Company Valuation Under IFRS : Interpreting and Forecasting ...

Chapter Four – Key issues in accounting and their treatment under IFRS
company has essentially crystallised a tax liability by earning profits but while
the profit has been recognised, the associated taxation liability has not.
We can use deferred taxation to make appropriate adjustments to overcome these
problems. As can be seen from the discussion of post deferred taxation balance
sheets below, we have adjusted the taxation charge to reflect the tax cost of
earning the royalty income in the first year. This transfers the taxation cost to the
year when the income is recognised in the income statement. In addition this also
achieves proper recognition of liabilities as we have a tax liability (deferred tax
provision) on the balance sheet. This provision is then paid in the second year as
the tax moves from being deferred to being current.
A simple way to calculate the required adjustment is to calculate the timing
difference and apply the relevant tax rate to it. So for example in the first year the
originating timing difference is £50,000. At a tax rate of 30 per cent this gives
rise to a deferred taxation adjustment of £15,000. A similar but reversing entry
takes place in year 2.
The entries are:
• Year 1: Increase tax cost and increase deferred tax provision by £15,000
• Year 2: Decrease tax cost and decrease provision for deferred taxation by
£15,000
3.2.3 Balance sheet focus
It is important to note that IFRS, in this case IAS 12, actually uses a balance sheet
approach to deferred taxation. This means that IFRS use a concept known as
temporary differences, rather than the conceptually much more straightforward
timing differences. Temporary differences arise where the tax value of an
asset/liability is different from the accounting value. In many cases this will
provide the same answer as timing differences; it is just a difference in emphasis.
However, it does mean that more differences relating to deferred taxation will
arise than under a timing difference system. For example, revaluations of fixed
assets must be reflected in deferred taxation under IAS 12 as the tax base of the
asset will not reflect the revaluation whereas the accounting value for
depreciation purposes will do so.
3.2.4 Advanced example
Exhibit 4.11 below is more difficult. Here we can see that the temporary
differences (note we shall use this term from now on rather than timing
differences) arise from the difference between the tax and accounting bases for
this asset. In reality this will reflect the difference between accounting
depreciation and tax depreciation.
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