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The Standard Applies to the Accounting for Income Taxes
Chapter 9
INCOME TAXES (IAS 12)
BACKGROUND AND INTRODUCTION
IAS 12 uses a liability method and adopts a statement of financial position approach. Instead of accounting for the timing differences between the accounting and
tax consequences of revenue and expenses, it accounts for the temporary differences between the accounting and tax bases of assets and liabilities. The Accounting
Standard adopts a full-provision statement of financial position approach to accounting for tax.
It is assumed that the recovery of all assets and the settlement of all liabilities have tax consequences and that these consequences can be estimated reliably and are
unavoidable.
The main reason why deferred tax has to be provided for is that International Financial Reporting Standards (IFRS) recognition criteria are different from those that
are normally set out in tax law. Thus there will be income and expenditure in financial statements that will not be allowed for taxation purposes in many jurisdictions.
A deferred tax liability or asset is recognized for future tax consequences of past transactions. There are some exemptions to this general rule.
DEFINITIONS OF KEY TERMS
Tax base. Value that the Standard assumes that each asset and liability has for tax purposes.
Temporary differences. Differences between the carrying amount of an asset and liability and its tax base.
The belief is that an entity will settle its liabilities and recover its assets eventually over time and at that point the tax consequences will crystallize. For
example, if a machine has a carrying value in the financial statements of $5 million and its tax value is $2 million, then there is a taxable temporary difference
of $3 million.
The tax base of a liability is normally its carrying amount less amounts that will be deductible for tax in the future. The tax base of an asset is the amount that
will be deductible for tax purposes against future profits generated by the asset.
The Standard sets out two kinds of temporary differences: a taxable temporary difference and a deductible temporary difference.
A taxable temporary difference results in the payment of tax when the carrying amount of the asset or liability is settled.
In simple terms, this means that a deferred tax liability will arise when the carrying value of the asset is greater than its tax base or when the carrying value of
the liability is less than its tax base.
Deductible temporary differences are differences that result in amounts being deductible in determining taxable profit or loss in future periods when the
carrying value of the asset or liability is recovered or settled. When the carrying value of the liability is greater than its tax base or when the carrying value of
the asset is less than its tax base, a deferred tax asset may arise.
Facts
This means, for example, that when an accrued liability is paid in future periods, part or all of that payment may become allowable for tax purposes.
CASE STUDY 1
An entity has the following assets and liabilities recorded in its statement of financial position at December 31, 20X9:
Carrying value $ million
Property 10
Plant and equipment 5
Inventory 4
Trade receivables 3
Trade payables 6
Cash 2