Learning Outcomes
After reading this article, you will be able to identify when deferred tax is not recognised under IAS 12, distinguish between taxable and deductible temporary differences, and calculate the tax base of common assets and liabilities. You will understand the key recognition exceptions for deferred tax and apply the tax base principle in both accounting and exam scenarios.
ACCA Strategic Business Reporting (SBR) Syllabus
For ACCA Strategic Business Reporting (SBR), you are required to understand the recognition, measurement, and exceptions for current and deferred tax in accordance with IAS 12 Income Taxes. This article focuses on the following key syllabus areas:
- Explain the need for deferred tax and recognise temporary differences
- Calculate and interpret tax bases for assets and liabilities
- Identify the main exceptions to recognition of deferred tax assets and liabilities
- Apply IAS 12 rules for recognition exceptions, including goodwill and initial recognition
- Analyse the impact of tax base calculations on 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.
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Which of the following does not result in recognition of a deferred tax liability or asset under IAS 12?
- Tax allowances on PPE differ from accounting depreciation
- Initial recognition of goodwill
- Accrued interest income taxed on receipt
- Revaluation of assets with no equivalent tax impact
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Define the tax base of an asset and give one example each for a tax base higher and lower than carrying amount.
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Deferred tax is not recognised for a liability arising on initial recognition if:
- The transaction is a business combination
- The transaction affects neither accounting nor taxable profit
- The asset acquired has a tax base higher than its carrying amount
- The asset relates to share-based payment
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True or false? All deductible temporary differences lead to recognition of a deferred tax asset.
Introduction
IAS 12 Income Taxes sets the rules for recognising both current and deferred tax in the financial statements. Deferred tax ensures profits are matched with their tax effects, but certain transactions are excluded. Understanding when to recognise deferred tax—and when not to—is fundamental for accurate reporting and critical in the ACCA SBR exam. You must also be able to determine the tax base for assets and liabilities, as this is the starting point for all deferred tax calculations. Mistakes often arise from confusion over recognition exceptions and tax base principles, so clarity on these points is essential.
Recognition of Deferred Tax: The Principle
IAS 12 requires deferred tax to be recognised for all taxable temporary differences (which produce deferred tax liabilities) and all deductible temporary differences (which may produce deferred tax assets, subject to certain restrictions).
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: Taxable temporary difference
A temporary difference that will result in taxable amounts in future periods when the asset is recovered or the liability is settled.Key Term: Deductible temporary difference
A temporary difference that will result in amounts deductible in future periods when the asset is recovered or the liability is settled.
Deferred tax ensures tax impacts are recognised in the same period as the related accounting profit, not when the tax authority eventually assesses tax.
Tax Base: The Basis for Deferred Tax
The tax base is essential for identifying temporary differences. You must compare carrying amount to tax base for every asset and liability.
Key Term: Tax base
The amount attributed to an asset or liability for tax purposes.
For assets, the tax base is the amount that will be deductible for tax purposes against future taxable economic benefits. For liabilities, it is the carrying amount less any amount that will be deductible in the future.
Worked Example 1.1
A company holds equipment with a carrying amount of $120,000, tax written down value (tax base) of $100,000. What is the temporary difference and deferred tax impact at a tax rate of 25%?
Answer:
Carrying amount: $120,000
Tax base: $100,000
Temporary difference: $20,000 (taxable)
Deferred tax liability: $20,000 × 25% = $5,000
Recognition Exceptions: When Not to Recognise Deferred Tax
There are three main exceptions where deferred tax is not recognised under IAS 12:
1. Initial recognition of goodwill
No deferred tax is recognised for temporary differences arising on the initial recognition of goodwill from a business combination. Recognising such a deferred tax would increase goodwill, defeating the purpose of the exemption.
Key Term: Goodwill (for IAS 12 recognition exception)
The excess of purchase consideration over the acquirer's interest in the net fair value of identifiable assets and liabilities at acquisition, excluding recognised deferred tax liabilities arising from goodwill itself.
2. Initial recognition of an asset or liability (not in a business combination)
No deferred tax is recognised for temporary differences arising when:
- the transaction is not a business combination;
- at the time of the transaction, it affects neither accounting profit nor taxable profit.
This avoids dealing with deferred tax on routine asset acquisitions—such as for assets that are not deductible for tax purposes.
Key Term: Initial recognition exemption
The prohibition on recognising deferred tax for temporary differences upon the initial recognition of assets or liabilities, outside of a business combination, where the transaction does not affect accounting or taxable profit.
3. Investments in subsidiaries, branches, associates, joint arrangements
Deferred tax is not recognised for temporary differences arising from investments if:
- The parent, investor, or venturer can control the timing of reversal, and
- It is probable that the temporary difference will not reverse in the foreseeable future.
Worked Example 1.2
Entity purchases a building for $1 million that is not deductible for tax. Carrying amount is $1 million; tax base is $nil. Should a deferred tax liability be recognised at acquisition?
Answer:
No. The difference arises from initial recognition (not in a business combination) and affects neither accounting nor taxable profit. The initial recognition exemption applies—no deferred tax liability is recorded at acquisition.
Exam Warning
Deferred tax must be recognised for revaluations of assets even if there is no intention to sell, unless the exception arises due to initial recognition or goodwill. Students frequently omit deferred tax on asset revaluations—this is a common exam trap.
Tax Base Calculations: Assets and Liabilities
Accurate tax base calculation is required for every deferred tax assessment.
Tax Base of an Asset
- If economic benefits are taxable: Tax base = Amount deductible for tax against future economic benefits.
- If benefits are not taxable: Tax base = Carrying amount.
Tax Base of a Liability
- If settlement leads to taxable outflow: Tax base = Carrying amount less amounts deductible for tax in settling the liability.
- Revenue received in advance: Tax base = Carrying amount less any amount of revenue not taxable in the future.
Worked Example 1.3
An entity has interest receivable recorded at $2,000. The interest will be taxed when received (not yet taxed). What is the tax base?
Answer:
Tax base = $0 (no tax has been paid or recognised yet)
Temporary difference = $2,000 (carrying amount) – $0 (tax base) = $2,000 taxable temporary difference.
Worked Example 1.4
A liability for accrued expenses stands at $4,000. Tax deduction only allowed when paid. What is the tax base?
Answer:
Tax base = $0
Temporary difference = Carrying amount ($4,000) – Tax base ($0) = $4,000 deductible temporary difference
Revision Tip
For quick tax base checks: ask whether future recovery (assets) or settlement (liabilities) creates taxable or deductible amounts. Always compare carrying amount with future tax consequences.
Summary
IAS 12 requires deferred tax to be recognised for most temporary differences unless specifically exempt. The main exceptions are for goodwill, initial recognition outside a business combination, and certain investments. Understanding how to determine tax bases is fundamental—these underpin all temporary difference calculations. Knowing when the initial recognition exception applies is critical for both financial reporting and examination success.
Key Point Checklist
This article has covered the following key knowledge points:
- Identify taxable and deductible temporary differences for deferred tax
- Calculate the tax base for assets and liabilities
- Explain the three main recognition exceptions for deferred tax under IAS 12
- Apply the initial recognition exception to practical scenarios
- Recognise situations when deferred tax must not be recorded, specifically for goodwill and certain initial asset and liability acquisitions
Key Terms and Concepts
- Temporary difference
- Taxable temporary difference
- Deductible temporary difference
- Tax base
- Goodwill (for IAS 12 recognition exception)
- Initial recognition exemption