IAS 12 – BT1

Balance sheet approach and analytical check of tax expense

ABC Ltd commenced operations in 20x1. It recorded a net profit of $1,000,000 for the financial
year ended 31 December 20x2 (20x1: $800,000). The following information applies to the tax
computation.
1. Included in the net profit of 20x2 was an amount of $18,000 (20x1: $25,000) of dividend
income
from an overseas subsidiary. For tax purposes, income earned from foreign sources is taxable
only
when remitted. The dividend income of $25,000 of 20x1 was received during 20x2. Of the
dividend income of $18,000 recognized in 20x2, $10,000 remained as a receivable at year-end.
2. Included also in the net profit was tax-exempt dividend income (i.e. recipient of dividends
does
not have to pay taxes on dividend income) of $35,000 for 20x2 and $40,000 for 20x1.
3. During 20x1, ABC Ltd incurred $40,000 in developing a patent whose useful life began only
in
20x2. For accounting purposes, the development costs were capitalised as an intangible asset that
was amortized over a five-year period commencing in 20x2 (assume a full year amortization).
However, for tax purposes, the expenditures were deductible as and when incurred.
4. Depreciation on a straight line basis for 20x2 was $88,000 (20x1: $66,000). However, for tax
purposes, capital allowances amounted to $150,000 in 20x2 (20x1: $150,000). Original cost of
the
asset was $450,000.
5. Trademarks of $30,000 were capitalized during 20x1 to be amortized over a four-year period.
Assume a full year amortization for 20x1. The expenditure was disallowed for tax purposes.
6. Unrealized exchange gains of $8,000 in 20x2 (20x1: $5,000) were included in net profit.
However, they were taxed only on realization. Assume that the gains materialized within the next
financial
period.
7. Net profit included fair value gains of securities measured at fair value through profit or loss
of
$65,000 for 20x2 and $70,000 for 20x1. For tax purposes, the gains are taxed only at the point of
sale. Original cost of the investments was $1,200,000. Fair value of the investments as at 31
December 20x2 was $1,335,000 (31 December 20x1: $1,270,000).
8. Tax rate was 21% in 20x2 (20x1: 22%).
Required
1. (a) Prepare the tax computations for 20x1 and 20x2.
(b) Prepare a schedule to show the movements in cumulative temporary differences for 20x1 and
20x2 using the balance sheet liability approach (i.e. identify the tax base).
(c) Prepare a schedule to show the movements in deferred tax liability for 20x1 and 20x2.
2. Prepare journal entries to record the tax expense for 20x1 and 20x2.
3. Perform analytical checks of tax expense for 20x1 and 20x2.
1 (a) Tax Computation for ABC Ltd
(TD =  Temporary Difference; PD = Permanent Difference)
Year:
20x1 20x2
Net profit before tax $800,000 $1,000,000
Adjustments
Dividend income $(25,000) $(18,000)
Remitted $0 $33,000
TD $(25,000) $(15,000)
Exempt dividend income (PD) $(40,000) $(35,000)
Amortization of patent $0 $8,000
Deduction $(40,000) $0
TD $(40,000) $8,000
Depreciation $66,000 $88,000
Capital allowances $(200,000) $(150,000)
TD $(134,000) $(62,000)
Disallowed amortization (PD) $7,500 $7,500
Exchange gains $(5,000) $(8,000)
Realized gains $0 $5,000
TD $(5,000) $(3,000)
Fair value gains $(70,000) $(65,000)
Taxable income $543,500 $865,500
Tax rate 22% 21%
Tax payable $119,570 $181,755

1 (b) Balance sheet liability approach

Year: 20x1 20x2
Carrying amount $25,000 $10,000
Tax base $0 0
Taxable temporary difference $25,000 $10,000

Development expenditure
Carrying amount $40,000 $32,000
Tax base $0 $0
Taxable temporary difference $40,000 $32,000

Fixed asset
Carrying amount $384,000 $296,000
Tax base $300,000 $150,000
Taxable temporary difference $84,000 $146,000

Unrealized exchange gains

Carrying amount $5,000 $8,000
Tax base $0 $0
Taxable temporary difference $5,000 $8,000

Investments at fair value

Carrying amount $1,270,000 $1,335,000
Tax base $1,200,000 $1,200,000
Taxable temporary difference $70,000 $130,000

Cumulative taxable temporary differences $224,000 $331,000

Taxable temporary difference of $15,000 (20x1: $22,500) arising from trademarks are not
recognized under IAS 12 paragraph 15.

Movements in cumulative taxable temporary differences

Year 20x1 20x2

Balance, 1 January $0 $224,000

Change $224,000 $107,000
Balance, 31 December $224,000 $331,000

1 (c) Movements in deferred tax liability

Year: 20x1 20x2
Balance, 1 January $0 $49,280
Change $49,280 (tax base x tax rate) $20,230
Balance, 31 December $49,280 $69,510

Determination of tax expense

Year: 20x1 20x2
Tax payable $119,570 $181,755
 Deferral tax liability $49,280 $20,230
Tax expense $168,850 $201,985
2. Journal entries
Year: 20x1 20x2
Dr Tax expense $168,850 $201,985
Cr Deferred tax liability $49,280 $20,230
Cr Tax payable $119,570 $181,755
Being tax expense recorded for the respective years.

3. Analytical check of tax expense

Year: 20x1 20x2
Profit before tax (PBT) $800,000 $1,000,000
Permanent differences (PD) $(32,500) $(27,500)
PBT +/- PD $767,500 $972,500
Tax on PBT after PD $168,850 $204,225
Effect of change in tax rates on beginning deferred tax (Note 1) $ (2,240)
Tax expense $168,850 $201,985

Note 1: A 1% reduction in tax rate leads to a reduction in tax expense. Beginning cumulative taxable
temporary differences was $224,000. With the reduction in tax rate, future tax payable is reduced and
a write-back can be made of the beginning deferred tax liability of $2,240 (i.e. 1% * $224,000)