ACCA F7 (INT) Financial Reporting - Study text - 2010

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Chapter 14: Taxation

The basic principle of IAS 12 is that the tax effects of transactions should be reported

in the same accounting period as the transactions themselves.

Therefore deferred tax is recognised in full on all temporary differences.

3.4 Further examples of when deferred tax might arise

Because the tax treatment of items varies from country to country, any examination

question will have to specify the tax treatment of particular items. However, the

following examples from IAS12 illustrate the types of situation you might be

required to deal with in your examination.

Interest receivable

Interest may be received in arrears, leading to a receivable in the statement of

financial position. However, this interest may not be taxable until the cash is

received.

Example

Entity B includes interest receivable of $4,000 in its financial statements at 31

December Year 1. Interest is not taxed until it is received. The relevant tax rate is

30%.

Required

Calculate the deferred tax liability at 31 December Year 1.

Answer

The interest receivable of $4,000 is included in income for Year 1. However, tax on

the interest income is not included in current tax for Year 1, which means that

taxable profits in Year 1 will be higher than accounting profits by $1,200 (= $4,000 ×

30%).

When the interest is received (in Year 2) taxable profits will be higher than

accounting profits and therefore more tax will be payable.

A deferred tax liability of $1,200 should therefore be recognised in Year 1, and

deferred tax of $1,200 included in the total tax charge for the year.

The liability will reverse to $0 in Year 2, and the net tax charge in Year 2 will be

computed by subtracting the reduction in the deferred tax liability from the current

tax charge for Year 2.

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Development costs

In calculating accounting profits, development costs may be capitalised and

amortised (in accordance with IAS38). However, tax relief may be given for the

development costs as they are paid.

Example

In the year ended 30 June Year 1, Entity C incurred development costs of $320,000.

These were capitalised in accordance with IAS38, with an amortisation charge of

$15,000 in Year 1. Development costs are an allowable expense for tax purposes in

the period in which they are paid. The relevant tax rate is 30%.

Required

Calculate the deferred tax liability at 30 June Year 1.

Answer

The charge for development costs in Year 1 in the financial accounts is the

amortisation charge of $15,000. However, total development costs were $320,000,

attracting tax relief in full at the rate of 30%. Taxable profits will therefore be much

lower than accounting profits in Year 1.

The development costs incurred but not yet amortised of £305,000 should be deducted

from accounting profits to arrive at taxable profits. In future years, when the remaining

amortisation charges are added back to accounting profits to arrive at taxable profits,

taxable profits will be higher and therefore more tax will be payable.

A deferred tax liability should therefore be set up for $305,000 × 30% = $91,500.

This calculation may be presented more completely in either of two ways:

 $

Accountingprofitreducedfordevelopmentcostsamortisationby: (15,000)

Taxableprofitreducedfordevelopmentcostsby: (320,000)



–

––––––––

Difference (305,000)



–

––––––––

Deferrredtaxliability(×30%) $91,500

Alternatively:

Assetvalueinstatementoffinancialposition($320,000‐$15,000) (305,000)

Taxwritten‐downassetvalue 0



–

––––––––

Difference (305,000)



–

––––––––

Deferrredtaxliability(×30%) $91,500

Chapter 14: Taxation

3.5 Deferred tax assets

A temporary difference may sometimes result in a situation where taxable profits

are higher than accounting profits. In such cases, because more tax is payable now

and less tax will be payable later, a deferred tax asset should be created.

For example, interest may be paid to a third party in arrears but may only be

allowable for tax purposes when the cash is paid over.

However, IAS12 states that a deferred tax asset should only be recognised to the

extent that it is probable that the deferred tax can be recovered against future

taxable profits. For example, if it is anticipated that the entity will only have taxable

losses in the future then it may never be possible to recover the deferred tax asset

and the asset should not be recognised.

Where a deferred tax asset is recognised it should be:

 separately disclosed in the statement of financial position in accordance with

IAS1 Presentation of financial statements

 reviewed at the end of each reporting period and reduced to the extent that it is

no longer probable that it can be recovered against future taxable profits.

