CHAPTER FIVE

5. DEFFERED TAX

Overview
 IAS 12 requires a mechanistic approach to the calculation of deferred
tax.
 The following flowchart summarises the steps necessary in
calculating a deferred tax balance in accordance with IAS 12.
• Flow Chart
Step 1
Establishing the accounting base of the
asset or liability

Step 2
Calculate the tax base of the asset or
liability

If there is no difference between tax

and accounting base, no deferred tax is
required. Otherwise go to step 3.

Step 3
Identify and calculate any exempt
temporary differences

Step 4
Identify the relevant tax rate and apply this
to calculate deferred tax

Step 5
Calculate the amount of any deferred tax
asset that can be recognised

Step 6
Determine whether to offset deferred tax
assets and liabilities
What is the accounting base?
The accounting base of an asset or liability is simply the carrying amount of that
asset or liability in the statement of financial position.
IAS 12 requires the calculation of deferred tax to take into account the expected
manner of recovery or settlement of assets and liabilities.
5.2 What is the tax base of an asset?
The tax base of an asset ‘is 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.
If those economic benefits will not be taxable, the tax base of the asset is equal to
its carrying amount’ (IAS 12.7).
What is the tax base of a liability?
The tax base of a liability is defined as: ‘its carrying amount, less any amount that
will be deductible for tax purposes in respect of that liability in future periods.
In the case of revenue which is received in advance, the tax base of the resulting
liability is its carrying amount, less any amount of the revenue that will not be
taxable in future periods’ (IAS 12.8).
Tax base of a revalued asset that is not depreciated
When an asset is revalued under IAS 16 ‘Property, Plant and Equipment’ and that
asset is non-depreciable, the carrying amount of that asset will not be recovered
through use.
Therefore the tax base and tax rate will be those applicable to the sale of that
asset.
5.3 What is a temporary difference?
A taxable temporary difference is described in IAS 12.5 as:
‘…temporary differences that will result in taxable amounts in determining taxable profit (tax
loss) of future periods when the carrying amount of the asset or liability is recovered or settled’
Example 3a – a taxable temporary difference: Company A holds an item of property, plant
and equipment which has a carrying value of birr 7,000 and a tax base of birr 4,000 at the
reporting date. There is a temporary difference of birr 3,000. As the carrying value of the asset
is higher than the deductions that will be available in the future, this is, therefore, a taxable
temporary difference
Example 3b – a deductible temporary difference: Company A contributes to a defined
contribution pension scheme. At the year end Company A has recognised an accrual of birr
5,000. In the country where Company A is domiciled, contributions to the scheme are taxed on
a cash basis, the tax base of this liability is nil and there is a temporary difference of birr 5,000.
As a tax deduction will be available in the future when these contributions are paid to the
scheme, this is a deductible temporary difference.
Exempt temporary differences

IAS 12 prohibits the recognition of deferred tax on certain temporary differences.

The following explains which temporary differences are exempt under the
standard:
Taxable temporary differences
IAS 12.15 prohibits the recognition of deferred tax on taxable temporary
differences that arise from:
 the initial recognition of goodwill or
 the initial recognition of an asset or liability in a transaction which:
▪ is not a business combination and
▪ at the time of the transaction, affects neither accounting profit nor taxable
profit (tax loss).
Deductible temporary differences

IAS 12.24 prohibits the recognition of a deferred tax asset if that asset arises from the
initial recognition of an asset or liability in a transaction that:
 is not a business combination and
 at the time of the transaction, affects neither accounting profit nor taxable profit (tax
loss).
Example 5 – exempt deductible temporary difference
Company A purchases an item of property, plant and equipment for birr 100,000. Tax
deductions of birr 150,000 will be available for that asset in accordance with the tax
legislation in the country where Company A is domiciled. There is therefore a deductible
temporary difference of birr 50,000. As this temporary difference arose on the initial
recognition of an asset, that was not acquired as part of a business combination, no
deferred tax should be recognised.
5.4 Calculation of deferred tax
Identification of the appropriate tax rate
Some of the factors to be considered include:
 the legal and related processes in the jurisdiction for the enactment of any changes in tax law
 the status of proposed tax changes and the extent of the remaining procedures to be
performed and
 whether those remaining procedures are administrative or ceremonial formalities which can
be perfunctorily performed.
5.5 Recognition of deferred tax assets
IAS 12.28 states that it is probable that taxable profit will be available against which a deductible
temporary difference can be utilised when there are sufficient taxable temporary differences
relating to the same taxation authority and the same taxable entity which are expected to reverse:
 in the same period as the expected reversal of the deductible temporary difference or
 in periods into which a tax loss arising from the deferred tax asset can be carried back or
forward.
Recognition of deferred tax assets---
Example 9a – timing of reversal
At 31 December 20X1, Company A has deductible temporary differences of birr
45,000 which are expected to reverse in the next year. Company A also has
taxable temporary differences of birr 50,000 relating to the same taxable
Company and the same tax authority. Company A expects birr 30,000 of those
taxable temporary differences to reverse in the next year and the remaining birr
20,000 to reverse in the year after.
Company A must therefore recognise a deferred tax liability for the birr 50,000
taxable temporary differences. Separately, as birr 30,000 of these taxable
temporary differences are expected to reverse in the year in which the deductible
temporary differences reverse, Company A can also recognise a deferred tax asset
for birr 30,000 of the deductible temporary differences.
5.6 Offsetting of deferred tax assets and liabilities

