Income taxes (IAS 12) - Tax base, rate changes, and disclosu...

Learning Outcomes

After reading this article, you will be able to explain how tax base is determined for assets and liabilities, apply IAS 12 rules for deferred tax calculation under changing rates, and identify required disclosures in the financial statements. You will also be able to solve typical ACCA exam scenarios involving differences between accounting profit and taxable profit, temporary differences, and rate changes.

ACCA Financial Reporting (FR) Syllabus

For ACCA Financial Reporting (FR), you are required to understand the concepts, measurement, and disclosures relating to income taxes under IAS 12. The following syllabus areas are examined in this article:

• The meaning and determination of tax base for assets and liabilities.
• The effect of temporary differences on current and deferred tax.
• Calculation and accounting for deferred tax, including where tax rates change.
• Disclosure requirements related to income tax in the financial statements.

Test Your Knowledge

Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.

1. What is meant by the tax base of an asset, and how is it determined?
2. Suppose a company revalues property upwards and tax is only paid when it is sold. What deferred tax effect arises?
3. True or false? Changes to the tax rate affect only the current tax expense, not deferred tax.
4. Name two items that must be disclosed, per IAS 12, regarding income taxes in the financial statements.

Introduction

IAS 12 Income Taxes requires entities to account for both current tax and deferred tax arising from differences between accounting profit and taxable profit. Temporary differences—arising from differences in carrying amount and tax base—create deferred tax assets and liabilities. This article focuses on determining tax base, handling deferred tax where tax rates change, and the main disclosure obligations.

Key Term: tax base
The amount attributed to an asset or liability for tax purposes.

Key Term: temporary difference
The difference between the carrying amount of an asset or liability in the statement of financial position and its tax base.

Key Term: deferred tax
Tax expected to be payable or recoverable in future periods as a result of temporary differences and their reversal.

Tax Base: The Basis for Deferred Tax

The tax base is essential for recognising both current and deferred tax.

• For an asset, the tax base is the amount that will be deductible for tax against any future economic benefit. If none is deductible, the tax base equals carrying amount.
• For a liability, the tax base is the carrying amount less any amounts that will be deductible for tax in respect of that liability in the future.

Example: Tax Base Calculation

• A machine costs $100,000 and has a carrying amount of $60,000. If tax depreciation of $80,000 has already been claimed, the tax base is $20,000.

Worked Example 1.1

ABC Ltd has inventories included in the statement of financial position at $12,000. For tax, the cost of these inventories is only deductible when sold (none deducted yet). What is the tax base?

Answer:
The tax base of inventories is $12,000, as this amount will be deductible for tax purposes when the inventories are sold.

Worked Example 1.2

An entity has recognised a liability for interest payable of $5,000. For tax, interest is only deductible when paid. What is the tax base of the liability?

Answer:
The tax base is zero. No amount has been deducted yet for tax purposes, so the full $5,000 will be deductible in future.

Deferred Tax and Temporary Differences

The difference between carrying amount and tax base creates either a taxable or deductible temporary difference:

• Taxable temporary differences lead to deferred tax liabilities (future taxable profits).
• Deductible temporary differences lead to deferred tax assets (future deductions).

Deferred tax is measured by multiplying the temporary difference by the tax rate expected to apply when the asset or liability is realised or settled.

Rate Changes and Deferred Tax

When enacted or substantively enacted tax rates change, all deferred tax balances must be recalculated using the new rate.

Worked Example 1.3

An asset has a carrying amount of $10,000 and a tax base of $7,000. The current tax rate is 30%. The government announces that from next year, the rate will be 25%, enacted before year-end. How is deferred tax calculated?

Answer:
Temporary difference: $10,000 – $7,000 = $3,000 (taxable). Deferred tax liability = $3,000 × 25% = $750.

Exam Warning

A common mistake is to calculate deferred tax at the old tax rate if the change is enacted before the reporting date. Always use the latest enacted or substantively enacted rate for deferred tax.

Disclosures Required by IAS 12

Entities must present clear information about income taxes in their financial statements. Key disclosures include:

• The amount of current and deferred tax recognised in profit or loss and in other comprehensive income.
• The amount of deferred tax relating to items charged or credited directly to equity (for example, revaluation surplus).
• A reconciliation of accounting profit to the tax expense, identifying main components.
• Explanation of the tax effects of changes in rates, unused tax losses, and unrecognised deferred tax assets.

Key Term: tax reconciliation
The explanation provided in the notes, showing how the tax expense is derived from accounting profit, often as a percentage (effective tax rate).

Summary Table: Asset and Liability Tax Base

Key Point Checklist

This article has covered the following key knowledge points:

• Tax base is the amount attributed to an asset or liability for tax purposes
• Temporary differences between carrying amount and tax base give rise to deferred tax
• Deferred tax is adjusted when tax rates change and new rates are enacted before year end
• Key IAS 12 disclosures must cover current/deferred tax, rate changes, and tax reconciliations

Key Terms and Concepts

• tax base
• temporary difference
• deferred tax
• tax reconciliation