the tax deduction only occurs when the options are exercised.
    • Computation
      • The Tax Base is similar to the usual computation for Carrying Value of the Share-based Payment Reserve, but with the FV at grant date substituted with the Intrinsic Value of the options at each reporting date.
      • The Carrying Value is 0 for deferred tax computation purposes, as the Tax Base will be fully tax deductible.
      • Hence Deferred Tax Asset = Tax Rate * [Expected number of instruments that will vest * Intrinsic value at Reporting Date * (Reporting Date – Grant Date) / (Vesting Date – Grant Date)]
      • Note that at the Exercise Date, the tax receivable will indeed be the tax rate * intrinsic value of all vested options. The FV at grant date does not come into the picture.
    • Recognition
      • If the estimated/actual tax deduction (i.e. the tax base) <= cumulative recognised P&L expense, the change in deferred tax asset is recognised in P&L.
      • If the estimated/actual tax deduction (i.e. the tax base) > cumulative recognised P&L expense, the excess tax benefits are recognised in OCI, flowing through to a separate equity reserve.

Deferred Tax in Business Combinations

Initial Goodwill

  • No recognition of DTL on goodwill or the subsequent impairment of this goodwill.

Adjustment of Goodwill and Recognition of DTL/DTA

  1. Revaluation of assets/liabilities
    • Carrying value of assets and liabilities are adjusted to FV after a business combination but the tax base remains unchanged.
    • Calculate the total temporary differences at consolidation and adjust the deferred tax account (there may already be some existing).
    • Any recognition of a DTL will reduce the fair value of net assets acquired, which in turn increases the goodwill by the same amount. This DTL is not expensed in P&L.
  2. Recognition of Parent’s DTA
    • Parent company may have an unrecognised DTA because it has no taxable profits to use against.
    • If the DTA can be used against the Sub’s taxable profits, the Parent will recognise the DTA, which in turn decreases the goodwill.
    • Goodwill = Cost of investment – (Shares of net assets acquired + DTA recognised).

Undistributed Profits of Group Companies

  • How DTL Arises
    • Tax base is the original cost of investment
    • Carrying value increases by the group’s share of profits over time
  • The temporary difference is reversed when the investment pays out its profits as dividends, which would reduce the carrying value of the investment.
  • An entity should recognise a DTL for the above unless both conditions are satisfied
    • Entity is able to control the timing of the reversal of the temporary difference; and
    • It is probable that the temporary difference will not reverse in the foreseeable future.
  • Hence a DTL can be not recognised for Subs and JV’s (>50% ownership), but not for Associates.

Unrealised Profits in Intra-Group Trading

  • How DTA Arises
    • For intra-group trading with inventory still held in the group, the unrealised profit is eliminated for accounting purposes, but still remains for tax purposes.
    • Hence more cash tax is paid now relative to accounting tax (but less cash tax is to be paid later relatively). This creates a DTA.
  • DTA = Eliminated URP * buyer’s tax rate
  • Note that the Current Tax provision (Balance Sheet Liability) of the seller in its separate financial statements would have included the tax provision for the URP. This needs to be eliminated during consolidation, while recognising a DTA calculated as above.


Offsetting DTL and DTA

  • DTL and DTA of the same tax jurisdiction can be offsetted.
  • If the net result is a DTA however, it can only be recognised if it is probable that it will be recovered in the foreseable future.

Current Tax and Deferred Tax

  • DTL and DTA are classified under non-current in the Balance Sheet.
  • Current tax asset and current tax liability can only be offsetted if there is a legal right to do so with the same tax authority.

Should Deferred Tax Liability Count Towards Invested Capital in Investments Analysis? [my thoughts]

  • The question here is whether or not the deferred tax liability is a real liability that needs to be paid, or a liability that can be held indefinitely without being paid.
  • If a company that keeps on investing in fixed assets for example, and generates new deferred tax liability faster than the previous temporary differences are reversed, then the company will end up with a (growing) deferred tax liability balance that will never need to be paid. In such a situation, deferred tax liability should be subtracted from Invested Capital (similar to non-interest-bearing current liabilities) so that the investor is actually investing less capital.
  • Whereas if the company in question has a history of realising deferred tax liabilities, then they should not be subtracted from Invested Capital, so those liabilities form part of the capital that an investor needs to place in the company.




4 thoughts on “Accounting for Taxes (IAS 12)

  1. Hi.. I would like to ask, the provision for annual leave is a temporary or permanent difference.?

    Posted by sam | May 6, 2016, 4:20 am


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