IAS 12, Income Tax

IAS 12 uses a liability method and adopts a balance sheet approach to accounting for taxation. It
accounts for the temporary differences between the accounting and tax bases of assets and
liabilities rather than accounting for the timing differences between the accounting and tax
consequences of revenue and expenses. IAS 12 adopts a full provision balance sheet 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 cannot be
avoided. As the IFRS recognition criteria are different from those which are normally set out in
tax law, certain income and expenditure in financial statements will not be allowed for taxation
purposes, thus causing 'temporary differences'.

A deferred tax liability or asset is recognised for the future tax consequences of past transactions
with certain exemptions. The standard assumes that each asset and liability has a value for tax
purposes and this is called a tax base. Differences between the carrying amount of an asset and
liability and its tax base are called temporary differences. The principle utilised in IAS 12 is that
an entity will settle its liabilities and recover its assets eventually over time and, at that point, the
tax consequences will crystallise. There are 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.This
means that a deferred tax liability will arise when the carrying value of the asset is greater than
its tax base, or 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 the carrying value of the
asset is less than its tax base, then a deferred tax asset may arise.