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Chapter 17 Accounting for Taxation

1. Objectives

1.1 Account for income taxes in accordance with HKAS 12.

1.2 Record entries relating to income taxes in the accounting records.1.3 Explain the effect of taxable temporar differences on accounting and taxable profit.

1.! "alculate deferred tax amounts.1.# Record deferred tax in the financial statements.

R e c o g n i t i o n $% e a s u r e m e n t

& r e s e n t a t i o n

' e f i n i t i o n

" u r r e n t( a x

( a x) a s e

R e c o g n i t i o n % e a s u r e m e n t ' i s c l o s u r e

( e m p o r a r ' i f f e r e n c e s

& e r m a n e n t' i f f e r e n c e s

' e f i n i t i o n

' e f e r r e d( a x

* n c o m e

( a x

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a/*ncome tax

4 4)an9 3# )al. b:d 3

*:S 0 underpro ision #

)al. c:d ! *:S 12 x 3 7/ !

,# ,#

b/*ncome tax

4 4)an9 2# )al. b:d 3

*:S 0 o erpro ision # *:S 12 x 3 7/ !)al. c:d !

, ,

2.! (xa$p!e 2 ) Tax !osses carried bac,

*n 2 1 )"" "o paid 4# in tax on its profits. *n 2 11 the compan made tax

losses of 42! . (he local tax authorit rules allow losses to be carried bac9 tooffset against current tax of prior ears.

%e*uired+

Show the tax charge and tax liabilit for 2 11.

So!ution+

(ax repa ment due on tax losses ; 3 7 x 42! ; 4, 2

(he double entr will be6'r 4/ "r 4/

(ax recei able S

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tax authorities.

2.# -resentation

a/ *n the statement of financial position tax assets and !iabi!ities should be

sho n separate!/ from other assets and liabilities.b/ "urrent tax assets and liabilities can be offset but this shou!d happen on!/

hen certain conditions app!/ .i/ (he enterprise has a !ega!!/ enforceab!e right to set off the

recogni=ed amounts.ii/ (he enterprise intends to sett!e the a$ounts on a net basis or to

rea!i'e the asset and sett!e the !iabi!it/ at the sa$e ti$e .

c/ (he tax expense income/ related to the profit and loss from ordinar acti itiesshould be shown on the face of the income statement.

0. eferred Tax ) ntroduction

3.1 'eferred tax is an application of the $atching concept . >nder the matching conceptthe tax conse5uences of a transaction or other e ent should be recognised at the sametime as the underl ing transaction or other e ent is recognised. (herefore if those tax

conse5uences are not recognised through the recognition of current tax in the periodi.e. the tax authorities will not ac9nowledge the transactions until a future period the

need to be recognised in the financial statements b accounting for deferred tax.3.2 'eferred tax is a basis of allocating tax expense to particular accounting periods. (he

9e to deferred tax !ies in the differences between the t o concepts of profit 6 the

accounting profit and the taxab!e profit .3.3 (he two figures of profit are unli9el to be the same because of per$anent

differences and te$porar/ differences .

3.! efinitions

a/ eferred tax !iabi!ities are the amounts of income taxes pa able in future

periods in respect of taxable temporar differences.b/ eferred tax assets are the amounts of income taxes reco erable in future

periods in respect of6i/ 'eductible temporar differencesii/ (he carr forward of unused tax losses

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iii/ (he carr forward of unused tax credits /c/ -er$anent differences ( ) are items included in the accounting

profit that will never be taxed or a!!o ed as reductions for example

di idends non-business entertainment disallowable/ and traffic finesdisallowable/. &ermanent differences will not re erse in future periods and

thus gi e rise to no tax effects in other periods .

d/ Te$porar/ differences ( ) are differences between the carr ingamount of an asset or liabilit in the statement of financial position and its tax

base. (emporar differences ma be either6i/ taxab!e te$porar/ difference / will result in an

increase in inco$e tax pa/ab!e in future reporting periods and

gi e rise to a deferred tax !iabi!it/ .ii/ deductib!e te$porar/ difference / will result in

a decrease in inco$e tax pa/ab!e in future reporting periods andgi e rise to a deferred tax asset .

e/ Tax base ( ) 0 the tax base of an asset or liabilit is the amountattributed to that asset or liabilit for tax purposes.

