IAS 12: Income Taxes - Course Overview and Guidelines

1. ICPAK • IAS 12 - Income taxes • by Simon Fisher • 31 March 2011 Institute of Certified Public Accountants of Kenya

2. Income taxes • This slide presentation has been prepared for general guidance only, and does not constitute professional advice. You should not act upon the information contained in these slides without obtaining specific professional advice. Accordingly, to the extent permitted by law, RSM Ashvir (and its employees and agents) accept no liability, and disclaim all responsibility, for the consequences of anyone acting, or refraining from acting, in reliance on the information contained in these slides or for any decision based on it, or for any consequential, special or similar damages even if advised of the possibility of such damages. Institute of Certified Public Accountants of Kenya

3. Income taxes Course objectives • By the end of today you should: • know the components making up tax expense • have a good understanding of the basic concepts of IAS 12 • understand the main exemptions within IAS 12 • be able to compute deferred tax on commonly encountered assets and liabilities • know what disclosures are required under IAS 12 • be able to prepare a ‘tax reconciliation’ • be aware of differences between full IFRS and the IFRS for SMEs. • This course does not cover the computation of taxable profit. Institute of Certified Public Accountants of Kenya

4. Income taxes Tax expense … • … is the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax (12.5). Institute of Certified Public Accountants of Kenya

5. Agenda/Contents • Section 1: Accounting for current tax • Section 2: Accounting for deferred tax Institute of Certified Public Accountants of Kenya

6. Agenda/Contents • Section 1: Accounting for current tax • Section 2: Accounting for deferred tax Institute of Certified Public Accountants of Kenya

7. Accounting for current tax Current tax • Current tax is the amount of income tax payable/recoverable in respect of the taxable profit/loss for the period (12.5). • Current tax for current and prior periods should, to the extent unpaid, be recognised as a liability (12.12). Institute of Certified Public Accountants of Kenya

8. Agenda/Contents • Section 1: Accounting for current tax • Section 2: Accounting for deferred tax Institute of Certified Public Accountants of Kenya

9. Accounting for deferred tax Deferred tax • We will be looking at: • Basic concepts • Measurement • the rule • the exceptions to the rule • Recognition • Presentation and disclosure. Institute of Certified Public Accountants of Kenya

10. Accounting for deferred tax Basic concepts • What is deferred tax? • Why do we need it? • How is it calculated? Institute of Certified Public Accountants of Kenya

11. Accounting for deferred tax What is deferred tax accounting ….. • Accounting for the tax consequences of the future recovery/settlement of the carrying amount of assets/liabilities in a company’s balance sheet. • IAS 12 (effective from 1998) uses the balance sheet liability method (as opposed to the deferral method) and focuses on ‘temporary differences’ existing at the balance sheet date (not ‘timing differences’) Institute of Certified Public Accountants of Kenya

12. Accounting for deferred tax Basic concepts • What is deferred tax? • Why do we need it? • How is it calculated? Institute of Certified Public Accountants of Kenya

13. Accounting for deferred tax • Measurement – the rule Institute of Certified Public Accountants of Kenya

14. Accounting for deferred tax The IAS 12 approach to calculating deferred tax • For every asset and liability in the balance sheet, and for tax losses carried forward: Institute of Certified Public Accountants of Kenya

15. Accounting for deferred tax What is a temporary difference? • Temporary difference = [the carrying value of an asset or liability] - [its tax base]: Institute of Certified Public Accountants of Kenya

16. Accounting for deferred tax The tax base is ….. • …… “the amount attributed to that asset or liability for tax purposes” (12.5) • The tax base of an asset is the amount that will be deductible for tax purposes … when the entity recovers the carrying amount of the asset (12.7). • ie Tax base = future deductible amount • Note: if the future recovery of the asset is not taxable, the tax base is equal to the carrying amount. Institute of Certified Public Accountants of Kenya

17. Accounting for deferred tax • Examples 1, 2 and 3 Institute of Certified Public Accountants of Kenya

18. Accounting for deferred tax The tax base is ….. • …… the amount attributed to that asset or liability for tax purposes • 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 (12.8). • Note: in the case of revenue 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. Institute of Certified Public Accountants of Kenya

19. Accounting for deferred tax Examples • Examples 4, 5 & 6 Institute of Certified Public Accountants of Kenya

20. Accounting for deferred tax Revaluations ….. • Revaluations of property, plant and equipment increase the carrying amount of an asset without affecting the tax base. • They therefore create additional temporary differences on which deferred tax must be recognised (12.20). Institute of Certified Public Accountants of Kenya

21. Accounting for deferred tax Consolidation • Compare the group carrying value with the tax base. • Temporary differences may be affected by: • Elimination of inter-company items • Fair value adjustments – eg on acquisition of a subsidiary • Unification of accounting policies. Institute of Certified Public Accountants of Kenya

22. Accounting for deferred tax • Question 1 Institute of Certified Public Accountants of Kenya

23. Accounting for deferred tax Temporary differences can be ….. • taxable differences - giving rise to deferred tax liabilities; or • deductible differences - giving rise to deferred tax assets (12.5) Institute of Certified Public Accountants of Kenya

24. Accounting for deferred tax • Measurement – • the exceptions to the rule Institute of Certified Public Accountants of Kenya

