International Financial Reporting Standards_guide.pdf

180 Chapter 15 Income Taxes (IAS 12)
EXAMPLE 15.3
There are varying accounting rules throughout the world that govern how the income tax
expense is reported on the Statement of Comprehensive Income. IFRS requires the use of the
liability method. To illustrate the essential accounting problem posed when different
accounting methods are used to develop financial information for tax and financial reporting
purposes, consider the Engine Works Corporation. In the year just ended, Engine Works
generated earnings from operations before depreciation and income taxes of $6,000. In addition,
the company earned $100 of tax-free municipal bond interest income. Engine Works
only assets subject to depreciation are two machines, one that was purchased at the beginning
of last year for $5,000, and one that was purchased at the beginning of this year for
$10,000. Both machines are being depreciated over five-year periods. The company uses an
accelerated-consumption method to compute depreciation for income tax purposes (worth
$5,200 this year) and the straight-line method to calculate depreciation for financial reporting
(book) purposes.
EXPLANATION
1. Based on this information, Engine Works’ income tax filing and Statement of Comprehensive
Income for the current year would be as follows:
Income Tax Filing ($) Statement of Comprehensive Income ($)
Income from operations before
depreciation and income taxes
6,000 Income from operations before
depreciation and income taxes
6,000
Tax-free interest income — a Tax-free interest income 100
Depreciation—tax allowance 5,200 Depreciation 3,000 b
Taxable income 800 Pretax income 3,100
Income taxes payable (35%) 280 Income tax expense ?
a. Tax-free interest income is excluded from taxable income.
b. 1/5 $5,000 + 1/5 $10,000 = $3,000.
2. Based on the income tax filing, the income tax that is owed to the government is $280. The
question is what income tax expense should be reported in Engine Works’ Statement of
Comprehensive Income? There are two reasons why accounting profit and taxable profit can
be different: temporary and permanent differences (not a term specifically used in IFRS 12).
3. Temporary differences are those differences between accounting profit and taxable profit
for an accounting period that arise whenever the measurement of assets and liabilities for
income tax purposes differs from the measurement of assets and liabilities for IFRS purposes.
For example, if an entity uses straight-line depreciation of its assets for IFRS purposes and
accelerated depreciation for income tax purposes, the IFRS carrying amount of the assets will
differ from the tax carrying amount of those assets. For income tax purposes, tax depreciation
will be greater than IFRS depreciation in the early years and lower than IFRS depreciation in
the later years.
4. Permanent differences are those differences between IFRS accounting profit and taxable
profit that arise when income is not taxed or expenses are not tax deductible. For example,
tax-free interest income is not included in taxable income, even though it is part of IFRS
accounting profit.
5. Permanent differences affect the current accounting period’s effective income tax rate (the
ratio of the reported income tax expense to pretax income), but do not have any impact on
future income taxes. Temporary differences, on the other hand, affect the income taxes that