3.# (xa$p!es of taxab!e te$porar/ differences

a/ (ransactions affecting the inco$e state$ent 6i/ nterest revenue recei ed in arrears included in the accounting profit

on a time apportionment basis but taxable on a cash basis.ii/ epreciation of an asset is accelerated for tax purposes.

iii/ eve!op$ent costs ha e been capitali=ed and will be amortised to theincome statement but were deducted for tax purposes as incurred.

i / -repaid expenses ha e alread been deducted on a cash basis for tax

purposes but are to be charged in the income statement in a later period.b/ (ransactions affecting the state$ent of financia! position

i/ Current invest$ents are carried at fair alue which exceeds cost butremain at cost for tax purposes.

ii/ on3current assets are re alued upwards for accounting purposes withno ad?ustment for tax purposes.

3.@ (xa$p!es of deductib!e te$porar/ differencesa/ Accu$u!ated depreciation of an asset in the financial statements is greater

than the cumulati e depreciation allowed up to the balance sheet date for tax

purposes.b/ (he net rea!i'ab!e va!ue of an ite$ of inventor/4 or the recoverab!e amount

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of an item of propert plant or e5uipment is less than the pre ious carr ingamount and an enterprise therefore reduces the carr ing amount of the asset

but that reduction is ignored for tax purposes until the asset is sold.

c/%esearch costs

or organi=ation or other start up cost/ are recognised as anexpense in determining accounting profit but are not permitted as a deduction

in determining taxable profit until a later period.d/ nco$e is deferred in the state$ent of financia! position but has alread

been included in taxable profit in current or prior periods.

5. eferred Tax ) %ecognition and &easure$ent

!.1 %ecognitionHKAS 12 pro ides that6

a/ a deferred tax !iabi!it/ shall be recogni'ed for a!! taxab!e te$porar/differences

b/ a deferred tax asset shall be recogni'ed for a!! deductib!e te$porar/differences to the extent that it is probable that taxable profit will be a ailableagainst which the deductible temporar difference can be utili=ed.

"A# Te$porar/ differences arising fro$ state$ent of financia! position ite$s

!.2 %ost of the taxab!e te$porar/ differences and deductib!e te$porar/ differencesarise because of the difference bet een the carr/ing a$ount and the tax base of

assets and !iabi!ities in the state$ent of financia! position .

(a) Tax base of assets

!.3 HKAS 12 pro ides that the tax base of an asset is the amount that will be deductiblefor tax purposes against an taxable economic benefit that will flow to an entit when

it reco ers the carr ing amount of the asset.

!.! (xa$p!e 0 ) Accounting depreciation and tax depreciation

A)" Btd with 31 'ecember accounting ear-end/ bought a machiner at a cost of43 on 1 Canuar 2 11.

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straight-line method o er fi e ears.

Assume that tax rules allow the cost of machiner to be claimed o er three ears

commencing 2 11 on straight-line method.

"omparing the carr ing amount and the tax base of the machiner will ield thefollowing taxable temporar differences assume a tax rate of 2#7/6

Dear "arr ingamount

4/

(ax base

4/

(axable temporardifferences

4/

'eferred taxliabilit

4/

2 11 2! 2 ! 1

2 12 1 1 2

2 13 12 12 3

2 1! @ @ 1#

2 1#

!.# (xa$p!e 5 ) nterest inco$e

) Btd with 31 'ecember accounting ear-end/ recogni=es interest income on accrual basis.

Fn 31 'ecember 2 11 ) Btd accrues for an interest income recei able of 41 .

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financial position as at 31 'ecember 2 11 arising from sales for the ear.

nder the tax rules the granting and subse*uent repa/$ent of the !oan has notax conse*uences .