25. Accounting for deferred tax Specific Exemption - Initial recognition • The tax effect of all temporary differences arising on initial recognition of an asset or liability which: • is not a business combination • at the time of the transaction, affects neither accounting profit nor taxable profit/loss, • should not be recognised (12.15). Institute of Certified Public Accountants of Kenya

26. Accounting for deferred tax Initial recognition of assets and liabilities Related to a business combination? Recognise DTA/DTL Yes No At the time of the transaction, affects accounting profit or taxable profit (tax loss)? Yes No Don’t recognise DTA/DTL Institute of Certified Public Accountants of Kenya

27. Accounting for deferred tax Initial recognition ….. • Question 2 • Saloon Car Institute of Certified Public Accountants of Kenya

28. Accounting for deferred tax • Saloon car – part 2 Institute of Certified Public Accountants of Kenya

29. Accounting for deferred tax Revaluations ….. • Revaluations of property, plant and equipment increase the carrying amount of an asset without affecting the tax base. • The resulting change in the temporary difference has not arisen on initial recognition. Therefore the deferred tax must be recognised (12.20). Institute of Certified Public Accountants of Kenya

30. Accounting for deferred tax Specific Exemption - Goodwill • No deferred tax liability shall be recognised in respect of goodwill arising in a business combination for which impairment is not deductible for tax purposes (12.15(b)). Institute of Certified Public Accountants of Kenya

31. Accounting for deferred tax • Measurement – Applicable rate Institute of Certified Public Accountants of Kenya

32. Accounting for deferred tax The applicable rate ….. Institute of Certified Public Accountants of Kenya

33. Accounting for deferred tax Expected manner • The measurement of deferred tax assets and liabilities should reflect the tax consequences that follow from the manner in which the enterprise expects to recover or settle the respective asset or liability (12.51). Institute of Certified Public Accountants of Kenya

34. Accounting for deferred tax Rate to be applied ….. • Deferred tax assets and liabilities should be computed at the rate expected to apply in the period when the asset is realised or the liability settled, based on rates enacted or substantively enacted at the balance sheet date (12.46). Institute of Certified Public Accountants of Kenya

35. Accounting for deferred tax Example of origination and reversal of temporary differences - PPE • Value • Carrying value = A • Tax base = B • Taxable temporary ___ • difference = C • === • Carrying value • Cost • A • C1 Provide via profit and loss account at income tax rates • B • C2 • Tax base • C3 • Time Institute of Certified Public Accountants of Kenya

36. Accounting for deferred tax Examples • Examples 7 & 8 Institute of Certified Public Accountants of Kenya

37. Accounting for deferred tax Measurement - discounting • Deferred tax assets and liabilities should not be discounted (12.53). Institute of Certified Public Accountants of Kenya

38. Accounting for deferred tax • Question 3 Institute of Certified Public Accountants of Kenya

39. Accounting for deferred tax • Recognition Institute of Certified Public Accountants of Kenya

40. Accounting for deferred tax Recognition ….. • All deferred tax liabilities should be recognised, except on goodwill and temporary differences subject to the initial recognition exception (12.15). • Deferred tax assets should be recognised to the extent that it is probable that taxable profit will be available against which the deductible temporary difference (including carry forward tax losses) can be utilised (12.24). • Annual reassessment is required (12.37). Institute of Certified Public Accountants of Kenya

41. Accounting for deferred tax Recognition ….. • Tax losses • The existence of tax losses is strong evidence that future taxable profit may not be available – there therefore has to be convincing evidence that it will be available (12.35). Institute of Certified Public Accountants of Kenya

42. Accounting for deferred tax • Question 4 and 5 Institute of Certified Public Accountants of Kenya

43. Accounting for deferred tax • Presentation and disclosure Institute of Certified Public Accountants of Kenya

44. Accounting for deferred tax Presentation …. • Deferred tax should be recognised in the profit and loss account except where the transaction giving rise to the asset or liability is recognised directly in equity, or from a business combination (12.58): eg • prior year adjustments • revaluation surpluses • “excess” depreciation. Institute of Certified Public Accountants of Kenya

45. Accounting for deferred tax Offsetting …. • Deferred tax assets and liabilities may be offset only if: • The entity has a legally enforceable right to set off current tax assets against current tax liabilities • The deferred tax assets and liabilities relate to income taxes levied by the same tax authority on the same taxable entity (12.74). Institute of Certified Public Accountants of Kenya

46. Accounting for deferred tax Disclosure in the notes to the profit and loss account….. • Definition: Tax expense is the aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax (12.5). • The components of the tax expense should be disclosed eg • current tax • deferred tax movement • prior period under/over provision • deferred tax asset not previously recognised (12.79). Institute of Certified Public Accountants of Kenya

47. Accounting for deferred tax Also ….. • Tax relating to discontinued operations (12.81(h)). Institute of Certified Public Accountants of Kenya

48. Accounting for deferred tax And ….. • ….. a reconciliation of: • the tax expense, to • the accounting profit multiplied by the applicable tax rate • The “proof of tax” (12.81(c)). Institute of Certified Public Accountants of Kenya

49. Accounting for deferred tax Proof of tax Institute of Certified Public Accountants of Kenya

50. Accounting for deferred tax Proof of tax Institute of Certified Public Accountants of Kenya