ACCOUNTING FOR TAXATION

Learning objectives
1. Account for current taxation in accordance
with relevant accounting standards.
2. Record entries relating to income tax in the
accounting records
3. Explain the effect of taxable temporary
differences on accounting and taxable profits

1
Introduction:
Companies are normally responsible for collection and
payment of three types of taxes namely:
1. Pay as you earn( PAYE) – This is a payroll tax paid by
the employees on their salaries and wages and other
benefits and is collected and paid by the company on
the employees’ behalf.
2. Corporation Tax – This is paid by corporations based
on their profits.
3. Income Tax (IAS 12)
A Company is a legal person and therefore is liable
for income tax on its profits made for the year. The
income tax is assessable and payable on the taxable
income which is regulated by the tax laws in place
not on the profits as reported in the statement of
comprehensive income.

2
Definitions:
1. Accounting profit - Net profit or loss for a period
before deducting tax expense.
2. Taxable profit(Tax loss) The profit(loss) for a period,
determined in accordance with the rules established
by the taxation authorities, upon which income taxes
are payable
3. Tax expense(Tax Income) The aggregate amount
included in the determination net profit or loss for the
period in respect of current tax and deferred tax
4. Current tax – is the amount of income taxes payable
(recoverable) in respect of the taxable profit(Tax loss)
for a period.

3
 Recognition of current tax liabilities and assets
IAS 12 requires any unpaid tax in respect of the current
or prior periods to be recognised as a liability
Any excess tax paid in respect of current or prior periods
over what is due should be recognised as an asset
Example:
In 2012 Dalton co had taxable profits of N$120,000. In the
previous year (2011) income tax on 2011 profits had been
estimated as N$30,000
Required:
Assuming 30%tax rate, calculate tax payable and the
charge for 2012 if the tax due on 2011 profits was
subsequently agreed with the tax authorities as:
(a) 35,000 or
(b) 25,000
Any under or over payments are not settled until the
following years tax payment is due

4
SOLUTION
a) Tax due on 2012 profits (120,000 x 30% = 36,000
Underpayment for 2011 5,000
Tax Charge and liability 41,000

b) Tax due on 2012 profits .................

Overpayment for 2011 .................
Tax charge and liability .................

5
 IAS 12 also requires recognition as an asset of the
benefit relating to any tax loss that can be carried
back to recover current tax of a previous period. This
is acceptable because it is probable that the benefit
will flow to the entity and it can be reliably measured.

Example: Tax losses carried back.

In 2011 Erasmus Co paid N$50,000 in tax on its profits
In 2012 the company made tax losses of N$24,000.
The local tax authority rules allow losses to be carried
back to offset against current tax of prior years.

Required:
Show the tax charge and tax liability for 2012.

6
 SOLUTION:

The repayment due on tax losses = 30% x24,000 =

N$7,200

The double entry will be:

DEBIT Tax receivable( SOFP) N$ 7,200
CREDIT Tax repayment (SOCI) N$ 7,200

The tax receivable will be shown as an asset until the

repayment is received from the tax authorities.

7
PRESENTATION:
In the statement of financial position, tax assets and
liabilities should be shown separately from other
assets and liabilities.
Current tax assets and liabilities can be offset but this
should happen only when certain conditions apply.
a) The entity has a legally enforceable right to set off
the recognised amounts
b) The entity tends to settle the amount on a net basis
or to realise the asset and settle the liability at the
same time.

8
 DEFERRED TAX
WHAT IS DEFERRED TAX?
Deferred tax is:
• the estimated future tax consequences of transactions
and events recognised in the financial statements of the
current and previous periods.
Deferred taxation is a basis of allocating tax charges to
particular accounting periods.

The key to deferred taxation lies in the two quite

different concepts of profit:
• The accounting profit (or the reported profit), which is
the figure of profit before tax, reported to the
shareholders in the published accounts
• The taxable profit, which is the figure of profit on which
the taxation authorities base their tax calculations

9
Accounting profit and taxable profit
The difference between accounting profit and taxable
profit is caused by:
• Permanent differences.
• Temporary differences.

Permanent differences are:

• one off differences between accounting and taxable
profits caused by certain items not being
taxable/allowable.
• differences which only impact on the tax computation
of one period.
• differences which have no deferred tax consequences
whatsoever
An example of a permanent difference is client
entertaining expenses.

10
• Temporary differences are differences between the carrying
amount of an asset or liability in the statement of financial
position and its tax base (the amount attributed to that asset
or liability for tax purposes).

Deferred tax is the tax attributable to temporary differences

which are differences between the carrying amount of an
asset or liability in the statement of financial position and its
tax base.
These can be either:
a) Taxable temporary differences- results in taxable amounts
in determining taxable profit of future periods when the
carrying amount of the asset or liability is recovered or
settled. Taxable temporary differences give rise to deferred
tax liabilities
b) Deductible temporary differences- result in amounts that
are deductible in determining taxable profit of future periods
when the carrying amount of the asset or liability is
recovered or settled. Deductible temporary differences give
rise to deferred tax assets

11
Before we move on let us look at these definitions

1.Tax base of an asset.

• The tax base of an asset is the amount that will be deductible for taxable
economic benefits that will flow to an entity when it recovers the carrying
amount of the asset.
2. Tax base of a liability.
• The tax base of a liability is its carrying amount, less any amount that will be
deductible for tax purposes in respect of that liability in future periods

• The difference between the carrying amount and tax base is called
TEMPORARY DIFFERENCE.