*n this case since the !oan is not taxab!e the tax base of the loan recei able amount

is deemed to be e5ual to its carr ing amount of 4# .

(here is thus no te$porar/ difference and conse5uentl no deferred taxliabilit :asset.

!. (xa$p!e 7 ) ividend receivab!e

E Btd has a di idend recei able account of 41 in its balance sheet as at 31'ecember 2 11.

Assuming the di idend is paid out of the exempt profit of the in estee the dividend

i!! not be taxab!e at the hand of E Btd under the rele ant tax rules.

*n this case since the di idend income is not taxable the tax base of the dividend

receivab!e account is dee$ed to be e*ua! to its carr/ing a$ount of 41 .

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(here is thus no te$porar/ difference and conse5uentl no deferred tax liabilit .

(b) Tax base of liabilities

!.G HKAS 12 pro ides that the tax base of a liabilit is its carr ing amount less anamount that will be deductible for tax purposes in respect of that liabilit in future

periods.

!.1 (xa$p!e 9 ) Accrued expense pa/ab!e

A)" Btd has an accrued expense pa able account of 41 in its statement of

financial position as at 31 'ecember 2 11.

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2 11 1 1

!.1# Su$$ar/

*t ma be useful to re$e$ber the funda$enta! princip!e upon which HKAS 12 is

based6 that an entit shall with certain limited exceptions recogni'e a deferred taxliabilit :asset henever recover/ or sett!e$ent of the carr/ing a$ount of an assetor a !iabi!it/ would $a,e the future tax pa/$ents !arger

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"=# Te$porar/ difference arising fro$ reva!uation of assets

!.1, >nder the Hong Kong tax rules re aluation of an item of propert plant ande5uipment under HKAS 1@ does not affect the tax base of the asset and the re aluation

surplus is not taxable in the period of re aluation. Howe er assuming the futurereco er of the carr ing amount with result in an inflow of taxable economic benefits

to the entit and the amount that will be deductible for tax purpose will differ from theamount of those economic benefits the difference between the carr ing amount of are alued asset and in tax base is a temporar difference.

!.1 HKAS 12 re5uires such temporar differences to be recogni=ed as deferred taxliabilit or asset. Assuming the gain

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4# 42 x 2#7/ should be recogni=ed.

Since the re aluation surplus is recorded directl in re aluation reser e the deferred

tax liabilit should similarl be ta9en directl to re aluation surplus.

"onse5uentl the re aluation in 2 @ will be recorded as follows6

'r. 4/ "r. 4/

Band 2Re aluation surplus 2

Re aluation surplus #'eferred tax liabilit #

Subse5uentl how the deferred tax liabilit is accounted for depends on whether ornot the gain on sale of land is taxable.

Scenario

Assume that the land is sold in 2 12 for 413 and the profit thereof attractstax at the rate of 2#7.

*n this case the taxable profit will be 43 413 0 41 / andthe tax pa able will be 4,# 43 x 2#7/. Howe er the accounting profitwill onl be 41 413 0 412 / and the tax expense thereof

shall be 42# 41 x 2#7/.

(he ?ournal entries to record the sale of land and the tax effect thereof will be asfollows6

'r. 4/ "r. 4/"ash 13

Band 12*:S 0 Jain on sale of land 1

(o record gain on sale of land/

'r. 4/ "r. 4/Re aluation reser e 1 #

Retained profit 1 #

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(o record reali=ation of re aluation surplus/

'r. 4/ "r. 4/

(ax expense 2#'eferred tax liabilit #

(ax pa able ,#(o record tax effect on gain on sale of land/

Scenario

Assume that the land is sold in 2 12 for 413 and the profit thereof is nottaxab!e . (he deferred tax liabilit pre iousl pro ided for should be re ersed.

