Question

Identify and explain the four steps required in order to calculate deferred tax. [8 marks]

Answer 1

Calculate tax bases

Standard IAS 12 on Income taxes defines a tax base:

• Of an asset: as the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset; and
• Of a liability: as its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods.

• Machinery: ABC can deduct 25 000 CU for of machinery’s cost for tax purposes (25% of 100 000). How much of machinery’s cost remains for future tax deductions? It is machinery’s cost of 100 000 less amount already deducted in the current (and previous) periods of 25 000. Therefore, machinery’s tax base is 75 000.

  Health care liabilities: The expense of 6 000 for creating the provision for health care benefits will be deductible in the future, when the benefits are paid. As it is a liability, its tax base is calculated as liability’s carrying amount of 6 000 less any amount tax deductible in the future – full 6 000 CU. Therefore, liability’s tax base is 0.

Calculate deferred tax asset or deferred tax liability

In the last column of the table, ABC can calculate its deferred tax asset or liability. As the taxable temporary differences give rise to deferred tax liabilities, those are all negative amounts. In ABC’s case, it relates only to machinery.

On the other hand, all deductible temporary differences give rise to deferred tax assets – all positive amounts in this case. In ABC’s case, it relates to health care liabilities.

The net deferred tax position of ABC as at 31 December of Year 1 is deferred tax asset of 200 CU.

Revise other items outside the statement of financial position

• Tax losses from previous years that could be deducted from current or future years’ taxable profit
• Certain expenses paid in the previous periods but tax deductible only when some conditions are met. For example, research expenses might have been paid years ago, but they might be tax deductible only after full research and development is completed.

Add up and make up an accounting entry

ABC can add up net deferred tax asset of 200 CU resulting from all temporary differences and deferred tax asset of 10 000 CU resulting from tax loss carried forward.

If all conditions for recognition of deferred tax are met, then ABC’s deferred tax asset shown in the statement of financial position is 10 200 CU.

Your own deferred tax calculation will depend on the specific transactions you might have in your company. Also, you need to make your calculation in line with all the rules set in IAS 12.

When you follow this systematic approach, your success rate will dramatically go up.