Income Taxes

IAS 12
Introduction

The objective of this Standard is to prescribe the accounting treatment for income taxes. The
principal issue in accounting for income taxes is how to account for the current and future tax
consequences of:

(a) the future recovery (settlement) of the carrying amount of assets (liabilities) that are
recognized in an entity’s statement of financial position; and

(b) transactions and other events of the current period that are recognized in an entity’s
financial statements.

It is inherent in the recognition of an asset or liability that the reporting entity expects to recover
or settle the carrying amount of that asset or liability. If it is probable that recovery or settlement
of that carrying amount will make future tax payments larger (smaller) than they would be if
such recovery or settlement were to have no tax consequences, this Standard requires an entity to
recognize a deferred tax liability (deferred tax asset), with certain limited exceptions.

Key Terms and Definitions

Current Tax Current tax is the amount of income taxes payable (recoverable) in respect
of the taxable profit (tax loss) for a period.

Deferred Tax Deferred tax assets are the amounts of income taxes recoverable in future
periods in respect of:
• deductible temporary differences
• the carry forward of unused tax losses
• the carry forward of unused tax credits. Deferred tax liabilities
are the amounts of income taxes payable in future periods in respect of
taxable temporary differences.
Tax base Tax base of an asset or liability is the amount attributed to that asset or
liability for tax purposes.

Tax expense Tax expense (tax income) is the aggregate amount included in the
(tax income) determination of profit or loss for the period in respect of current tax and
deferred tax.

Temporary Temporary difference is a difference between the carrying amount of an

difference asset or liability in the balance sheet and its tax base.

Taxable Taxable temporary difference is a difference that will result in taxable

temporary amounts in determining taxable profit (tax loss) of future periods when the
difference carrying amount of the asset is recovered or the liability is settled.

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 Deductible Deductible temporary difference is a difference that will result in amounts
temporary that are deductible in determining taxable profit (tax loss) of future periods
difference when the carrying amount of the asset is recovered or the liability is settled.

Adoption status in Bangladesh

IAS 12 is applicable to annual periods beginning on or after 1 January 1988 in Bangladesh.

Scope
IAS 12 deals with: a) Current tax consequences of transactions and other events that give rise to
current tax assets and liabilities, and b) Future tax consequences of transactions and other events
that give rise to deferred tax assets and liabilities.

Difference between accounting profit and taxable profit

Accounting profit is profit or loss for a period before deducting tax expense.  Please note that
IAS 12 defines accounting profit as a before-tax figure (not after tax as we normally do) in order
to be consistent with the definition of a taxable profit.
Taxable profit (tax loss) is the profit (loss) for a period determined in accordance with the rules
established by the taxation authorities upon which income taxes are payable (recoverable).
We can clearly see here that these 2 numbers can differ significantly because accounting and tax
rules are not the same.  A number of differences can pop out between accounting profit and
taxable profit we have to make the following adjustments to our accounting profit:

 Add back the expenses recognized but non-deductible for tax purposes
 Add income not recognized but included under tax regulations
 Deduct expenses not recognized but deductible for tax purposes
 Deduct income recognized but not taxable under tax regulations.

The difference between accounting profit and taxable profit occurs for the following two
reasons:

 Permanent differences

The difference between accounting profit and taxable profit may be caused by permanent factors
suppose entertainment expense is not allowed in the statement of profit or loss for tax purposes.
Consequently it will increase tax expense permanently.

 Temporary differences

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A temporary difference arises when an expense is allowed for both tax and accounting purposes,
but within different accounting periods. This gives rise to temporary differences in the current
period but will be offset in the future periods. For example, temporary differences occurs
between non-current asset’s accounting depreciation and tax depreciation in the current period.

Recognition:
Recognition of current tax
Current tax for the current and prior periods should be recognized as a liability to the extent that
it has not yet been settled, and as an asset to the extent that the amounts already paid exceed the
amount due. The benefit of a tax loss which can be carried back to recover current tax of a prior
period should be recognized as an asset. Current tax assets and liabilities for the present and prior
periods should be measured at the amount expected to be paid to (recovered from) the taxation
authorities, using the tax rates (and tax laws) that have been enacted or substantively enacted by
the reporting date. A corresponding amount is recognized as an expense or income in the income
statement for the period.