*n this case the ?ournal entries related to the sale of land and the tax effect thereofwill be as follows6

'r. 4/ "r. 4/

"ash 13Band 12

*:S 0 Jain on sale of land 1(o record gain on sale of land/

'r. 4/ "r. 4/'eferred tax liabilit #

Re aluation reser e #(o record the re ersal of the deferred tax liabilit pre iousl pro ided for./

'r. 4/ "r. 4/

Re aluation reser e 1 #Retained profit 1 #

(o record reali=ation of re aluation surplus./

"C# Other issues

(a) Changes in tax rates

!.23 here the corporate rate of inco$e tax f!uctuates fro$ one /ear to another a

problem arises in respect of the amount of deferred tax to be credited debited/ to the

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statement of comprehensi e income in later ears.!.2! HKAS 12 re5uires deferred tax assets and liabilities to be $easured at the tax rates

expected to app!/ in the period hen the assets is rea!i'ed or !iabi!it/ sett!ed

based on tax rates and laws enacted at the end of the reporting period. *n other wordsHKAS 12 re5uires the liabilit method to be used.

!.2# (xa$p!e 10 ) Changes in tax rates

*n +o ember 2 11 the go ernment announced that the tax rate which has been 2 7

will be lowered to 2#7 effecti e from 1 Canuar 2 12.

A Btd has to a taxable profit of 41 for the ear ended 31 'ecember 2 11. *ts

taxable temporar differences ha e increased from 4# as at 31 'ecember 2 1to 4@ as at 31 'ecember 2 11.

*n this case the current tax pa able will be 42 measured based on 2 7. (hedeferred tax liabilit as at 31 'ecember 2 11 will be 41# 4@ x 2#7/

measured based on 2#7. (he deferred tax liabilit as at 31 'ecember 2 1 was41! 4# x 2 7//.

(he ?ournal entr to record the tax expense will be as follows6

'r. 4/ "r. 4/(ax expense 2G

'eferred tax liabilit 1(ax pa able 2

(he tax expense charged to the income statement for the ear ended 31 'ecember2 11 will therefore be 42G .

*n the statement of financial position as at 31 'ecember 2 11 the current tax pa able

will be carried at 42 and the deferred tax liabilit will be carried at 41# .

(b) Discounting

!.2@ HKAS 12 states that deferred tax assets and liabilities shou!d not be discounted because the complexities and difficulties in ol ed will affect reliabilit . 'iscounting

would re5uire detailed scheduling of the timing of the re ersal of each temporar

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difference but this is often impracticable.

6. isc!osure

#.1 (he main disclosure are6

a/ (he tax expense income/ should be presented on the face of the incomestatement.

b/ (he ma?or components of tax expense income/ should be disclosed separatelin a note.

c/ "urrent and deferred tax charged:credited directl to e5uit .

d/ (he amount of income tax relating to each component of other comprehensi eincome.

e/ An explanation of the relationship between tax expense income/ andaccounting profit in either or both of the following forms6

i/ a numerical reconciliation between tax expense income/ and the profitof accounting profit multiplied b the applicable tax rate s/ disclosing

also the basis on which the applicable tax rate s/ is are/ computed.ii/ a numerical reconciliation between the a erage effecti e tax rate and

the applicable tax rate disclosing also the basis on which the applicable

tax rate is computed.

(xa$ination St/!e >uestions

>uestion 1

Culian recognised a deferred tax liabilit for the ear end 31 'ecember 2 3 which related

solel to accelerated tax depreciation on propert plant and e5uipment at a rate 3 7. (he net boo9 alue of the propert plant and e5uipment at that date was 431 and the tax written

down alue was 423 .

(he following data relates to the ear ended 31 'ecember 2 !6

i/ At the end of the ear the carr ing alue of propert plant and e5uipment was 4!@and their tax written down alue was 42, . 'uring the ear some items werere alued b 4G . +o items had pre iousl re5uired re aluation. *n the tax

?urisdiction in which Culian operates re aluations of assets do not affect the tax base ofan asset or taxable profit. Jains due to re aluations are taxable on sale.

ii/ Culian began de elopment of a new product during the ear and capitalised 4@ in

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accordance with *AS 3 . (he expenditure was deducted for tax purposes as it wasincurred. +one of the expenditure had been amortised b the ear end.

iii/ CulianLs income statement showed interest income recei able of 4## but onl

4!# of this had been recei ed b the ear end. *nterest income is taxed on a receipts basis.

i / 'uring the ear Culian made a pro ision of 4! to co er an obligation to clean upsome damage caused b an en ironmental accident. +one of the pro ision had been

used b the ear end. (he expenditure will be tax deductible when paid.

