As stated above, deferred tax liabilities arise on taxable temporary differences, ie those temporary differences that result in tax being payable in the future as the temporary difference reverses. So, how does the above example result in tax being payable in the future? Entities pay income tax on their taxable profits. When determining taxable profits, the tax authorities start by taking the profit before tax accounting profits of an entity from their financial statements and then make various adjustments.
For example, depreciation is considered a disallowable expense for taxation purposes but instead tax relief on capital expenditure is granted in the form of capital allowances. Therefore, taxable profits are arrived at by adding back depreciation and deducting capital allowances from the accounting profits. Entities are then charged tax at the appropriate tax rate on these taxable profits.
Table 1: The carrying value, the tax base of the asset and therefore the temporary difference at the end of each year Example 1. In the above example, when the capital allowances are greater than the depreciation expense in years 1 and 2, the entity has received tax relief early. This is good for cash flow in that it delays ie defers the payment of tax. However, the difference is only a temporary difference and so the tax will have to be paid in the future.
In years 3 and 4, when the capital allowances for the year are less than the depreciation charged, the entity is being charged additional tax and the temporary difference is reversing. Hence the temporary differences can be said to be taxable temporary differences. In accordance with the concept of prudence, a liability is therefore recorded equal to the expected tax payable.
This will be recorded by crediting increasing a deferred tax liability in the Statement of Financial Position and debiting increasing the tax expense in the statement of profit or loss. At the end of year 4, there are no taxable temporary differences since now the carrying value of the asset is equal to its tax base.
This can all be summarised in the following working. The movements in the liability are recorded in the statement of profit or loss as part of the taxation charge. The closing figures are reported in the Statement of Financial Position as part of the deferred tax liability. Example 1 provides a proforma, which may be a useful format to deal with deferred tax within a published accounts question.
The movement in the deferred tax liability in the year is recorded in the statement of profit or loss where:. The closing figures are reported in the Statement of Financial Position as the deferred tax liability.
As IAS 12 considers deferred tax from the perspective of temporary differences between the carrying value and tax base of assets and liabilities, the standard can be said to take a valuation approach. However, it will be helpful to consider the effect on the statement of profit or loss. However, income tax is based on taxable profits not on the accounting profits.
The taxable profits and so the actual tax liability for each year could be calculated as in Table 2. The income tax liability is then recorded as a tax expense. As we have seen in the example, accounting for deferred tax then results in a further increase or decrease in the tax expense. Therefore, the final tax expense for each year reported in the statement of profit or loss would be as in Table 3. It can therefore be said that accounting for deferred tax is ensuring that the matching principle is applied.
The tax expense reported in each period is the tax consequences ie tax charges less tax relief of the items reported within profit in that period. Deferred tax is consistently tested in the published accounts question of the Paper F7 exam. It should not be ruled out however, of being tested in greater detail in Question 4 or 5 of the exam. Here are some hints on how to deal with the information in the question. It is important that you read the information carefully.
You will need to ascertain exactly what you are being told within the notes to the question and therefore how this relates to the working that you can use to calculate the figures for the answer. Consider the following sets of information — all of which will achieve the same ultimate answer in the published accounts. The notes to the question could contain one of the following sets of information:.
Situations 1 and 2 are both giving a figure that can be slotted straight into the deferred tax working. In situations 3 and 4 however, the temporary differences are being given. These are then used to calculate a figure which can be slotted into the working.
In all situations, the missing figure is calculated as a balancing figure. Table 4 shows the completed workings. Revaluations of non-current assets NCA are a further example of a taxable temporary difference. When an NCA is revalued to its current value within the financial statements, the revaluation surplus is recorded in equity in a revaluation reserve and reported as other comprehensive income.
While the carrying value of the asset has increased, the tax base of the asset remains the same and so a temporary difference arises. As seen, there are conflicting judgments on this and this requires clarification from the government or decision by the high court. MAT does not give rise to any difference between book income and taxable income. Products IT. About us Help Center. Log In Sign Up. File Tax Returns Expert assistance on your annual filings Advice on registration requirements Expert assited tax filing Advance tax payment Buy now Chat with an expert.
Get Expert Assistance. Request a Callback. Get an Expert. Tax Saving Investments Made Simple. Start Tax Saving. Best Tax Saving Funds — Returns Axis Long Term Equity Fund. Was this article helpful? Have a query? ITR Resources. Sometimes companies also push the current profits into future, this gives them the opportunity to decrease the tax amount. By doing this instead of paying the saved money as taxes, they use that extra money for making investments.
Example of Deferred Tax Asset and Liability. Deferred Tax Asset Now, to understand these concepts better, let us discuss them with examples. Deferred Tax Liability.
Effect of Tax Holiday w. Effect on MAT w. An increase in the book profit is caused by: Paid income tax or a provision An amount that is moved to any reserve Arrangements made for unpredictable liabilities Provision made for Deferred Tax etc.
Best investment policies at lowest premiums. Top performing investment plans, better than mutual funds. Plans with zero commissions. Frequently Asked Questions. What is a deferred tax asset? What is deferred tax in simple terms? How do I calculate deferred tax? To calculate deferred tax, follow these steps: List the assets and the liabilities in a table Calculate the bases of the Tax Determine the temporary differences Calculate rate of the applicable tax liability Determine the tax asset Recognise items outside the financial position Add them all up and make an entry in the accounts.
What is deferred tax liabilities? What causes deferred tax liability? How does a deferred tax asset work? Is Deferred tax a current asset? Read More About Tax. Income Tax. Tax Forms.
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