Present value PROVISIONS AND CONTINGENCIES

Chapter 15 – Taxation Page 187 differences. A temporary difference is the difference between the carrying amount of an asset or liability in the statement of financial position and the amount of that item for tax purposes, which is called its tax base. [IAS 12.5] The concept of deferred tax is best described through the use of a simple example. Illustration 1 An entity acquires a new computer for CU1,200 in the year. The entity depreciates computer equipment over 3 years in accordance with IAS 16 Property, plant and equipment. Local government provides a tax incentive to businesses for investments in new computer equipment and therefore the full cost of the equipment is allowable for tax purposes in the year that it is purchased. At the end of the year, the computer equipment has the following carrying amount and tax base: Balance sheet carrying amount: CU1,200 less depreciation of CU1,200 x 13 CU400 = CU800 Tax base: CU1,200 less amount deductible for tax purposes of CU1,200 = nil A temporary difference arises of CU800, being the difference between the carrying amount in the balance sheet and the value for tax purposes. The temporary difference reflects the fact that the entity has reduced its actual tax liability by CU1,200 multiplied by the tax rate although only CU400 is shown an expense in profit or loss for the period. This means that the current tax expense is less than what a user would expect to see based on the results reported in the entity’s statement of comprehensive income. The reason that an entity is required to recognise deferred tax is because:  a deferred tax liability will ultimately translate itself into an actual liability by, for example, resulting in a larger tax liability in future periods;  the matching of items recognised in an entity’s financial statements is consistent with the requirements of IAS 1 Presentation of financial statements on the preparation of an entity’s financial statements; and  ignoring deferred tax may lead to the reported profit in a period being misinterpreted. 6 Deferred Tax: Recognition and Measurement An entity is required to recognise a deferred tax liability where it has identified a taxable temporary difference between an asset’s or liability’s carrying amount for accounting purposes and its value for tax purposes. A deferred tax liability arises where the carrying amount of an asset liability for accounting purposes is greater less than its tax value. [IAS 12.15] There are two exceptions to this requirement to recognise a deferred tax liability: firstly, where it arises from the initial recognition of goodwill i.e. the excess paid for a business above the value of its net assets and secondly, where the initial recognition of an item, that is not part of a business combination, does not affect accounting or tax profit. [IAS 12.15] Chapter 15 – Taxation Page 188 IAS 12 requires that an entity should recognise a deferred tax asset where tax is recoverable in the future, as a result of a deductible temporary difference arising on the assessment of an asset’s or liability’s value for accounting and tax purposes. For a deferred tax asset to be recognised the entity should assess its recoverability as being probable. [IAS 12.24] A potential deferred tax asset arises where the carrying amount of an asset liability for accounting purposes is less greater than its tax value. As with a deferred tax liability, an entity should not recognise a deferred tax asset where it arises from a transaction that is neither a business combination nor affects accounting or tax profit at the time of recognition. [IAS 12.24] The recognition and measurement of deferred tax balances can be determined by a number of steps which are explained in the remainder of this chapter.

6.1 Carrying amount versus tax base

An entity should determine an asset’s or liability’s carrying amount in its statement of financial position and its value for tax purposes, i.e. its tax base. Where there is a difference between the two amounts the entity may need to recognise a deferred tax asset or liability. The tax base of an asset is the amount that will be deductible for tax purposes against future profits generated by the asset. In simple terms the asset’s tax base is the amount of the asset in the current period for tax purposes. Illustration 2 An entity has an asset in its statement of financial position representing interest receivable of CU500. Although the interest will not be received until after the end of the reporting period, it has been earned in the current period and therefore has been recorded as income. The carrying amount of the asset at the end of the reporting period date is therefore CU500. The interest will be chargeable to tax when the cash is received, i.e. in the following period. The interest asset has no value for tax purposes in the current period, so its tax base is nil. The tax base of a liability is its carrying amount less any amount that will be deductible for tax purposes in future periods. Illustration 3 An entity has recognised a current liability for expenses that it has incurred but not yet paid at the end of its reporting period of CU1,000. The expenses will be fully allowable for tax purposes when they are paid in the following period. The carrying amount of the liability at the end of the reporting period is therefore CU1,000. The tax base is nil, being the carrying amount of CU1,000 less the amount that will be deductible for tax purposes in future periods i.e. CU1,000.

6.2 Calculate the temporary difference

Temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base. Temporary differences may be either: [IAS 12.5] a taxable temporary differences, which result in taxable amounts arising in future accounting periods, as the carrying amount of the asset or liability is recovered or settled.