The temporary difference multiplied by the tax rate will give:

The deferred tax balance in the statement of financial position.

12
Example:
A non –current asset costing NS 2000 was acquired at the
start of year 1. it is being depreciated straight line over 4
years, resulting in annual depreciation charges of N$500.
Thus a total of N$2000 of depreciation is being charged.
The capital allowances granted on this asset are:
N$
Year 1 800
Year 2 600
Year 3 360
Year 4 240
Total capital allowances 2000

Required : Calculate the taxable temporary differences for

years 1-4 and the deferred tax including the movement
in the deferred tax liability assuming 25% tax rate.

13
 SOLUTION
Year Carrying amount Tax base Temporary difference

1 1500 1200 300

2 1000 600 400
3 500 240 260
4 nil nil nil

14
Deferred tax

Year 1 = 300 x 25% = 75

Year 2 = 400 x 25 = 100

Year 3 = 260 x 25% = 65

Year 4 = Nil since carrying amount = tax base

15
 DOUBLE ENTRY
Year 1
Dr Tax expense ( P& L) 75
Cr Deferred tax liability ( sofp) 75
Year 2
Dr Tax expense 25
Cr Deferred tax liability 25

Year 3
Dr Deferred tax liability 35

Cr Tax expense 35

16
The movement in the liability are recorded in the
income statement as part of the taxation charge

Year 1 2 3 4
Opening deferred 0 75 100 65
tax liability

75 25 (35) (65)
Increase/decrease

Closing deferred 75 100 65 0

tax Liability

17
• The movement in the deferred tax liability in the year
is recorded in the income statement where:
- An increase in the liability, increases the tax expense
- A decrease in the liability decreases the tax expense
The Closing figures are reported in the statement of
financial position as the deferred tax liability

18
 Continuing with the previous example, suppose that the
profit before tax of the entity for each of years 1-4 is N$
10000( After charging depreciation) since the tax rate is
25% it would be logical to expect the tax expense for
each year to be N$ 2500. HOWEVER INCOME TAX IS
BASED ON TAXABLE PROFITS NOT ON ACCOUNTING
PROFITS.

19
 The taxable profits and so the actual tax
liability for each year could be calculated as
follows:
Year 1 year 2 Year 3 Year 4
Profit before
tax 10 000 10 000 10 000 10 000
Depreciation 500 500 500 500
Capital
Allowance (800) (600) (360) (240)
Taxable 9700 9900 10 140 10260
profits
Tax liability
@25% 2425 2475 2535 2565

20
 AS we have seen in the example, accounting for deferred
tax then results in a further increase or decrease in the tax
expense. Therefore the final tax expense for each year reported
in the income statement would be as below

Year 1 Year 2 Year 3 Year 4

Income
Tax 2425 2475 2535 2565
Increase /
Decrease
due to 75 25 (35) (65)
deferred
tax
Total tax
expense 2500 2500 2500 2500

21
 MEASUREMENT OF DEFERRED TAX.
There are two methods of measuring deferred tax,
although IAS 12 only refers to one.
• The income statement approach ;and
• Balance Sheet approach

The latest version of IAS 12 refers only to the

Balance sheet method and therefore the Income
Statement method will not be amplified in this study.

22
The Balance sheet method requires deferred tax to be
measured based on the difference between :

• The carrying amount of the entity’s assets and

liabilities, and
• The Tax base of each of the entity’s assets and
liabilities

The SOFP approach thus requires that we compare

the carrying amount of each of the assets and
liabilities with its tax base .
The carrying amount of an asset or liability is the
balance recognised in the statement of financial
position based in International financial reporting
standards.
The tax base of an asset or liability is the balance
calculated based on Tax legislation.

23
The definition of a tax base of an asset refers to
two types of assets
1. An asset that represents a future inflow of
economic benefits that will be taxable.( e.g)
plant earning taxable profits
2. An asset that represent a future inflow of
economic benefits that will not be taxable( e.g
an Investment earning exempt dividend
income
24
• If the inflow will be taxable, the tax base is
the future deductions
• If the inflow will not be taxable the tax base
will be its carrying amount.

25
The definition of a tax base of a liability refers to
two types of a liability

1. Liabilities that represent income received in

advance
2. Liabilities that represent expenses

26
• If the liability is income received in advance,
the tax base will its carrying amount less the
portion that wont be taxable in the future.
• In the case of any other liability
The tax base will be its carrying amount less any
portion that represents future deductions(i.e the
portion of the carrying amount that will not be
allowed as a tax deduction in the future.

27
 Useful format for calculating deferred Tax using the
balance sheet approach

CARRYING TAX BASE Temporary Deferred

AMOUNT
(SOFP) Difference Tax

(a) (b) (b–a ) (c ) x 30%

(c ) ( d)

28
 TEST YOUR UNDERSTANDING.

QUESTION 2 . JULIAN

29
 SOLUTION TO QUESTION 2

CARRYING TAX BASE TEMPORARY

VALUE DIFFERENCE
PROPERTY
PLANT &
EQUIPMENT 460 270 190
DEVELOPMENT 60 0 60
EXPENDITURE

INTERST 10 0 10
RECEIVABLE(55-
45)
PROVISION (40) 0 (40)

30
KATUTURA LIMITED

31
 …………………..

ASSETS
If the carrying amount is greater than the tax
base then it’s a tax liability

LIABILITIES
If the carrying amount is greater than the tax
base then it’s a tax asset

32
END

33