Recognition of deferred tax assets

A deferred tax asset should be recognized when there is a deductible temporary difference
between the tax base of an asset or liability and its carrying amount in the balance sheet. A
deductible temporary difference arises when the carrying amount of a liability exceeds its tax
base, as the future settlement of its carrying amount will be deductible (e.g. provision for
warranty is recognized in the accounts at the point of sale but it is only recognized as a tax
deduction when the expense is incurred and paid).

Further, a deductible temporary difference arises when the carrying amount of an asset is less
than its tax base, as its future recovery will generate a tax deduction (e.g. a depreciable asset
where accumulated depreciation is greater for accounting than tax purposes, or an asset is
revalued downwards but the unrealized loss is not tax deductible until the loss is crystallized by
disposal).

A deferred tax asset should be recognized for deductible temporary differences, unused tax
losses and unused tax credits to the extent that it is probable that taxable profit will be available
against which the deductible temporary differences can be utilized, unless the deferred tax asset
arises from:

• negative goodwill which was treated as deferred income under IFRS 3, Business
Combinations; or

• the initial recognition of an asset/liability other than in a business combination which, at

the time of the transaction, does not affect the accounting profit or the taxable profit (tax loss).

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Deferred tax assets for deductible temporary differences arising from investments in subsidiaries,
associates, branches and joint ventures should be recognized to the extent that it is probable that
the temporary difference will reverse in the foreseeable future and that taxable profit will be
available against which the temporary difference will be utilized. The carrying amount of
deferred tax assets should be reviewed at the end of each reporting period and reduced to the
extent that it is no longer probable that sufficient taxable profit will be available to allow the
benefit of part or all of that deferred tax asset to be utilized. Any such reduction should be
subsequently reversed to the extent that it becomes probable that sufficient taxable profit will be
available. A deferred tax asset should be recognized for an unused tax loss carry forward or
unused tax credit if, and only if, it is considered probable that there will be sufficient future
taxable profit against which the loss or credit carry forwards can be utilized.

Recognition of deferred tax liabilities

A deferred tax liability should be recognized when there is a taxable temporary difference
between the tax base of an asset or liability and its corresponding carrying amount in the balance
sheet. This arises when the carrying amount of an asset exceeds its tax base. Consequently, the
future recovery of the carrying amount will generate taxable profit.

For example:

• Accumulated depreciation of an asset in the financial report is less than the cumulative
depreciation allowed up to the reporting date for tax purposes, e.g. depreciation of an asset is
accelerated for tax purposes

• Development costs have been capitalized and will be amortized to the income statement
but were deducted in calculating taxable amounts in the reporting period in which they were
incurred.

A taxable temporary difference also arises when the carrying amount of a liability is less than its
tax base, because the future settlement of its tax base will generate taxable profit (e.g. a loan
initially recognized at fair value net of borrowing costs incurred in the loan establishment but the
tax deductions for the costs are amortized over the life of the loan). The general principle in IAS
12 is that deferred tax liabilities should be recognized for all taxable temporary differences.
There are 3 exceptions to the requirement to recognize a deferred tax liability, as follows:

• Liabilities arising from the initial recognition of goodwill or goodwill for which
amortization is not deductible for tax purposes;

• Liabilities arising from the initial recognition of an asset or liability other than in a
business combination which, at the time of the transaction, does not affect either the accounting
profit or the taxable profit (tax loss); and

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 • Liabilities arising from undistributed profits from investments where the enterprise is
able to control the timing of the reversal of the difference, and it is probable that the reversal will
not occur in the foreseeable future.

Measurement
Measurement of current tax
Measurement of current tax liabilities (assets) is very straightforward. The entity needs to use the
tax rates that have been enacted or substantively enacted by the end of the reporting period and
apply these rates to the taxable profit (loss).

Current tax = Taxable profit (loss) × Tax rate

Measurement of deferred tax assets and liabilities

Deferred tax assets and liabilities should be measured at the tax rates that are expected to apply
to the period when the asset is realized or the liability is settled (liability method), based on tax
rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting
period.

