Accounting for income taxes

 Do not confuse accounting for income taxes

with tax accounting. They are 2 different
things!
 Accounting for income taxes
 One of contents covered by financial accounting
(financial reporting) like others – accounting for
inventories, accounting for PPE etc.
 Measures and reports effects of income taxe
transactions on financial information (presented on
financial statements)

Accounting for income taxes

 Tax accounting
 A branch (subsector) of accounting profession
(along with others like financial accounting,
management accounting)
 focuses more on tax returns and payments instead
of financial statement preparation. It is governed
by tax law and regulations

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 Common terms used in taxation law
 Assessable income
 Deductions (Deductible expenses)
 Taxable income
 Tax rate
 Tax payable

Tax formula
under taxation law

Taxable Assessable
= - Deductions
income income

Tax Taxable
= X Tax rate
payable income

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 IAS 12 definitions of profit
 Accounting profit is profitor loss for a period
before deducting tax expense
 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)

Accounting profit vs. taxable profit

under IAS 12

Accounting
= Revenues - Expenses
profit

Taxable
Taxable profit = - Tax deductions
income

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 Reporting effects of tax transactions
on financial statements
 Accounting for income tax requires to disclose
on financial statement information about
 Income tax expense (on profit or loss statement)
and,
 Income tax payable (on balance sheet)
 However, incomes and expenses recognized in
financial reporting (accounting) are regulated
differently from incomes and expenses
reported for tax purposes

Difference b/w financial reporting and tax

reporting in determining income and expenses
 Many items of accounting revenues and
expenses are not accounted for as taxable
income and deductible expenses under tax law
 Examples are
 Unearned revenue
 Prepaid expense (prepaid rent)
 Bad debt expense
 Depreciation
 Product warranty expense
 …
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 Example 1
 Determine taxable profit and income tax
payable for 2023 and 2024
 Compare the amounts of tax payable in 2 years
 Compare total amounts of tax payabe in 2
years with that of the same period, if there are
no different treatment of expenses between
accounting and tax reporting

Difference b/w financial reporting and tax

reporting in determining income and expenses
 The differences b/w financial reporting and tax
reporting on taxable profit and accounting
profit fall into 2 categories
 Permanent differences and
 Temporary differences

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 Permanent differences
 Permanent difference arises from transactions
included
 in computing taxable profit but never in
accounting profit
 in computing accounting profit but never in
taxable profit
 Examples are
 Tax-free interest income
 Fines, penalties resulting from a violation of law
 …
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Permanent differences
 Permanent differences have permanent effects
on income tax payable and will never be
reversed (as compared with those of temporary
differences)
 Permanent differernces have the same effects
on income tax expense for financial reporting
and income tax payable for tax reporting. And
these effects occur in the period the
transactions give rise to the difference

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 Temporary differences
 Aka “timing difference” arises because of
differences in recognizing items of financial
statements (assets, liabilities, equity, income
and expenses) under accounting standars and
tax laws
 Temporary differences originate in one (or
more) accounting period(s) and reverse in one
(or more) subsequent accounting period(s)

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Temporary differences
 There are 2 types of temporary differences
 Taxable (assessable) temporary difference
 If a temporary difference requires payment of more tax
in the future it is taxable temporary difference
 Deductible temporary difference
 If a temporary difference requires payment of less tax in
the future it is deductible temporary difference

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 Methods in accounting for income tax

 Accounting practice on income tax has been

evolving over time. Various methods,
approaches have been applied in practice, all is
about how and what amount of income tax
expense and income tax payable (liability)
should be recorded on profit or loss and
balance sheet

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Methods in accounting for income tax

 Tax-payable method
 Tax-effect accounting
 Deferral method (income statement method)
 Asset/liability method (balance sheet method)

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 Tax-payable method
 Under this method the amount of income tax
expense reported on profit or loss is equal the
amount of tax payable (liability) to tax office
in current period
Income tax Income tax
= = Taxable profit X Tax rate
expense payable (current)

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Diferral method

Income tax
= Accounting profit X Tax rate
expense

Income tax
= Taxable profit X Tax rate
payable (current)

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 Deferral method
 Focus on matching of expense of a period with all
revenues of that period (income statement focus), also
called “income statement method”
 Did not focus on measuring asset or liability amounts
related to timing difference
 Deferred income tax balance is not an asset or a
liability, simply an amount temporarily recorded on
balance sheet before being carried forward to the
income statement
 Prevailing during 1960s and 1970s. Since 1998 it was
not allowed in international accounting standards
system
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Accounting for income taxes

asset/liability method
 The approach applied in current IAS 12
 Focus on measuring asset and liability amounts
(tax assets and tax liabilities) related to timing
difference (also known as “balance sheet
approach/method)
 Under asset/liability method, all current period
tax consequences are included
 Either in the income taxes payable in the current
period, or
 Recorded as a (deferred) asset or liability
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 Tax consequences
 (Temporary) differences can have
 Current tax consequences and
 Future tax consequences
 The tax consequences must be recorded in the
period the transactions occur

