Deferred Tax

Part A

Deferred taxation is not a form of taxation. It is an accounting ‘invention’ that is used as a basis for
allocating tax charges to particular accounting periods.

Profit for tax purposes is not the same as the profit reported in the financial statements. There are two
reasons for the differences between tax profit and accounting profit:

(a) temporary differences whereby the value of assets and liabilities in the accounts are different
from their value for tax purposes

(b) permanent differences, caused by the fact that some items of income and expense are either
disallowable or non-taxable under tax rules.

In principle, temporary differences should cancel out over time, but permanent differences will not. Full
deferred tax accounting eliminates the effect of temporary differences between accounting profit and
tax profits, in such a way that the total tax charge reported in the accounts is in direct relation to the
reported (accounting) profit.

One of the main reasons for deferral of tax is the availability in many countries of capital allowances (tax
depreciation) on purchases of non-current assets. The tax allowance is usually different from the
depreciation charge in the accounts, so that accounting profit and tax profit differ in each period, even
though they are the same over the full life of an asset.

Accounting for deferred tax

When the tax value of assets is less than their carrying value in the accounts, there is a deferred tax
liability in the statement of financial position.

An increase in the deferred tax liability during a period is reported as an addition to the tax charge for
the period. A reduction in the deferred tax liability leads to a reduction in the tax charge in the accounts.

The liability reduces the profit for the year, and is also shown as a separate item under provisions in the
statement of financial position.

Movements to and from the deferred tax account must also be disclosed. When the tax actually
becomes due, the deferred tax account is debited with the amount.

IAS 12 Income Taxes requires that full provision should be made for deferred tax assets and liabilities
arising from temporary differences. Most deferred tax balances will be liabilities due to accelerated
capital allowances.

The tax rate that should be used to calculate deferred tax balances should be measured using tax rates
that have been enacted by the statement of financial position date.

Any net deferred tax liability should be shown on the statement of financial position as a provision in
non-current liabilities.

Marking Scheme – one mark per point up to a max of 5.

Part B

William

At 30 June 2017
$000
Cost 3000
Accumulated depreciation (W1) 300
Carrying value in accounts 2700
Tax base (W2) 1800
Difference 900

Deferred tax liability at 30% 270

There is a creation of a deferred tax liability. This will appear as a credit item in the tax charge for the
year.

The deferred tax balance in the statement of financial position at 30 June 2017 is a liability of $270,000.

Workings

(W1) Depreciation charge each year = ($3 million  $600,000)/8 years = $300000.

(W2)

Original tax base at 1 July 2016 (cost) 3000

Tax depreciation, year to 30 June 2017: 40% (1200)
Tax base at 30 June 2017 1800

½ mark for each correct number up to 5 marks