An exception arises when the item is credited or charged directly to equity (e.g. the revaluation
of property, plant and equipment, or an adjustment to the opening balance of retained earnings
due to a change in accounting policy or an error correction), in which case the amount of
deferred tax liability or asset is charged or credited directly to equity.

The measurement of deferred tax liabilities and deferred tax assets should reflect the entity's
expectations, at the reporting date, as to the manner in which the carrying amount of its assets
and liabilities will be recovered or settled. Deferred tax assets and liabilities should not be
discounted.

The carrying amount of a deferred tax asset shall be reviewed at each reporting date. An entity
shall reduce the carrying amount of a deferred tax asset to the extent that it is no longer probable
that sufficient taxable profit will be available to allow the benefit of part or all of that deferred
tax asset to be utilized. Any such reduction shall be reversed to the extent that it becomes
probable that sufficient taxable profit will be available.

Deferred tax = Temporary difference × Tax rate

This temporary difference may be of two types: taxable and deductible.

Temporary differences

Temporary differences are differences between the carrying amount of an asset or liability in the
statement of financial position and its tax base.

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When the carrying amount of an asset or a liability is greater than its tax base, then there is
a taxable temporary difference and it gives rise to deferred tax liability.
In the opaque situation, when the carrying amount of an asset or a liability is lower than its tax
base, there is a deductible temporary difference and it gives rise to deferred tax asset.
Taxable temporary difference = Carrying amount – Tax base [with respect to expense]

Deductible temporary difference = Tax base – Carrying amount [with respect to income]

Deferred tax liability = Taxable temporary difference × Expected tax rate

Deferred tax asset = Deductible temporary difference × Expected tax rate

Difference between current tax and deferred tax

Point of differences Current tax Deferred tax
Substance Payable to tax office Accounting measure
Basis Taxable profit (loss) Temporary differences
Timing Current year Future periods

Deferred tax liability

We need to recognize deferred tax liability for all taxable temporary differences we discovered,
except for the following situations:

 No deferred tax liability shall be recognized from initial recognition of goodwill

 No deferred tax liability shall be recognized from initial recognition of asset or liability in
a transaction that is not a business combination and at the time of the transaction it affects
neither accounting nor taxable profit (loss).

The most common examples of taxable temporary differences giving rise to deferred tax
liabilities are:
1. Timing differences
Timing difference arises when the recognition of certain item in the financial statements
occurs in a different time than its recognition in tax return; for example, interest received
is taxed deductible only when cash is received.
2. Business combinations
In a business combination identifiable assets and liabilities can be revalued upwards to

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 fair value at the acquisition date, but no adjustment is made for tax purposes. As a result,
taxable temporary difference arises.
3. Assets carried at fair value
When a company applies policy of revaluation (for example, revaluation model for
property, plant and equipment in line with and some assets are revalued upwards to their
fair value, taxable temporary difference arises.
4. Initial recognition of an asset / liability
When an asset or liability are initially recognized in the financial statements, part or all of
it could be tax-non-deductible or not taxable. In this case, deferred tax liability is
recognized based on the specific situation.

Deferred tax asset

While we need to recognize deferred tax liability for all taxable temporary differences, here the
situation is different.
A deferred tax asset shall be recognized for all deductible temporary differences to the extent
that it is probable that taxable profit will be available against which the deductible temporary
difference can be utilized.
No deferred tax asset shall be recognized from initial recognition of asset or liability in a
transaction that is not a business combination and at the time of the transaction it affects neither
accounting nor taxable profit (loss).
The most common examples of deductible temporary differences giving rise to deferred tax
assets are:
1. Timing differences
Timing difference arises when the recognition of certain item in the financial statements
occurs in a different time than its recognition in tax return, for example, accrued expenses
are tax deductible only when paid.
2. Business combinations
In a business combination identifiable assets and liabilities can be revalued downwards to
fair value at the acquisition date, but no adjustment is made for tax purposes. As a result,
deductible temporary difference arises.
3. Assets carried at fair value
When a company applies policy of revaluation (for example, revaluation model for

