Accounting policies and options, CIG, 2022-2023, Classes 6-7

IAS 12 Income taxes

IFRS may require the use of certain (accounting) policies and options that might not be recognized from a
tax perspective. Therefore, differences may appear between the income tax calculated in financial reporting
and income tax payable (i.e., established in accordance with tax rules). If these differences are temporary
(reversible over time), they are dealt with via the deferred tax mechanism.

Example 1
Determine any differences between the financial reporting and the tax treatments over the useful life of an
asset in each of the following independent cases (accounting profit for the year is 1,000 CU; the applicable
income tax rate is 16%):
a) An entity purchases an asset on 1.1.N for 600 CU. Its management estimates an even use of the
asset, over 3 years, and no residual value. For tax purposes though, the asset is depreciated on 2
years, also by using the SLM.
b) What if the asset is depreciated on 2 years for financial reporting purposes, and on 3 years for tax
purposes?

Solution a)
Financial reporting depreciation Tax depreciation
Date Annual Carrying Date Annual tax Tax base
depreciation amount depreciation
1.1.N 1.1.N
31.12.N 31.12.N
31.12.N+1 31.12.N+1
31.12.N+2 31.12.N+2

Solution b)
Financial reporting depreciation Tax depreciation
Date Annual Carrying Date Annual tax Tax base
depreciation amount depreciation
1.1.N 1.1.N
31.12.N 31.12.N
31.12.N+1 31.12.N+1
31.12.N+2 31.12.N+2

Example 2

Discuss the extent to which differences between accounting and taxation appear in each of the following
cases, from an income tax perspective:
a) A piece of equipment is depreciated over 3 years, and it has a big residual value.
b) A building is revalued; the revaluation is required by the tax authority.
c) FIFO is used for inventories. FIFO is also recognized for the computation of the taxable profit.
d) Accounts receivable are written down. The adjustment is not tax deductible.
e) The company was fined. The fines are not deductible for tax purposes.

Solution
a)
b)
c)
d)
e)
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© Professor Catalin Albu, Department of Accounting and Auditing, ASE Bucharest
 Accounting policies and options, CIG, 2022-2023, Classes 6-7

IAS 12 Income taxes covers the income taxes resulting from temporary differences between accounting
and tax bases, which generate deferred taxes. Permanent differences do not reverse over time (they will
only be recognized for either accounting or tax purposes).

If it is probable that the recovery or settlement of the carrying amount of an asset or a liability will make
future tax payments larger (smaller) than they would be if such recovery or settlement were to
have no tax consequences, IAS 12 requires an entity to recognize a deferred tax liability (deferred tax
asset), with certain limited exceptions.

Example 1 (cont.): check this statement on data in Example 1 above.

Solution:
a)

b)

Accounting profit is profit or loss for a period before deducting tax expense.

Taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with the rules established
by the taxation authorities, upon which income taxes are payable (recoverable).

Tax expense (tax income) is the aggregate amount included in the determination of profit or loss for the
period, in respect of current tax expense (income) and deferred tax expense (income).

Current tax is the amount of income taxes payable (recoverable) for a period in respect of the taxable
profit (tax loss) for that period.

Deferred tax liabilities are the amounts of income taxes payable in future periods in respect of taxable
temporary differences.

Deferred tax assets are the amounts of income taxes recoverable in future periods in respect of deductible
temporary differences and other items.

Temporary differences (TD) are differences between the carrying amount of an asset or liability in the
statement of financial position and its tax base. Temporary differences reverse over time. TDs may be:
(a) taxable temporary differences (TTD), which are temporary differences that will result in taxable
amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset
or liability is recovered or settled; or
(b) deductible temporary differences (DTD), which are temporary differences that will result in amounts
that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of
the asset or liability is recovered or settled.

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 Accounting policies and options, CIG, 2022-2023, Classes 6-7

Example 1 (cont.) Identify accounting and taxable profit, how much tax expense should be, and how much
current tax expense is, in example 1 above.

a) N a) N+1 a) N+2 Total tax b) N b) N+1 b) N+2 Total tax

Accounting profit
Tax expense
Taxable profit
Current tax expense

Example 2 (cont.) Are the differences identified in example 2 above temporary or permanent?

Solution
a)
d)
e)

The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes. Here
are the rules for determining TB for assets and liabilities, and the resulting type of temporary differences.
You must know how to apply these rules.

TB of assets is the of liabilities is the

amount that will be deductible for tax purposes carrying amount less any amount that will be
against any taxable economic benefits that will deductible for tax purposes in respect of that
flow to an entity when it recovers the carrying liability in future periods (=carrying amount
amount of the asset (amount deductible in the minus any amount that is deductible in the
future for tax purposes). future for tax purposes).
If the recovery of the asset or the settlement of a liability will have no tax consequences, then the
item’s TB equals its CA.
If the corresponding line (of the asset or liability) is a revenue, and:
- if the revenue is taxable in the future, the deductible amount is 0;
- if the revenue is not taxable in the future (e.g., because it was already taxed, or the corresponding
expense was not tax deductible), the deductible amount is the amount of the revenue.
CA>TB → Taxable temporary differences (TTD) →Deductible temporary differences (DTD)
CA<TB →Deductible temporary differences (DTD) →Taxable temporary differences (TTD)

Example 1 (cont.) Identify any TTD/DTD in Example 1 above.

