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It's funny how many quotes are credited to Albert Einstein. Some years ago, I came across this quote credited to Einstein, "the hardest thing in the world to understand is the income tax".
Income taxes truly can be complex but the main aim is to ensure companies provide a fair and accurate representation of their income tax liabilities. Some of the key concepts in IAS 12 are explained below.
Current tax: The amount of income tax payable (or recoverable) for the current period.
Deferred tax: The amount of income tax that will be payable (or recoverable) in future periods as a result of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their respective tax bases.
Temporary differences: Differences between the carrying amounts of assets and liabilities for financial reporting purposes and their respective tax bases.
Deferred tax asset: A deferred tax asset is recognized when it is probable that future taxable profits will be available against which the deductible temporary differences can be utilized.
Deferred tax liability: A deferred tax liability is recognized for all taxable temporary differences, except for those that arise from goodwill and certain other intangible assets.
This blog post compiles for you guidance made available by thought leaders to help you with the learning and understanding of IAS 12 Income taxes.
Fun facts:
The world's oldest known income tax system was implemented in ancient Egypt around 3000 BC.
In some countries, such as Denmark and Sweden, citizens are required to pay taxes on their pets.
In the United Kingdom, there is a tax on gambling winnings, but not on losses.
The first income tax in the United States was introduced in 1861 to help fund the Civil War.
The highest income tax rate in the United States was 94% during World War II.
The average American spends about 7 hours per year filling out their income tax form.
The Internal Revenue Service (IRS) receives over 150 million individual income tax returns each year.
We will use the scenario below to explain the key concepts in IAS 12.
Company A is a manufacturing company that uses the straight-line method for depreciation for financial reporting purposes and the accelerated depreciation method for tax purposes. As a result, the company has a temporary difference between the carrying amount of its depreciable assets for financial reporting purposes and their respective tax bases.
In the current year, Company A has a pre-tax profit of $1,000,000. For financial reporting purposes, the company's depreciation expense is $100,000. However, for tax purposes, the company's depreciation expense is $200,000. As a result, the company's taxable income is $800,000.
The company's current tax expense is calculated as follows:
Taxable income * Tax rate = Current tax expense
$800,000 * 30% = $240,000
The company's deferred tax liability is calculated as follows:
Temporary difference * Tax rate = Deferred tax liability
($100,000) * 30% = $30,000
The company's deferred tax asset is calculated as follows:
Temporary difference * Tax rate = Deferred tax asset
($200,000) * 30% = $60,000
In summary
Current tax is the amount of income tax payable (or recoverable) for the current period. In this scenario, Company A's current tax expense is $240,000.
Deferred tax is the amount of income tax that will be payable (or recoverable) in future periods as a result of temporary differences. In this scenario, Company A's deferred tax liability is $30,000 and its deferred tax asset is $60,000.
Temporary differences are differences between the carrying amounts of assets and liabilities for financial reporting purposes and their respective tax bases. In this scenario, the temporary difference is the difference between the company's depreciable assets for financial reporting purposes ($1,000,000) and their respective tax bases ($800,000).
A deferred tax asset is recognized when it is probable that future taxable profits will be available against which the deductible temporary differences can be utilized. In this scenario, the company has a deferred tax asset of $60,000 because it is probable that the company will have future taxable profits against which it can utilize the $200,000 in deductible temporary differences.
A deferred tax liability is recognized for all taxable temporary differences, except for those that arise from goodwill and certain other intangible assets. In this scenario, the company has a deferred tax liability of $30,000 because it is probable that the company will have to pay taxes on the $100,000 in taxable temporary differences in the future.
The below resources (PDF and eLearn) provide comprehensive coverage of IAS 12 Income taxes, including its key requirements and practical guidance. Whether you're new to IAS 12 or looking for a refresher, these resources are valuable.
Click the links below to download them.
IAS 12 Income taxes
Source: ACCA
eLearn
Source: Deloitte
Deloitte IAS 12 Income taxes eLearn 1
Deloitte IAS 12 Income taxes eLearn 2
Source: BDO
PS: All resources above are sourced directly from the public domain of the owners as made publicly available by them and are compiled here by IFRS IS EASY for your convenience.
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