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 property, plant and equipment in line with  and some assets are revalued downwards to
their fair value, deductible temporary difference arises.
4. Initial recognition of an asset / liability
When an asset or liability are initially recognized in the financial statements, part or all of
it could be tax-non-deductible or not taxable. In this case, deferred tax asset is recognized
based on the specific situation.
Unused tax losses and tax credits

A deferred tax asset shall be recognized for the unused tax losses carried forward and unused tax
credits to the extent that it is probable that future taxable profit will be available against which
the unused tax losses and unused tax credits can be utilized. The following formula can be used
in the calculation of deferred taxes arising from unused tax losses or unused tax credits:
Deferred tax asset = Unused tax loss or unused tax credits × Tax rate

Recognition of tax amounts for the period

The following formula summarizes the amount of tax to be recognized in an accounting period:

Tax to be recognized for the period = Current tax + Movement in deferred tax balances for the
Period

Determination of the tax base:

Guidance on determining the tax base of assets:

The tax base of an asset is the amount that will be deductible against taxable economic benefits
that will flow to an entity when it recovers the carrying amount of the asset. If those economic
benefits will not be taxable, the tax base of the assets is equal to its carrying amount.

Examples:

1. A machine cost Tk. 1,000 and has a carrying amount of Tk. 800. For tax purposes,
depreciation of Tk. 300 has already been deducted in the current and prior periods
and the remaining cost will be deductible in future periods, either as depreciation
or through a deduction on disposal. Revenue generated by using the machine is
taxable, any gain on disposal of the machine will be taxable and any loss on
disposal will be deductible for tax purposes.
The tax base of the machine is = Tk. (1,000-300) = Tk. 700
Carrying amount of the machine is Tk. 800.
Taxable temporary difference = Carrying amount – Tax base = 800-700 = Tk. 100
It gives rise to deferred tax liability.

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 2. Interest receivable has a carrying amount of Tk. 500. The related interest revenue
will be taxed on a cash basis. The tax base of the interest receivable is nil.
Taxable temporary difference = 500-0 = Tk. 500
3. Trade receivables have a carrying amount of Tk. 3,000. The related revenue has
already been included in taxable profit or loss. The tax base of the trade
receivables is Tk. 3,000
As both the carrying amount and the tax base are equal, it will not give rise to any
taxable temporary difference.
4. Dividends receivable from a subsidiary have a carrying amount of Tk. 300. The
dividends are not taxable. In substance, the entire carrying amount of the asset is
deductible against the economic benefits. Consequently, the tax base of the asset
is equal to its carrying amount i.e., Tk. 300.

As both the carrying amount and the tax base are equal, it will not give rise to any
taxable temporary difference.

5. A loan receivable has a carrying amount of Tk. 500. The repayment of the loan
will have no tax consequences. The tax base of the loan receivable is equal to its
carrying amount i.e., Tk. 500.

As both the carrying amount and the tax base are equal, it will not give rise to any
taxable temporary difference.

6. If goodwill is not recognized for tax purposes, no deductions are available and its
tax base s nil.

Guidance on determining the tax base of liabilities:

The tax base of a liability is its carrying amount, less any amount that will be deductible for tax
purposes in respect of that liability in future periods.

In case of revenue which is received in advance, the tax base of the resulting liability is its
carrying amount, less any amount of the revenue that will not be taxable in future periods.

Examples:

1. Current liabilities include accrued expenses with a carrying amount of Tk. 1,000. The
related expense will be deducted for tax purpose on a cash basis. The tax base of the
liability is nil.
Temporary difference = Carrying amount – Tax base = 1,000-0 = Tk. 1,000
2. Current liabilities include accrued expenses with a carrying amount of Tk. 1,000. The
related expense has already been deducted for tax purposes. The tax base of the liability
is 1,000.

