Company Valuation Under IFRS : Interpreting and Forecasting ...

Chapter Four – Key issues in accounting and their treatment under IFRS
3. Taxation
3.1 Why is it important?
Taxation is one of the more confusing areas of accounting. The terminology is
opaque and the numbers are often driven by rules in legislation that have little to
do with sensible economics. However, for analysts a clear understanding of
taxation is vital. Firstly, it is a core cost for all companies irrespective of the
specific sector. Secondly, there can be significant value attached to certain tax
numbers such as tax losses. It is not untypical to find a complete mistreatment of
these potentially important items in valuation models. Thirdly, tax has important
implications for the cost of capital as discussed in Chapter two.
3.2 What is current GAAP under IFRS for taxation?
3.2.1 Taxation refresher
It is very important to distinguish between the two types of tax that we see in a
typical set of financials; current taxation and deferred taxation. We shall deal with
current taxation initially prior to returning to the thorny issue of deferred
taxation.
Current taxation
During each accounting period the company must estimate how much taxation is
due on the profits that are generated in the accounting period. This is calculated as:
Profits chargeable to tax X local tax rate.
Profits chargeable to taxation are pre-tax accounting profits adjusted for tax
purposes. A typical calculation of taxable profit would be:
Profit before taxation (per the accounting income statement)
X
Add back disallowables:
• Accounting depreciation X
• Certain non-cash expenses such as general provisions X
Less allowables:
• Tax depreciation (X)
• Cash expenses (i.e the cash equivalent to the disallowed costs) (X)
Profits chargeable to tax
X
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