Other measurement points PROVISIONS AND CONTINGENCIES

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. Chapter 15 – Taxation Page 189 This is where the carrying amount of an asset liability for accounting purposes is greater less than its tax base; or b deductible temporary differences, which result in amounts that are deductible in future periods as the carrying amount of the asset or liability is recovered or settled. This is where the carrying amount of an asset liability for accounting purposes is less greater than its tax base. Illustration 4 The temporary differences in illustrations 2 and 3 are: Illustration 2: Carrying amount of the interest receivable is CU500 less its tax base of nil – temporary difference is CU500. Illustration 3: Carrying amount of the liability is CU1,000 less its tax base of nil – temporary difference is CU1,000. The temporary differences in Illustration 2 is a taxable temporary difference and in Illustration 3 is a deductible temporary difference.

6.3 Determining deferred tax

Deferred tax liabilities represent income taxes payable in future periods in respect of taxable temporary differences. A taxable temporary difference therefore creates a deferred tax liability. [IAS 12.5] Deferred tax assets are “amounts of income taxes recoverable in future periods in respect of deductible temporary differences”. [IAS 12.5] Deferred tax assets may also arise as a result of tax losses and tax credits that can be used to reduce an entity’s future tax liability. An entity should only recognise a deferred tax asset in respect of tax losses and recoverables where it is probable that it will gain benefit from them, i.e. taxable profits will be made in future periods that they can be offset against. A deductible temporary difference therefore creates a potential deferred tax asset. [IAS 12.34] A deferred tax asset or liability is calculated by multiplying the temporary difference by the relevant tax rate. The tax rate to be used in the calculation for determining a deferred tax asset or liability is the rate that is expected to apply when the asset is realised, or the liability is settled. These rates should be based on tax laws that have already been enacted or substantively enacted by the end of the reporting period. [IAS 12.47] Illustration 5 An entity operates in Muldovia, and enters into a long-term contract to build a motorway in that country. During the year ended 31 December 2007, the entity recognises CU4million of income on this contract in profit or loss for the period, although it does not expect to receive the related cash until the year ending 31 December 2009. Under the tax rules of Muldovia tax is charged on a cash receipts basis. The tax rate for businesses in Muldovia was 30 in the year to 31 December 2007, but the government has voted in favour of a reduction to 29 for 2008. There is currently a rumour that the rate will drop to 28 in 2009, but no announcement has been made.