Deferred tax assets and liabilities are required to be offset only in certain restricted scenarios.
Deferred tax assets and liabilities must be recognised gross in the statement of financial position
unless:
 the entity has a legally enforceable right to set off current tax assets against current tax liabilities and
 the deferred tax assets and the deferred tax liabilities relate to income taxes levied by the same
taxation authority on either:
the same taxable entity or different taxable entities which intend either to settle current tax liabilities and assets on a net basis,
or to realise the assets and settle the liabilities

The deferred tax charge or credit for the year can arise from a number of sources and therefore
may need to be allocated to:
 continuing operations within profit or loss,
 discontinued operations within profit or loss,
 other comprehensive income (OCI) or equity ,
 Goodwill in order to comply with this basic principle.
5.7 Disclosures

IAS 12 contains a number of disclosure requirements.

These disclosures include:
 details of the components of the current and deferred tax charge
 a reconciliation of the total tax charge to the profit multiplied by the applicable tax rate
 details of the temporary differences forming the deferred tax asset or liability
 details of any un provided deferred tax.

Additional disclosures in respect of business combinations

The following disclosures are required in the specific situations mentioned
below:
 if a business combination causes a change in the amount recognised for the acquirer’s
 if the deferred tax benefits acquired in a business combination are not recognised at the
acquisition date but are recognised after the acquisition date,
Definition of an income tax
The scope of IAS 12 is limited to income taxes.
This is defined in IAS 12.2 as follows: ‘For the purposes of this standard,
income taxes include all domestic and foreign taxes which are based on taxable
profits. Income taxes also include taxes, such as withholding taxes, which are
payable by a subsidiary, associate or joint arrangement on distributions to the
reporting entity.’
The following definitions are drawn from the definition in IAS12
Term Description

Accounting profit Accounting profit is the profit or loss for a period before deducting tax expense.
Current tax Current tax is the amount of income taxes payable (recoverable) in respect of the
taxable profit (tax loss) for a period.
Deductible temporary
Deductible temporary differences are temporary differences that will result in
difference
amounts that are deductible in determining taxable profit (tax loss) of future periods
when the carrying amount of the asset or liability is recovered or settled.
Deferred tax liabilities Deferred tax liabilities are the amounts of income taxes payable in future periods in
respect of taxable temporary differences.
Deferred tax assets
Deferred tax assets are the amounts of income taxes recoverable in future periods in
respect of:
• deductible temporary differences
• the carry forward of unused tax losses and
• the carry forward of unused tax credits.

Tax base The tax base of an asset or liability is the amount attributed to that asset or liability
for tax purposes.
Conti--
Tax base of an asset
The tax base of an asset is 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. If those economic benefits will not be taxable, the tax
base of the asset is equal to its carrying amount.
Tax base of a liability
The tax base of a liability is its carrying amount, less any amount that will be deductible
for tax purposes in respect of that liability in future periods. In the case of revenue which
is received in advance, the tax base of the resulting liability is its carrying amount, less
any amount of the revenue that will not be taxable in future periods.
Tax expense (tax income) Tax expense (tax income) is the aggregate amount included in the determination of profit
or loss for the period in respect of current and deferred tax.
Taxable profit (tax loss) Taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with
the rules established by the taxation authorities, upon which income taxes are payable
(recoverable).
Taxable temporary Taxable temporary differences are temporary differences that will result in taxable
differences amounts in determining taxable profit (tax loss) of future periods when the carrying
amount of the asset or liability is recovered or settled.

Temporary difference
A temporary difference is a difference between the carrying amount of an asset or
liability in the statement of financial position and its tax base. Temporary differences may
THE END