Solution
a)
Date CA TB TTD DTD
31.12.N
31.12.N+1
31.12.N+2
b)
Date CA TB TTD DTD
31.12.N
31.12.N+1
31.12.N+2

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© Professor Catalin Albu, Department of Accounting and Auditing, ASE Bucharest
 Accounting policies and options, CIG, 2022-2023, Classes 6-7

Example 3
Calculate any temporary differences in each of the following cases, as at 31.12.N, by using the following
table:
1) equipment was purchased at the beginning of year N-1, for CU1,000. For accounting purposes, the
item is depreciated on a straight-line basis, on 5 years; from a tax perspective, it is depreciated on
a SL basis as well, but on 4 years.
2) accounts receivable is CU1,000; revenues are recognized for tax purposes when they are recognized
in accounting.
3) prepaid expenses of CU500 – representing rent prepaid in year N for N+1; the amount is tax
deductible when it is recognized in accounting.
4) fines payable CU200; the fines are not tax deductible.
5) deferred income CU300 – representing royalties received in advance in year N, for year N+1; the
revenue is taxed when it is recognized in accounting.
6) deferred income CU1,500 – representing interest received in advance in year N, for year N+1; the
amount is taxed on a cash basis.
7) warranty provisions of CU600, of which CU200 are tax deductible when they are recognized in
accounting.

Solution

Item Nature of item CA TB TTD DTD

1 Equipment
2 Accounts receivable
3 Prepaid expenses
4 Fines payable
5 Deferred income 300
6 Deferred income 1,500
7 Warranty provisions
Total

Par. 15 A deferred tax liability shall be recognised for all taxable temporary differences […]

Par. 24 A deferred tax asset shall be recognised for all deductible temporary differences to the
extent that it is probable that taxable profit will be available against which the deductible temporary
difference can be utilized […]

Example 1 (cont.) Journalize the deferred tax implications in Example 1 above and determine the
resulting tax expense.

Solution
a) As a reminder,
Date CA TB TTD DTD
31.12.N 400 300 100 -
31.12.N+1 200 0 200 -
31.12.N+2 0 0 0 -

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© Professor Catalin Albu, Department of Accounting and Auditing, ASE Bucharest
 Accounting policies and options, CIG, 2022-2023, Classes 6-7

b) as a reminder,
Date CA TB TTD DTD
31.12.N 300 400 - 100
31.12.N+1 0 200 - 200
31.12.N+2 0 0 - 0

Example 3 cont. Journalize any deferred taxes resulting from the cases above (the applicable
income tax rate 16%).

Solution
As a reminder,
Item Nature of item (A/L) CA TB TTD DTD
Total 100 1900

Par. 61A Current and deferred tax shall be recognized outside profit or loss if the tax relates to
items that are recognized, in the same or a different period, outside profit or loss.

Example 4 The following information relates to the end of years N and N+1:
End of N End of N+1
TTD 10,000 8,000
DTD 6,000 9,000

A DTL of CU1,000 existed at the beginning of year N. The applicable income tax rate is 16%.
1) Journalize any deferred taxes resulting for the two years.
2) What would it be different if the entity had revalued its land properties in N+1, which
generated a TTD of CU1,500?

Solution
1) Year N

Year N+1

2) Year N+1 only

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© Professor Catalin Albu, Department of Accounting and Auditing, ASE Bucharest
 Accounting policies and options, CIG, 2022-2023, Classes 6-7

Example 5
Merchandise is held at the end of the year N and N+1 for CU1,000. The net realizable value of this
merchandise at 31.12.N is CU950, and is CU1,050 as of December 31 N+1. The value adjustments
for inventory write-down are not tax deductible. The accounting profit of each year is CU500. The
applicable income tax rate is 16%. Determine any deferred taxes and explain their impact on the
financial statements.

Solution

Year N

Year N+1

Example 6
An entity purchases transportation equipment on January 1 N for CU1,000. A useful life of 3 years
and a residual value of CU100 are estimated in accounting. The asset is depreciated for tax
purposes on 4 years. SLM is used for both accounting and tax purposes. The asset is sold at the
end of its useful life for CU100. The yearly accounting profit is CU1,000. The applicable income
tax rate is 16%.
a) Determine the yearly depreciation for accounting and tax purposes, the asset’s carrying
amount and its tax base, and any temporary differences resulting over the asset’s useful
life
b) Determine any deferred taxes effect
c) Calculate the current tax and discuss the impact of deferred taxation on the financial
statements of the three years of the useful life (N, N+1 and N+2) (compute tax expense).

Solution
Date Depreciable Annual Accumulated CA TB DTD
amount depreciation depreciation

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 Accounting policies and options, CIG, 2022-2023, Classes 6-7

Par. 81A An entity shall also disclose separately an explanation of the relationship between tax
expense (income) and accounting profit.

Example 7
The accounting profit of year N was CU15,000, and the taxable profit was CU14,000. Fines were
recorded for CU1,000. TTD at the end of year N amounted to CU20,000, and DTD to CU1,000.
DTL had an opening balance for year N of CU2,720. Discuss the relationship between the
accounting profit and the tax expense (i.e., calculate the effective income tax rate), if the applicable
income tax rate is 16%.

Solution

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© Professor Catalin Albu, Department of Accounting and Auditing, ASE Bucharest