Assessing problems with reconciling the tax liability

Category: Accounting

The main objective of the accounting for income taxes, is to address the problem of reconciling the tax liability (actual tax payable) with that of tax expense (accounting disclosure).

This accounting standard deals with all income taxes, such as withholding taxes, foreign taxes and domestic taxes. And in the specific areas, this accounting standard will explain three areas in the following. Firstly, it capture is criteria for recognizing and measuring, disclosing the assets and liabilities of deferred tax and current tax. Secondly, it capture is outlining the difference between the main concepts of accounting and taxable profit. Thirdly, it capture is accounting for tax losses. There are some key features of this accounting standard in the following.

The definition and recognition of current tax and deferred tax assets (liabilities); and definition of temporary differences

There are some key features in this accounting standard, such as current tax; deferred tax and so on. Firstly, current tax is the expected tax payable for the year, using tax rates enacted or substantively enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years. As the same time, the current tax recognises a liability and expense in the period to which it relates two areas. In one area, the asset or liability for unpaid or overpaid current taxes should be raised. It means that if the current tax to extent unpaid; it is recognised as a liability. And in the other area, when the tax loss' benefit carried back to recover tax paid with respect to a prior period, it should be recognized as an asset. "The benefit relating to a tax loss that can be carried back to recover current tax of a previous period shall be recognised as an asset."

Secondly, the deferred tax liabilities are "the amounts of income taxes payable in future periods in respect of taxable temporary differences." And the deferred tax assets are "the amounts of income taxes recoverable in future periods in respect of deductible temporary differences; the carry forward of unused tax losses and the carry forward of unused tax credits." As the same time, how to recognise the deferred tax liabilities and assets. On the one hand, all of taxable temporary differences recognise the deferred tax liabilities. However, it except to the extent, when the deferred tax liabilities arise from the initial recognition of an asset and goodwill. And if the deferred tax liabilities shall be recognised, the taxable temporary differences associated with investments in branches and associates and interests in joint ventures. On the other hand, the deferred tax assets shall be recognised for all deductible temporary differences. Ulteriorly, it is probable that taxable profit will be available against which the deductible temporary difference can be utilised, unless the deferred tax asset arises from the initial recognition of an asset or liability in a transaction that is not a business combination and affects neither accounting profit nor taxable profit at the time of transaction. As the same time, the deferred tax and current tax shall be recognised as an expense or income. For the period, the profit or loss includes the deferred tax and current tax. However, it expect to extent, when the tax arises from a transaction or event which is recognised, outside profit or loss, either in other comprehensive income or directly in equity.

Thirdly, the temporary differences are "differences between the carrying amount of an asset or liability in the statement of financial position and its tax base." There are two kind of temporary differences in the following. One is the taxable temporary differences that when the carrying amount of the asset or liability is recovered or settled, it will result in taxable amounts in determining tax loss of future periods. The other one is the deductible temporary differences that when the carrying amount of the asset or liability is recovered or settled, it will result in amounts that are deductible in determining taxable profit of future periods.

Measurement of the deferred tax and current tax

For the current and prior periods, using the tax rate that have been enacted or substantively enacted by the end of the reporting period to measures the current tax liabilities and assets at the amount expected to be paid to the taxation authorities. As the same time, based on the tax rate that have been enacted or substantively enacted by the end of the reporting period, the deferred tax liabilities and assets shall be measured at the tax rates that are expected to apply to the period when the liability is settled or the asset is realised. When measure the deferred tax assets and liabilities, it reflect tax consequences that would follow from the manner in which the entity expects to settle or recover the carrying amount of its liabilities and assets at the end of the reporting period. "An entity shall reduce the carrying amount of a deferred tax asset to the extent that it is no longer probable that sufficient taxable profit will be available to allow the benefit of part or all of that deferred tax asset to be utilised."

There is an example about the capital allowances and deferred tax. And according to this example, it explains and measures the deferred tax and so on. The example that an asset costs 30,000 pounds and it has a six year life and zero residual value. As the same time, the company buying the asset has profit before depreciation of 12,000 pounds. And the tax rate is 35% and annual capital allowances for taxation are 25% on a reducing balance basis. There is a form about this example in the following:

In the form (1), there are some concepts needs to explained and measured and these concepts are related for deferred tax. And there are two methods can measure the deferred tax in the following. In this form, Accounting profit = the profit before depreciation (12,000 pounds) - annual depreciation charge (30,000/6) = 7,000 pounds.