(he corporate income tax rate recentl enacted for the following ear is 3 7 unchanged

from the pre ious ear/.

(he current tax charge was calculated for the ear as 4!# .

"urrent tax is settled on a net basis with the national tax authorit .

%e*uired+

a/ &repare a table showing the carr ing alues tax bases and temporar differences for

each for the items abo e at 31 'ecember 2 !.

b/ &repare the income statement and statement of financial position notes to the financialstatements relating to deferred tax for the ear ended 31 'ecember 2 !.

>uestion 2

a/ Explain with examples the nature and purpose of deferred taxation. 1 mar9s/

b/ (he information below relates to J for the ear ended 31 %arch 2 3.

(he balance on the pro ision for deferred taxation account at 1 April 2 2 was 43# .

(his represented taxation at 3#7 on cumulati e timing differences of 41 at 1April 2 2. "apital allowances tax depreciation/ and depreciation for the ear ending

31 %arch 2 3 are as follows.

"apital allowances 'epreciation

4 4

2 3 actual/ 1 G

(he income tax rate for 2 3 is 3 7 and is expected to remain at this le el for the

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foreseeable future.

%e*uired+

State with reasons how to account for deferred tax in the ear ended 31 %arch 2 3.

# mar9s/(otal 1# mar9s/

>uestion 0

a/ HKAS 12 *ncome (axes details the re5uirements relating to the accounting treatment of

deferred taxes.

%e*uired+

Explain wh it is considered necessar to pro ide for deferred tax and briefl outline the principles of accounting for deferred tax contained in HKAS 12 *ncome taxes.

! mar9s/

b/ )owtoc9 purchased an item of plant for 42 on 1 Fctober 2 . *t had an

estimated life of eight ears and an estimated residual alue of 4! . (he plant is

depreciated on a straight-line basis. (he tax authorities do not allow depreciation as adeductible expense. *nstead a tax expense of ! 7 of the cost of this t pe of asset can beclaimed against income tax in the ear of purchase and 2 7 per annum on a reducing

balance basis/ of its tax base thereafter. (he rate of income tax can be ta9en as 2#7.

%e*uired+

*n respect of the abo e item of plant calculate the deferred tax charge:credit in

)owtoc9Ls income statement for the ear to 3 September 2 3 and the deferred tax balance in the statement of financial position at that date. @ mar9s/

+ote. or9 to the nearest 4L . (otal ; 1 mar9s/

Amended A""A 2.#

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method.

A) depreciates all non-current assets at 2 7 a ear on the straight line basis.

(he rate of corporate income tax appl ing to A) for 2 3: ! and 2 !: # was 3 7. Assume

A) has no other 5ualif ing non-current assets.

%e*uired+

Appl HKAS 12 *ncome (axes and calculate6

i/ the deferred tax balance re5uired at 31 %arch 2 !

ii/ the deferred tax balance re5uired at 31 %arch 2 #iii/ the charge to the income statement for the ear ended 31 %arch 2 #.

# mar9s/

Adapted "*%A &, uestion 6

)" a small entit purchased its onl non-current tangible asset on 1 Fctober 2 3. (he assetcost 4G all of which 5ualified for tax depreciation.

)"8s asset 5ualified for an accelerated first ear tax allowance of # 7. (he second and

subse5uent ears 5ualified for tax depreciation at 2#7 per ear on the reducing balancemethod.

)"8s accounting depreciation polic is to depreciate the asset o er its useful economic life offi e ears assuming a residual alue of 4# .

Assume that )" pa s tax on its income at the rate of 3 7.