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 As both the carrying amount and the tax base are equal, it will not give rise to any
temporary difference.
3. Current liabilities include accrued fines and penalties with a carrying amount of Tk. 500.
Fines and penalties are not deductible for tax purposes. The tax base of the liability is Tk.
500.
As both the carrying amount and the tax base are equal, it will not give rise to any
temporary difference.
4. A loan payable has a carrying amount of Tk. 400. The repayment of the loan will have no
tax consequences. The tax base of the liability is Tk. 400.
As both the carrying amount and the tax base are equal, it will not give rise to any
temporary difference.
5. Current liabilities include interest received in advance with a carrying amount of Tk. 100.
The related revenue was taxed on a cash basis. The tax base of the unearned interest
revenue is nil.
Taxable temporary difference = Carrying amount – Tax base = 100-0 = Tk. 100

Guidance on determining the tax base of unrecognized items:

If items have a tax base but are not recognized in the statement of financial position, the carrying
amount is nil.

Example:

Research costs are recognized as an expense in determining accounting profit in the period in
which they are incurred but may not be permitted as a deduction in determining taxable profit or
tax loss until a later period. The difference between the tax base of the research costs, being the
amount the tax authorities will permit as a deduction in future periods, and the carrying amount
of nil is a deductible temporary difference that results in a deferred tax asset.

Guidance on determining the tax base of an item that is not immediately

apparent:
When the tax base of an asset or liability is not immediately apparent, it is helpful to consider the
fundamental principle upon which this standard is based; that an entity shall, with certain
exceptions, recognize a deferred tax liability (asset) whenever recovery or settlement of the
carrying amount of an asset or liability would make future tax payments larger (smaller) than
they would be if such recovery or settlement were to have no tax consequences. Here the tax
base of an asset or liability depends on the expected manner of recovery or settlement.

Example:

An asset with a cost of Tk. 100 and a carrying amount of Tk. 80 is revalued to Tk. 150. No
equivalent adjustment is made for tax purpose. Cumulative depreciation for tax purpose is Tk. 30

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and the tax rate is 30%. If the asset is sold for more than cost, the cumulative tax depreciation
will be included in taxable income (taxed at 30%) and the sale proceeds will be taxed at 40%
after deducting an inflation-adjusted cost of Tk. 110.

The tax base of the asset is Tk. 70 (100-30) and there is a taxable difference of Tk. 80 (150-70).
If the entity expects to recover the carrying amount by using the asset, it must generate income of
Tk. 150, but will only be able to deduct depreciation of Tk. 70.

Deferred tax liability = 80 × 30% = Tk. 24

If the entity expects to recover the carrying amount by selling the asset immediately for proceeds
of Tk. 150, the entity will be able to deduct the indexed cost of Tk. 110. The net proceeds of Tk.
40 will be taxed at 40%. In addition, the cumulative tax depreciation of Tk. 30 will be included
in taxable income and taxed at 30%. On this basis, the tax base is Tk. 80 (110-30), there is a
taxable temporary difference of Tk. 70.

Deferred tax liability = {(40×40%) + (30×30%)} = Tk. 25

If the tax base is not immediately apparent in this case, it may be helpful to consider the
fundamental principle set out in the guidance i.e., the tax base depends on the expected manner
of settlement.

Additional deferred tax that arises on the revaluation is to be recognized in other comprehensive
income.

Problem -1:
a) An asset which cost Tk. 150 has a carrying amount of Tk. 100. Cumulative depreciation
for tax purpose is Tk. 90 and the tax rate is 25%.
Required:
I. Determine the tax base.
II. Compute the taxable temporary difference
III. Compute the deferred tax liability
IV. Show the accounting treatment of deferred tax liability on the financial
statements.
b) An entity recognizes a liability of Tk. 100 for accrued product warranty costs. For tax
purposes, the product warranty costs will not be deductible until the entity pays claims.
The tax rate is 25%.
Required:
I. Determine the tax base.
II. Compute the deductible temporary difference
III. Compute the deferred tax asset

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 IV. Show the accounting treatment of deferred tax asset on the financial statements.

Solution:
a) Tax base = 150-90 = Tk. 60
Taxable temporary difference = Carrying amount – Tax base = 100-60 = Tk. 40
Deferred tax liability = 40 × 25% = Tk. 10
Deferred tax liability is to be shown on the statement of profit or loss as a part of the
current tax expense and under non-current liability section on the statement of financial
position.
b) Tax base = Carrying amount – Amount that will be deductible for tax purpose in respect
of that liability in future periods
= 100-100
=0
Deductible temporary difference = Carrying amount –Tax base
= 100-0
= 100
Deferred tax asset = 100 ×25% = Tk. 25

Deferred tax asset reduces the amount of income tax expense on the statement of profit or
loss and is to be shown under non-current assets sections on the statement of financial
position.

