IAS 12 Income Taxes

Understanding IAS 12: Income Taxes

IAS 12 is a critical standard in financial reporting that deals with the accounting treatment for income taxes. The main objective of IAS 12 is to prescribe how to account for the current and future tax consequences of various transactions and events recognized in an entity’s financial statements. This blog post will explore the key concepts, principles, and important things to look out for when dealing with IAS 12, along with some relevant formulas and notes.

Objective and Scope

The primary objective of IAS 12 is to establish the accounting treatment for income taxes, ensuring that entities recognize the tax consequences of transactions and events in the same way that they account for those transactions and events themselves. For example, if a transaction is recognized in profit or loss, any related tax effects should also be recognized in profit or loss. Similarly, if a transaction is recognized outside profit or loss (e.g., in other comprehensive income or directly in equity), the related tax effects should also be recognized outside profit or loss.

IAS 12 applies to all domestic and foreign taxes based on taxable profits, including withholding taxes payable by a subsidiary, associate, or joint arrangement on distributions to the reporting entity.

Key Definitions

• Accounting Profit: Profit or loss before tax expense is deducted.

• Taxable Profit (Tax Loss): Profit (loss) for a period as determined by the tax authorities.

• Current Tax: The amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period.

• Deferred Tax Liabilities: Amounts of income taxes payable in future periods in respect of taxable temporary differences.

• Deferred Tax Assets: Amounts of income taxes recoverable in future periods in respect of deductible temporary differences, unused tax losses, and unused tax credits.

Recognition of Current and Deferred Taxes

Current Tax Liabilities and Assets

Current tax for the current and prior periods should be recognized as a liability to the extent it is unpaid. If the amount already paid exceeds the amount due, the excess should be recognized as an asset. For instance, if a tax loss can be carried back to recover current tax of a previous period, it should be recognized as an asset when it occurs.

Deferred Tax Liabilities and Assets

A deferred tax liability should be recognized for all taxable temporary differences unless it arises from the initial recognition of goodwill or the initial recognition of an asset or liability in a transaction that is not a business combination and affects neither accounting profit nor taxable profit.

Deferred tax assets should be recognized for all deductible temporary differences, unused tax losses, and unused tax credits to the extent that it is probable that taxable profit will be available against which they can be utilized.

Measurement of Current and Deferred Taxes

Current tax liabilities (assets) should be measured at the amount expected to be paid to (recovered from) the taxation authorities, using the tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period.

Deferred tax liabilities and assets should be measured using the tax rates expected to apply to the period when the liability is settled or the asset is realized, based on tax rates (and tax laws) that have been enacted or substantively enacted by the end of the reporting period.

Key Formulas and Examples

Calculation of Deferred Tax Liability

To calculate a deferred tax liability, you can use the following formula:

Deferred Tax Liability=(Carrying Amount−Tax Base)×Tax Rate

Example: An asset has a carrying amount of 100, a tax base of 60, and the tax rate is 25%.

Deferred Tax Liability=(100−60)×0.25=40×0.25=10

Calculation of Deferred Tax Asset

To calculate a deferred tax asset, you can use the following formula:

Deferred Tax Asset=(Tax Base−Carrying Amount)×Tax Rate

Example: A liability has a carrying amount of 100, a tax base of 120, and the tax rate is 25%.

Deferred Tax Asset=(120−100)×0.25=20×0.25=5

Important Considerations

When dealing with IAS 12, there are several critical points to keep in mind:

1. Temporary Differences: Understanding the distinction between taxable and deductible temporary differences is essential for correctly recognizing deferred tax liabilities and assets.

2. Tax Rate Changes: Always consider the tax rates that have been enacted or substantively enacted by the end of the reporting period, as these rates will impact the measurement of deferred tax assets and liabilities.

3. Recognition of Deferred Tax Assets: Be cautious and only recognize deferred tax assets to the extent that it is probable that future taxable profits will be available to utilize these assets.

4. Presentation and Disclosure: Properly present and disclose the components of tax expense (income), current tax, and deferred tax in the financial statements. Provide detailed disclosures about the nature of the temporary differences, the amounts of deferred tax assets and liabilities, and any unrecognized deferred tax assets.

Conclusion

IAS 12 provides a comprehensive framework for accounting for income taxes, ensuring that entities accurately reflect the tax consequences of their transactions and events in their financial statements. By adhering to the principles and guidelines set out in IAS 12, entities can achieve greater transparency and comparability in their financial reporting, aiding stakeholders in making informed decisions.

Understanding the nuances of IAS 12, from recognizing and measuring current and deferred taxes to the detailed presentation and disclosure requirements, is crucial for accurate financial reporting and compliance with international accounting standards.