3.6 Deferred tax relating to revaluations

When an item is recognised in other comprehensive income, such as the revaluation

of a non-current asset, there might be an associated tax charge or tax credit.

IAS12 comments that, in the case of assets carried at fair value, the difference

between the carrying amount of a revalued asset and its tax base (i.e. written down

tax value) is a temporary difference that gives rise to a deferred tax liability or asset.

‘This is true even if the entity does not intend to dispose of the asset.’

If the asset is eventually sold at its revalued amount, additional tax will be payable.

Therefore, on revaluation, a deferred tax liability is set up. This is calculated as

follows.

Revaluation surplus × Tax rate = Deferred tax liability

The double entry is:

$ $

Dr Revaluation reserve X

Cr Deferred tax liability X

Example

A company recently re-valued a non-current asset from its carrying amount of

$300,000 to a revalued amount of $400,000. The revaluation surplus is $100,000. The

tax rate is 25%.

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On revaluation, a deferred tax liability should be created. This is $25,000 (= 25% ×

$100,000). The balance on the revaluation reserve is $75,000 (= the revaluation of

$100,000, minus the deferred tax liability of $25,000).

The increase in the deferred tax liability is reported in other comprehensive income

as the tax charge associated with the revaluation of the asset.

However, when the asset is eventually sold, and the tax on the gain is based on the

historical cost of the asset, the deferred tax liability is reduced to $0, reducing the

total reported tax charge for the year in which the disposal occurs.

3.7 Deferred tax in the examination

It is possible that you will be given a question specifically on deferred tax in your

examination, but it is perhaps more likely that you will be given a question in which

deferred tax is one of several items to consider.

For example, you might be given information in a question about the deferred tax

liability at the beginning of the financial year for a company, and also information to

enable you to calculate the deferred tax liability at the end of the year, and the

amount of deferred tax to include in profit or loss or in other comprehensive income

for the year.

Example

Entity XYZ had a deferred tax balance of $6 million at the beginning of its financial

year, on 1 January.

At 31 December, there were $45 million of taxable temporary differences, of which

$10 million related to a gain on the revaluation of a non-current asset. The income

tax rate is 20%.

How should deferred tax be reported in the financial statements for the year?

Answer

We need to establish the amounts for deferred tax to include in:

(a) the statement of financial position at the end of the year

(b) the tax charge in profit or loss for the year

Statement of financial position

Taxable temporary differences at the end of the year are $45 million and the tax rate

is 20%.

Therefore there should be a deferred tax liability of $9 million in the statement of

financial position at the end of the year.

Chapter 14: Taxation

Deferred tax in the tax charge in profit or loss for the year

Of the total taxable temporary differences, $10 million relates to the revaluation

gain, which is other comprehensive income. This means that taxable temporary

differences relating to profit and loss are $35 million (= $45 million - $10 million)

and deferred tax on this (at 20%) is $7 million.

The deferred tax balance at the beginning of the year was $6 million. There has been

an increase of $1 million in deferred tax that should be included in the total tax

charge for the year for inclusion in profit or loss.

Deferred tax in other comprehensive income

Other comprehensive income for the year includes the revaluation gain of $10

million, for which the related deferred tax is $2 million. Other comprehensive

income should report the revaluation gain of $10 million less the related deferred

tax of $2 million.

3.8 Other methods of accounting for deferred tax

IAS12 requires full provision to be made for deferred tax. This method is:

 easy to understand

 allows few opportunities for manipulation.

Two other methods of accounting for deferred tax are also theoretically possible, but

they are not permitted by IAS12.

 The nil provision method makes no provision for deferred tax. This method is

inconsistent with the accruals concept.

 The partial provision method only makes provision for deferred tax to the

extent that a liability is actually expected to arise. For example, perhaps an entity

expects to invest increasing amounts of money each year in property, plant and

equipment, so that the additions to the total deferred tax provision will always

exceed the ‘reversals’. Under the partial provision method, in this situation, no

liability for deferred tax would be recognised

The main problem with the partial provision method is the subjectivity involved in

making the decision about whether a deferred tax liability will actually arise. This

gives scope for manipulation of the reported accounting profits.