According to form (1) and (2), the value of taxable profit equal to the profit before depreciation (12,000 pounds) less the value of capital allowance annual year. However, the value of deferred tax = (accounting profit - taxable profit) * tax rate. Therefore, like the calculations in the following:

In year 1, deferred tax = (7000 -4500) *35% = 875

In year 2, deferred tax = (7000 -5625) *35% = 219

Secondly method is the temporary differences approach that the deferred tax = (value asset for accounting less value asset for tax) * tax rate. There are two forms can explain it in the following:

In form (3) and (4), the accounting value = the asset costs (30,000 pounds) - depreciation charge (every year is different); it like the calculations in the following:

In year 1, accounting value = 30,000 - 30,000/6 = 25,000

In year 2, accounting value = 30,000 - (30,000/6)*2 = 20,000

And the tax value = the asset costs each year - capital allowances each year; it like the calculations in the following:

In year 1, tax value = 30,000 - 7500 = 22,500

In year 2, tax value= 22,500 - 5625 = 16,875

Therefore, according to the function, we can calculate the deferred tax. However, it notes that it need less the opening value. And the opening value that is the deferred tax in last year.

Disclosure of the current tax and deferred tax

According to the measurement of the current tax and deferred tax, the company need to disclose the value of current tax and deferred tax in the balance sheet in each year. There are some demands that IAS 12 is quite prescriptive in the presentation of tax assets and liabilities in accounts in the following. Such as deferred tax should be shown under non-current and distinguished from current tax; the tax liabilities and assets must be separated from other assets and liabilities in balance sheet; and deferred tax liabilities and assets can only be offset where the entity has a legally enforceable right to do so for current taxes and they relate to tax levies by the same taxation authority. As the same time, current tax liabilities and assets can only be offset where the entity has a legally enforceable right to do so and it intends to settle on a net basis or to realize the asset and settle the liabilities simultaneously. There is a form that about the balance sheet of Tesco to disclose them in the following:

This form is the balance sheet of Tesco at 23/2/2008. And according this form, the Tesco supper market discloses the deferred tax and current tax in the balance sheet. For example, the deferred tax assets are 104 millions in 2008 and in 2007 are 32 millions. The deferred tax assets disclose in Non-current asset on the balance sheet. As the same, the key components of tax expense shall be disclosed separately. It includes some components, such as the amount of deferred tax expense relating to the origination and reversal of temporary differences and changes in tax rates or the imposition of new taxes; any adjustments recognised in the period for current tax of prior periods and current tax expense; and the benefit that arising from temporary difference of a prior period that is used to reduce deferred tax expense and current tax expense. There is a form that about the balance sheet of Tesco to disclose them in the following:

This form is the balance sheet of Tesco in 2008. And according this form, the Tesco supper market discloses the deferred tax expense and current tax expense in the Taxation.

The development of IAS 12- income taxes

Beginning on 1/1/1998, IAS 12-income taxes become operative for financial statement. "if an entity applies this standard for financial statement covering periods beginning before 1/1/1998, the entity shall disclose the fact it has applied this standard instead of IAS 12, approved in 1979." On 1 January 2001, this accounting standard become operative for annual financial statement. In 17 September 2002, this accounting standard added to the IASB agenda and there are some meeting in each year after it. As the same time, the IASB meeting perfect this accounting standard year by year. On 31/3/2009, the IASB issued for comment an exposure draft proposing to replace IAS 12- income taxes with a new standard titled Income Tax. There are some changes in this exposure draft. Such as the new definition of tax basis; exceptions for investments in subsidiaries and related entities and recognition of deferred tax asset and so on. And the current IASB-FASB meeting on 24 March 2010, the IAS 12-income taxes become more well than before.

The limitation of IAS 12- income taxes

There are also situations that deferred tax is not suitable. For example, a problem occurs if a company buys assets regularly, which is a realistic assumption as companies tend to become more capital intensive. Then there is a high probability that tax allowance is always high than deprecation during the period. The transfer to the deferred tax account can be seen to be the result of an amalgam of positive originating timing differences relating to depreciation. If the entity finds it is effectively in the position of paying gradually more and more money for fixed assets each year, then the balance of liability on the deferred tax account will gradually rise and tend to continue. Therefore, the liability balance does not seem to be getting paid, neither in the foreseeable future is it likely to be paid. Liability is an amount to be paid out in the future. Therefore, it appears that it is not a liability at all within the meaning of the word liability. In the former case the tax deferred will all have become payable by the end of the asset's life, so deferred tax provision would seem to be necessary. In the latter case the aggregate liability is likely to go on increasing so deferred tax provision would seem to be unnecessary.

Conclusion

IAS 12- income taxes adopts an approach based on the balance sheet and on temporary differences. It requires full provision for deferred tax based on the liability method. Here, deferred tax is provided using the balance sheet liability method, providing for temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. As the same time, there are also situations that deferred tax is not suitable. Therefore, it is still need accountants deal with problem of IAS 12 and provide perfect form more than before for this accounting standard.