Under/over provision of income tax:

Any under/over provision from the prior year is dealt with in the current year’s tax charge. This
does not affect the year-end tax liability. They affect the current year tax expense on the
statement of profit or loss.

 An under-provision increases the current year income tax expense.

 An over-provision decreases the current year income tax expense.

Problem-2:
ABC Ltd. estimated its income tax liability for the year ended 31 December 20X3 at Tk. 2,
15,000. In the previous year the income tax liability had been estimated as Tk. 1, 80,000.

Required:

Calculate the income tax expense that will be shown in the statement of profit or loss for the year
ended 31 December 20X3 if the amount was actually settled with the tax authorities in respect of
20X2 was:

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 a) Tk. 2,00,000
b) Tk. 1,55,000

Solution:
a) Under-provision:

Statement of profit or loss

Income tax expense:

Current year estimate 2, 15,000

Under-provision (2, 00,000-1, 80,000) 20,000

2, 35,000

b) Over-provision:

Statement of profit or loss

Income tax expense:

Current year estimate 2, 15,000

Over-provision (1, 80,000-1, 55,000) (25,000)

1, 90,000

Revaluation of non-current assets:

When a revaluation takes place, the carrying amount of the asset will change but the tax base will
remain unaffected. The revaluation of non-current assets results in taxable temporary differences
and so a deferred tax liability. This is shown in other comprehensive income (alongside the
revaluation gain itself) rather than the statement of profit or loss.

Problem-3:
On 1 January 20X3 ABC Ltd. decided to revalue its land for the first time. A qualified valuer
reported that the fair value of the land on that date was Tk. 90,000. The land was originally
purchased 5 years ago for Tk. 75,000.

The required provision for income tax for the year ended 31 December 20X3 is Tk. 21,500. The
difference between the carrying amounts of the net assets of ABC Ltd. (including the revaluation

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of the land above) and their (lower) tax base at 31 December 20X3 is Tk. 30,000. The opening
balance on the deferred tax account was Tk. 3,500. ABC’s rate of tax is 25%.

Required:

Prepare the extract of the financial statements to show the effect of the above transactions.

Solution:

Working notes:
1. Deferred tax:

Balance c/d (30,000 * 25%) 7,500

Less: Balance b/d (given) (3,500)

Increase in deferred tax 4,000

2. Deferred tax relating to revaluation gain:

Revaluation gain = 90,000-75,000 = Tk. 15,000

Deferred tax relating to revaluation gain = 15,000 × 25% = Tk. 3,750

Normal deferred tax = 4,000 – 3,750 = Tk. 250

3. Income tax expense:

Year-end estimate 21,500

Add: Increase in deferred tax 250

Total tax expense 21,750

Extracts of the financial statements:

Statement of profit or loss and other comprehensive income

Income tax expense (3) 21,750

Other comprehensive income:

Revaluation gain 15,000

Deferred tax (2) (3,750)

11,250

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 Statement of financial position

Non-current assets:

Land 90,000

Equity:

Revaluation surplus 11,250

Non-current liabilities:

Deferred tax 7,500

Current liabilities:

Income tax payable 21,500

Statement of changes in equity

Revaluation gain 15,000

Deferred tax on revaluation gain (3,750)

Revaluation surplus 11,250

Problem-4:
In 20X3, ABC Ltd. paid Tk. 60,000 in tax on its profits. In 20X4, the entity made tax losses of
Tk. 32,000. The tax authority rules allow losses to be carried back to offset against current tax of
prior years. The tax rate is 25%.

Required:

Show the tax charge and tax liability for 20X3.

Solution:
Tax repayment due on tax losses – 32,000 × 25% = Tk. 8,000

Tax receivable of Tk. 8,000 will be shown as an asset on the statement of financial position and
tax repayment of Tk. 8,000 will be credited in the statement of profit or loss.

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