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Tax consequences
 Current tax consequences
 E.g non-deductible expense means taxable profit is
greater than accounting profit
 Therefore, current tax payments will be higher
 Future tax consequences
 E.g., an expense which is not deductible now but
will be in future periods
 Therefore, future tax payments will be lower

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 Tax consequences
 Current tax consequences give rise to
 Current tax liability (payable) and/or
 Current tax asset
 Future tax consequences give rise to
 Deferred tax liabilities (DTLs) and/or
 Deferred tax assets (DTAs)

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Recognizing income tax expense

 IAS 12 requires current and deferred tax items
be reported as expense (income tax expense)
or income (income tax income) on profit or
loss of current period
 Current and deferred tax liabilities lead to the
recognition of expense
 Current and deferred tax assets lead to the
recognition of income

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 Recognizing income tax expense
 Tax expense comprises
 Current tax expense represented by the amount of
current tax liability (payable) and
 Deferred tax expense represented by the amount of
deferred tax liability (payable)
 Accounting etries?
Dr Income tax expense (current payable amount)
Dr Income tax expense (deferred payable amount)
Cr Income tax liability (payable)
Cr Deferred tax liability
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Current tax calculation

 Current tax payable (liability) is calculated by
adjusting accounting profit to allow for differing
treatments of income and expense items
recorded during the period
Accounting profit
(-) Incomes that are not taxable
(+) expenses that are not deductible for tax
(+)/(-) differences b/w accounting income and taxable income
(+)/(-) differences b/w accounting expenses and tax deductible expenses
= Taxable profit

Taxable profit X tax rate = current tax liability = current tax expense

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 Measuring tax consequences
 Current tax (assets and liabilities) creates not
much of a problem to financial reporting
(accounting for income tax). As the current tax
assets or liabilities can be determined based on
the calculation of taxable profit of current
period according to tax law
 The complication lies in the future tax
consequences that lead to the recognition of
deferred tax assets and liabilities

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Measuring deferred tax assets and

liabilities
 Permanent differences do not have future tax
consequences, the effect is included in current
tax payable and does not give rise to deferred
tax asset or liability
 Temporary differences have effects on tax of
current period and subsequent period(s), then
give rise to deferred liabilities and assets

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 Measuring deferred tax assets and
liabilities
 Temporary differences give rise to 2 effects
 Amount of taxable profit is different from
accounting profit in certain period(s) and this
effect is reversed in subsequent period(s)
 Amounts of assets and liabilities reported in
financial statements are different from tax base of
these assets and liabilities

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Example 3
 Compare carrying amount (book value) of the
assets with value of the asset for tax purposes
(tax base)
 Observe the reversal of tax effect in
subsequent periods

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 Determining 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 (IAS 12, Par.5)
 Amount of temporary difference is pre-tax
amount
 Tax base of an asset or liability is the amount
attributed to that asset or liability for tax
purposes

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Tax base for asset

 The tax base of an asset is the amount that will
be deductible for tax purposes against any
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 asset is equal to
its carrying amount. (IAS 12, Par. 7)

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 Tax base for asset

Tax base Carrying Future taxable Future deductible

= - +
of asset amount amount amount

 Future taxable amount

 Any amount derived from the asset that is expected to be
taxable, and is equivalent to the expected cash flows to be
received from the asset either through use of sale. It is
assumed to be, at a maximum, equal to carrying amount of
the asset
 Future deductible amount
 Represent the allowable tax deductions in the future
applicable to that asset

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Tax base for asset

 Assets which normally have a CA equal to
their tax base include:
 Cash
 Inventory
 Depreciable assets where tax and accounting rates
are the same
 Accrued revenue where the revenue is not
assessable

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 Temporary difference for asset

Tax base Carrying Future taxable Future deductible

= - +
of asset amount amount amount

Carrying Tax base Future taxable Future deductible

- = -
amount of asset amount amount

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Exercise 2
 Determine tax base of assets under each
scenario
 Compute temporary differences

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 Measuring future tax consequences
 Rules to remember
 “Taxable” (assessable) means more tax,
 “Deductible” means less tax
 Taxable temporary difference leads to the
recognition of deferred tax liability
 Deductible temporary difference leads to the
recognition of deferred tax asset

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Measuring future tax consequences

 Recall: temporary differences are pre-tax
amounts!
 Deferred tax liability
= taxable (assessable) temporary difference x tax rate
 Deferred tax asset
= deductible temporary difference x tax rate

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 Practice
 Revisit exercise 2
 Determine types of temporary differences under
each scenario
 Compute amount of deferred tax assets/liabilities
arisen from tax consequences under these
scenarios
 Provide appropriate accounting entries to record
these deferred tax assets/liabilities

