University of Economics, Prague. Income taxes (IAS 12)

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1 University of Economics, Prague Faculty of Finance and Accounting Department of Financial Accounting and Auditing Income taxes (IAS 12) 1FU496 Intermediate Accounting (MiFA course) David Procházka

2 Agenda Basic characteristics of income taxes IAS 12: Differences between accounting and taxable profits IAS 12: Recognition and presentation Recommended issues for the final exam

3 1 Basic characteristics of income taxes IAS 12 Income Taxes Except for cases, all countries require companies to pay taxes from their net income Tax rules and complexity of taxation systems differ across countries Taxation: - does not follow accounting principles (different systems with different objectives) - is applied usually on individual companies and not on consolidated profits (some exceptions e.g. in the U.S. or France; CCCTB proposals within the EU) The differences between accounting and taxation: - add complexity to the preparation of financial statements (an expert input is needed) - causes that accounting profit multiplied by tax rate does not equal to income tax to be paid => tax figure is not intuitive - enable companies to obtain tax advantages in current period, but they will be reversed in following years => potential risk of excess distribution of profits A purely accounting concept of deferred tax is introduced

4 Current tax Deferred tax What should be actually paid to tax authority Depends on the tax rules Is not really paid; it is internal liability (receivable) of company to owners Depends on temporary differences between accounting and tax rules Is calculated outside accounting, but has to be booked DT liability is always recognised; DT asset only if it is realisable

Depends on temporary differences between accounting and tax rules Is calculated outside

5 2 IAS 12: Differences between accounting and taxable profits Accounting profit is profit or loss for a period before deducting tax expense, which is reported to the owners in income statement Taxable profit is determined in accordance with the tax rules, which is reported to the taxation authorities in given country in company s tax filling Differences between accounting principles and taxation rules might be: - permanent, which means that given expense is not allowed for taxation purposes (e.g. representation expenses, fines, entertainment expenses, etc.) => higher tax to be paid to government without any allowances in future periods - temporary, which arises, when accounting expense is allowed also for taxation purposed, but the timing of recognition differs (e.g. different taxation rules) => higher tax paid in current period is reconciled by lower taxation in future periods and vice versa Deferred tax arises only from the temporary differences, which might be: - taxable, which are a result of favourable tax rules in current period with negative

rules might be: - permanent, which means that given expense is not allowed for taxation purposes (e.g. representation expenses, fines, entertainment expenses, etc.

6 impact on current tax in later years IAS 12 Income Taxes - deductible, which are a result of unfavourable tax rules in current period, but they may be turn into lower taxation in future periods In case, that there are only temporary differences, then effective tax rate is equal to statutory tax rate

may be turn into lower taxation in future periods In case, that there are

7 Effective tax rate Statutory tax rate Current tax + Deferred tax Pre-tax profit? Rate stated in tax rules 07-E08

8 3 IAS 12: Recognition and presentation 3.1 Current tax IAS 12 Income Taxes Unpaid tax for current and prior periods is presented as a liability; overpaid tax is presented as an asset Current tax expense is presented on separate line in P&L (together with deferred tax expense) unless it relates to items classified as: - discontinued operations - other comprehensive income - directly influencing equity

liability; overpaid tax is presented as an asset Current tax expense is presented on separate line

9 3.2 Deferred tax IAS 12 Income Taxes Deferred tax liability is always recognised on the balance sheet Deferred tax asset is recognised on the balance sheet only if it is probable that taxable profit will be available against which the deductible temporary difference can be utilised Presentation on the face of balance sheet: - always as non-current asset/liability - shall not be discounted - DTA and DTL shall be offset only if (a) the entity has a legally enforceable right to set off current tax assets against current tax liabilities and (b) the deferred tax assets and the deferred tax liabilities relate to income taxes levied by the same taxation authority Deferred tax expense is presented on separate line in P&L (together with current tax expense) unless it relates to items classified as: - discontinued operations - other comprehensive income

and DTL shall be offset only if (a) the entity has a legally enforceable right to set off current tax assets against current tax liabilities and (b) the deferred tax assets and the deferred tax

10 - directly influencing equity Deferred tax assets and liabilities shall be measured at the tax rates that are expected to apply to the period when the asset is realised or the liability is settled, based on tax rates that have been enacted or substantively enacted by the end of the reporting period: 07-E09; 07-E10

asset is realised or the liability is settled, based on tax rates that have

11 DTL DTA Always recognised Recognised only if realisable Arises from taxable temporary differences Arises from deductible temporary differences; unused tax losses carried forward; tax credits Always presented under non-current liabilities Always presented under non-current assets

differences; unused tax losses carried forward; tax credits Always

12 4 Recommended issues for the final exam Covered by this Presentation - explain the difference between current and deferred income tax - explain the difference between permanent and temporary differences - outline the asymmetry between recognition of deferred tax liability and deferred tax asset - describe the presentation of deferred tax both on balance sheet and comprehensive income statement - calculate deferred tax Not covered by this Presentation, but relevant for the topic - state examples of taxable and deductible temporary differences - discuss specifics of deferred tax on goodwill

- describe the presentation of deferred tax both on balance sheet and comprehensive income statement - calculate deferred tax Not covered by this

13 David Procházka Department of Financial Accounting and Auditing Faculty of Finance and Accounting University of Economics, Prague W. Churchill Sq. 4 Prague, Czech Republic Web: <prochazd@vse.cz>

1. Taxable income is calculated in accordance with prescribed tax regulations and rules.

1. Taxable income is calculated in accordance with prescribed tax regulations and rules. Chapter 20 Accounting for Income Tax LECTURE OUTLINE The material in this chapter can be covered in three class periods. The conceptual issues in this chapter are difficult and the accounting procedures