Accounting for Income Taxes (IAS 12)

● IAS 12 covers both current tax and deferred tax.

● Generally, the assumption, until now, is that accounting for income tax was a very straight
forward for organization taxable profits would be computed and recorded as follows:

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Tax Expense x

Tax payable (i.e. accrued) x

● However, complexities arise when we consider the future tax consequences of what is
going on it the accounts now. This is an aspect of tax called diferred tax.

Definitions of key terms

a) Accounting profit.
It is the net profit or loss for a period before deducting tax expense (i.e. PBT)

b) Taxable profit
It is the profit (or loss) for a period, determined in accordance with the rules established
by the taxation authorities (e.g. KRA) upon which income tax are payable.
c) Tax Expense (Tax Income)
The aggregate amount of tax included in the determination of the net profit or loss for a
period in respect current tax and deferred tax.

IAS 12 – Income taxes therefore states that there are two elements of tax that will need
to be accounted for. They include:

1. Current Tax
 It is the amount of tax that is actually payable to the tax authority in relation to the
trading activities of the entity during the period.

NB:
Current tax is different from corporation tax as it is based on taxable profit
determined by the tax authority (and not the company) and it excludes incomes or
expenses that the tax authority considerers to be disallowable items.

2. Deffered Tax
● It is the estimated future tax consequences of transactions and events recognized in the
financial statements of the current and previous periods.
● Differed taxation is the basis of allocating tax expense (or tax charges) to particular
accounting periods.
● Differed tax originates from the differences between the accounting profit and taxable
profit.

Differences between Accounting profit and Taxable profit

The difference is caused by:

1) Permanent difference
2) Temporary difference (Timing Difference)

1) Permanent Differences
They are one – off differences that occur when certain items of revenue or expenses are
excluded form the computation of taxable profits i.e. they are considered to be
disallowable. (However, this pertains to a particular time period only).These differences
arise from the following:
a) Certain types of incomes recognized in the computation of accounting profit but are
disallowed in the determination of taxable profits.
They include:
 i. Government grants and subsidies.
ii. Dividend incomes from companies considered to be residents in Kenya.
iii. Incomes considered to be windfalls e.g. prize money from lotteries.

b) Certain types of expenses recognized in determining the accounting profit but are not
allowed for tax purposes. Examples include:
i) Depreciation expenses
ii) Legal expenses that pertain to tax disputes
iii) Loss on disposal of a non-current asset.
iv) Entertainment expenses not related to the business.

2) Temporary differences (or Timing Differences)

● They occur when items of revenue or expenses are included in the determination of
both accounting profit and taxable profits, but not for the same accounting period.
● For example, an expense which is allowable as a deduction in arriving at taxable
profit for the year 2016 might not be included in the financial statements until 2017
or later. In the long run, the total taxable profits and total accounting profits will be
the same (Except for permanent differences).
● This therefore implies that timing differences that originate in one period are
capable of reversal in one or more subsequent periods.
NB: Differed Tax is ONLY attributable to temporary differences

Temporary Differences can be computed as follows:

Temporary Differences = carrying value – Tax base

Carrying value (CV) of an Asset

It is also referred to as the Net Book Value (NBV).

CV = Cost of the Asset – Accumulated Depreciation

Tax Base of an Asset and Liability

It is also known as written down value (WDV). It is the amount attributed to that asset or
liability for tax purpose.

1) Tax Base of an Asset

It is the amount that will be deductible for tax purposes against any taxable economic benefits
that will flow to the entity when it recovers the carrying value of the asset.

Tax Base of an asset = Cost of the asset -Accumulated capital allowances

Example

A machine that was bought 3 years ago for £1,000,000 has accumulated capital allowances,
since then, of £300,000 . Compute its Tax Base to date

2) Tax Base of a Liability

It is the carrying value of that liability less any amount that would be deductible for tax
purposes in respect of that liability in future periods.

Computation of Deferred Tax

Deferred Tax = Corporation Tax rate x Temporary Differences

i.e. D.T. = C.T. x T. D.

Accounting for Deferred Tax

The differed tax balances at the beginning and the end of the year should be compared and the
difference should be recorded as follows:
1. Increase in deferred tax: provision

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Tax Expense x

Deferred Tax x

2. Decrease in deferred tax provision

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Deferred Tax x

Tax Expense x

Additional Notes

a) Deferred tax can be a liability as well as an assets

Deferred Tax Liabilities

They are the amounts of income taxes payable in future periods in respect of taxable
temporary differences.
NB: when CV>Tax Base = DT Liability

Deferred Tax Assets

They are amounts of income taxes recoverable in future periods in respect of:
i) Deductible temporary differences
ii) The carry-forward of un used tax loses
iii) The carry forward of un used tax credits.

NB: when CV< Tax Base = DT Assets

 b) Computation of taxable profits and current tax
Proforma
£
Profit before tax (i.e. Accountability profit) x
Add Depreciation expense x
x
Less capital allowances (x)
Taxable profit x
Less current tax (@ 30%) x key items

Example 1

A machine that was bought 3 years ago for £ 1,000,000 has accumulated capital allowances of £
300,000 to date. Compute the tax base to date.

Example 2

Trench town Plc. bought a machine on 1st January 2016 for £ 1 Million that was expected to
have a useful life of 5 years and was to be depreciated on a straight line basis. The tax
authorities had agreed that the capital allowances for this machine were to be as follows:

YEAR CAPITAL ALLOWANCE

£ ‘000
2016 250
2017 250
2018 200
2019 200
2020 100
The company’s profit before tax (PBT) for the 5 years were as follows:

YEAR PBT
£’000’
2016 2,000
2017 2,000
2018 2,500
2019 2,500
2020 3,000

Required

i. Compute the deferred tax liability/asset

ii. Prepare the deferred tax a/c ( or Statement of increase/ decrease of deferred tax)
iii. Prepare extracts of the SPL and SFP for the five years.

Example Two

Blackwood PLC bought a machine for £ 700,000 on 1st January, 2009. The following information
pertains to the profits made by the company together with the depreciation expenses and
capital allowances on the machine.

PBDT DEPRECIATION EXPENSE CAPITAL ALLOWANCES

YEAR £ ‘000 £’000 £’000
2014 11,000 20 30
2015 13,000 19 22
2016 12,500 18 17
2017 14,000 17 14
2018 13,300 16 11
2019 14,200 15 9
2020 13,900 14 6
The machine has a useful life of 10years corporation tax rate is 30%

Required

a. Compare the deferred tax asset/ liability

b. Deferred tax a/c (i.e. asset/liability a/c) for year 2009-2015
c. SPL extract for the years 2014-2020
d. Statement of financial position extract for the same period