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Presentation and disclosure requirements of IAS12

 Presentation requirements

 Disclosure requirements

4 Presentation and disclosure requirements of IAS12

4.1 Presentation requirements

The major components of tax expense (or tax income) should be disclosed

separately. As indicated earlier, current and deferred tax should be recognised:

 in profit or loss for the period, except to the extent that the tax arises from a

transaction or event classified as other comprehensive income or recognised

directly in equity

 in other comprehensive income, if it relates to an item of other comprehensive

income

 recognised directly in equity, if it relates to an item that is recognised directly in

equity.

Current tax assets and current tax liabilities are included as current assets and

current liabilities in the statement of financial position. Current tax assets and

current tax liabilities should be offset against each other only if the entity:

 has a legally enforceable right of set-off, and

 either intends to settle the tax receivable/payable on a net basis, or to realise the

tax asset and settle the tax liability simultaneously.

Deferred tax assets and deferred tax liabilities are also included as assets and

liabilities in the statement of financial position.

4.2 Disclosure requirements

IAS12 requires additional disclosures in notes to the financial statements. These

include:

 The major components of the tax expense (or income) for the financial period.

These include:

− current tax

− the under-provision or over-provision for current tax from prior periods

− deferred tax due to temporary differences

− possibly, deferred tax due to changes in tax rates or the introduction of new

taxes.

Chapter 14: Taxation

Illustration:

Current tax for the year 101,500

Over-provision of tax in the previous year (32,000)

Deferred tax 56,000

–

––––––

Total tax charge 125,500

–

––––––

 The total current tax and deferred tax charged (or credited) directly to equity.

 The amount of tax relating to each component of other comprehensive income

 A ‘tax reconciliation’. This either

− reconciles the accounting profit multiplied by the applicable tax rate to the

tax expense, or

− reconciles the average effective tax rate to the applicable tax rate.

 An explanation of changes in the applicable tax rate, compared to the previous

accounting period.

Paper F7: Financial reporting (International)

Paper F7 (INT)

Financial reporting

CHAPTER

Reporting of non-group

financial statements

Contents

1 The examination question on non-group financial

statements

2 Example 1: Preparing financial statements from a

trial balance

3 Example 2: Re-stating draft financial statements

Paper F7: Financial reporting (International)

The examination question on non-group financial statements

 The ACCA approach to examining the syllabus

 Developing an approach to an answer

1 The examination question on non-group financial

statements

1.1 The ACCA approach to examining the syllabus

The syllabus for the F7 paper states that the second question in the paper will test

the reporting of non-group financial statements. This means that you will normally

be required to prepare the financial statements of a single company in accordance

with international accounting standards.

The question may take either of the following forms:

(a) Prepare financial statements from information in a trial balance together with

some supplementary information

(b) Re-state draft financial statements by making adjustments and corrections.

This type of question has two aims.

One is to test your ability to present financial statements in accordance with the

requirements of IAS1. You might be required to prepare a statement of financial

position and/or either a statement of comprehensive income or just the income

statement element of a statement of comprehensive income. You might also be

expected to present a statement of changes in equity, or calculate the earnings per

share.

The second aim of such questions is to test your understanding of a range of

accounting standards, by expecting you to make adjustments so that the reported

figures in your financial statements comply with the relevant standard. You will

therefore apply your understanding of a number of different topics that have been

covered in the previous chapters of this text.

The purpose of this chapter is to provide some guidance on how to deal with this

type of examination question.

1.2 Developing an approach to an answer

To answer this type of question, you are strongly advised to present clear workings,

so that for each accounting adjustment that you make, the marker can see clearly

what you are trying to do. As a general rule, you should be able to deal with each

adjustment individually. The adjustments you need to make will be:

 Normal end-of-year adjustments, such as calculations for depreciation charges

and any accruals or prepayments

ACCA F7 (INT) Financial Reporting - Study text - 2010 - Emile Woolf Publishing

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