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Practice
 Scenario 1
Dr Income tax expense (deferred) 450
Cr Deferred tax liability 450
 Scenario 3
Dr Deferred tax asset 600
Cr Income tax expense (deferred) 600
 Scenario 4
Dr Income tax expense (deferred) 4500
Cr Deferred tax liability 4500
 Scenario 5
Dr Income tax expense (deferred) 3000
Cr Deferred tax liability 3000

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 Tax base for 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 the 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

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Tax base for liabilities

Tax base Carrying Future deductible

= -
of liability amount amount

Revenue received in
Tax base Carrying
= - advance which will not
of liability amount
be taxable in future periods

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 Tax base for liability
rules to remember
 All liabilities other than revenue received in
advance will have taxable amounts = $0
 Liabilities which normally have a carrying
amount equal to their tax base include:
 Loans
 Accounts Payable
 Current tax liability
 Non-deductible accrued expenses

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Exercise 3
 Determine tax base for liabilities
 Compute and determine type of temporary
differences
 Calculate and prepare journal entries to record
tax consequences

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 Determining DTA/DTL

Deferred tax Deferred tax

liability asset

Carrying amount > Carrying amount <

Assets
tax base tax base
Carrying amount < Carrying amount >
Liabilities
tax base tax base

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Accounting for deferred tax assets

and liabilites
 At the end of the period adjustment entries must be
made to record the tax effects on deferred tax assets
and liabilities. The adjustments are made based on
 Outstanding balance of DTA/DTL account (balance before
adjustments)
 The amount of DTA/DTL determined at reporting date
(required ending balance of these items)
 Net change (of DTA/DTL) will be recorded as
expense or income (deferred income tax
expense/income) of current period

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 Accounting for deferred tax assets
and liabilites
 Ajdustments for DTA/DTL are recorded by
entries
Dr income tax expense (deferred)
Cr deferred tax liability
 Or
Dr deferred tax asset
Cr income tax expense/income (deferred)

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Practice
 Exercise 5
 Complete accounting entries for income tax
 Revisit exercise 1
 Determine tax consequence of temporary
differences
 Compute amount DTA and DTL arisen as a result
of tax consequences of current period and prepare
entries to record these deferred tax assets/liabilities
 Show complete accounting entries for income tax
of current period

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 Measure DTA/DTL at the reporting
date – using worksheet
 The future tax consequences are determined
end recognized at the end of the period by
analyzing temporary differences between
carrying amounts and tax base of respective
assets and liabilities on the balance sheet
 DTA and DTL will be then measured and
appropriate entries to deferred income tax
expense and DTA/DTL accounts can be
prepared
 This procedure can be done using a worksheet
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Measure DTA/DTL at the reporting

date – using worksheet
Carrying Taxable Deductible Tax base Taxable Deductible
amount amount amount temporary temporary
difference differenct

Assets

Liabilities

Temporary differences xxx xxx

Excluded differences (xxx) (xxx)

Net temporary differences xxx xxx

Deferred tax liability xxx

Deferred tax asset xxx

Opening balance

Movement during year

Adjustment xxx xxx

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 Tax losses
 Tax losses arise when allowable deductions
exceed assessable (taxable) income
 Losses can be carried forward and used as a
deduction against future taxable profit. Losses
then provide future tax benefits (reduce the
amount of tax payable in future period) –
temporary deductible differences
 The carry-forward of unused tax losses gives
rise to the recognition of deferred tax asset

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Example 4
 Calculate taxable profit (tax loss)
 Provide journal entry to record tax consequences of
tax loss in 2022. What information should be
presented in Profit or Loss
 Assume in 2023 the company earned a profit before
income tax of $42,000, other adjustments for the
differences b/w accounting profit and taxable profit
were the same as of 2022. What would be the results
of the above requirements
 If the amount of profit earned in 2023 was $52,000
instead, what would be the answer?
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 Tax on revaluation of non-current
assets
 Current IFRS allows certain assets to be
recognised at fair value or at revalued
amounts.
 If “the revaluation or restatement of an asset
does not affect taxable profit in the period of
the revaluation or restatement and,
consequently, the tax base of the asset is not
adjusted” (IAS 12, Par. 20)

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Tax on revaluation of non-current

assets
 The difference between the carrying amount of
a revalued asset and its tax base is a temporary
difference and gives rise to a deferred tax
liability or asset (IAS 12, Par. 20)
 Deferred tax that arises on the revaluation is
recognised in other comprehensive income, not
on profit or loss (not as income tax expense)

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 Illustration
 On January 1, 2022 Endless Summer Limited
purchased for $800,000. At the end of the year
the company decides to revalue land to its fair
value of $1,000,000. Under current tax regime
the revaluation of land does not affect tax base
of the asset or taxable profit
 The income tax rate is 30%

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Presentation
 Current tax liability and deferred tax liability
must be presented on balance sheet separately
 Deferred tax assets and liabilities are classified
as non-current on balance sheet

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