"alculate )"8s deferred tax balance re5uired in the balance sheet as at 3 September 2 #

according to HKAS 12 *ncome taxes.! mar9s/

Adapted "*%A &, uestion

"D had the following amounts for 2 3 to 2 #6

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Dear ended 31 'ecember6 2 3 2 ! 2 #

4 4 4

Accounting depreciation for the ear 1 @3 1 #G 1 #3

(ax depreciation allowance for the ear 2 12 1 @ 1 32

At 31 'ecember 2 2 "D had the following balances brought forward6

"ost of propert plant and e5uipment 5ualif ing for tax depreciation 2

Accounting depreciation #

(ax depreciation 12 #

"D had no non-current asset ac5uisitions or disposals during the period 2 3 to 2 #.

Assume the corporate income tax rate is 2#7 for all ears.

"alculate the deferred tax pro ision re5uired b HKAS 12 N*ncome (axesO at 31 'ecember 2 #.

3 mar9s/

Adapted "*%A &, uestion 7

Fn 31 %arch 2 @ "H had a credit balance brought forward on its deferred tax account of 4@!2 .

(here was also a credit balance on its corporate income tax account of 431 representing an o er-

estimate of the tax charge for the ear ended 31 %arch 2 #.

"H8s taxable profit for the ear ended 31 %arch 2 @ was 4G!@ . "H8s directors estimated the

deferred tax pro ision re5uired at 31 %arch 2 @ to be 4,#G and the applicable income tax rate

for the ear to 31 %arch 2 @ as 227.

"alculate the income tax expense that "H will charge in its income statement for the ear ended 31

%arch 2 @ as re5uired b *AS 12 *ncome (axes. 3 mar9s/

Adapted "*%A &, uestion 9

A go ernment wanted to encourage in estment in new non-current assets b entities and decided to

change tax allowances for non-current assets to gi e a 1 7 first ear allowance on all new non-

current assets purchased after 1 Canuar 2 #.

E' purchased new machiner for 4! on 1 Fctober 2 # and claimed the 1 7 first ear

allowance.

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E' had no other temporar differences. "alculate the amount of deferred tax that E' would show in

its balance sheet at 3 September 2 ,.

Assume E' had no other temporar differences.

"alculate the amount of deferred tax that E' would show in its balance sheet at 3 September 2 ,.

3 mar9s/

Adapted "*%A &, uestion : ) Te$porar/ differences of assets

(he cost of a machine is HK41 . (he carr ing amount of the machine is HK4 after

deducting accumulated depreciation of HK42 . (he machine is used with other assets to generate

taxable operating income. uestion 1; ) Te$porar/ differences of !iabi!ities

(he balance sheet of a reporting entit has the following liabilities6

1/ an interest pa able with a carr ing amount of HK41 the whole amount of which will be

deductible for tax purposes when it is paid

2/ a foreign currenc loan pa able with a carr ing amount of HK4G . Fn initial recognition

the carr ing amount of the foreign currenc loan was HK41 . (he carr ing amount was

subse5uentl reduced to HK4G to reflect the change in exchange rates that is a foreign

exchange gain was recognised. *n accordance with the rele ant tax regulations exchange gains

are taxable onl when the are realised that is when the entit settles the foreign currenc loan

and

3/ interest recei ed in ad ance with a carr ing amount of HK41 which has been taxed when

the interest was recei ed.

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Explain our calculations where it is necessar .

>uestion 12 ) &easure$ent of eferred Tax Assets and 8iabi!ities

An entit is in a ?urisdiction where income taxes are pa able at a higher rate of # 7 on undistributed

profits and a lower rate of 3#7 on distributed profits. (he difference is refundable when profits are

distributed. At the balance sheet date the entit does not recognise a liabilit for di idends of

HK41 declared after the balance sheet date. (axable income for the ear is HK41 . (he

net taxable temporar difference for the ear is HK4! .

%e*uired+

How should the entit account for the current and deferred taxes in relation to the di idends in its

financial statements for the current and subse5uent periodP