Best estimate 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]