However, the difference is only a temporary difference and so the tax will have to be paid in the future. This is good for cash flow in that it delays (ie defers) the payment of tax. In the above example, when the capital allowances are greater than the depreciation expense in years 1 and 2, the entity has received tax relief early. Entities are then charged tax at the appropriate tax rate on these taxable profits. Therefore, taxable profits are arrived at by adding back depreciation and deducting capital allowances from the accounting profits. ![]() For example, depreciation is considered a disallowable expense for taxation purposes but instead tax relief on capital expenditure is granted in the form of capital allowances. When determining taxable profits, the tax authorities start by taking the profit before tax (accounting profits) of an entity from their financial statements and then make various adjustments. So, how does the above example result in tax being payable in the future?Įntities pay income tax on their taxable profits. Table 1 shows the carrying amount of the asset, the tax base of the asset and therefore the temporary difference at the end of each year.Īs stated above, deferred tax liabilities arise on taxable temporary differences, ie those temporary differences that result in tax being payable in the future as the temporary difference reverses. The capital allowances granted on this asset are: Thus a total of $2,000 of depreciation is being charged. It is being depreciated straight line over four years, resulting in annual depreciation charges of $500. Where at the year-end the cumulative depreciation charged and the cumulative capital allowances claimed are different, the carrying amount of the asset (cost less accumulated depreciation) will then be different to its tax base (cost less accumulated capital allowances) and hence a taxable temporary difference arises.Ī non-current asset costing $2,000 was acquired at the start of year 1. ![]() However, within tax computations, non-current assets are subject to capital allowances (also known as tax depreciation) at rates set within the relevant tax legislation. Within financial statements, non-current assets with a limited useful life are subject to depreciation. Depreciable non-current assets are the typical deferred tax example used in FR. IAS 12 requires that a deferred tax liability is recorded in respect of all taxable temporary differences that exist at the year-end – this is sometimes known as the full provision method.Īll of this terminology can be rather overwhelming and difficult to understand, so consider it alongside an example. Taxable temporary differences are those on which tax will be charged in the future when the asset (or liability) is recovered (or settled). Temporary differences are defined as being differences between the carrying amount of an asset (or liability) within the Statement of Financial Position and its tax base ie the amount at which the asset (or liability) is valued for tax purposes by the relevant tax authority. However, to understand this definition more fully, it is necessary to explain the term ‘taxable temporary differences’. So, in simple terms, deferred tax is tax that is payable in the future. ![]() IAS 12 defines a deferred tax liability as being the amount of income tax payable in future periods in respect of taxable temporary differences. In FR, deferred tax normally results in a liability being recognised within the Statement of Financial Position. An introduction to professional insightsĭeferred tax is accounted for in accordance with IAS ® 12, Income Taxes.Virtual classroom support for learning partners.Becoming an ACCA Approved Learning Partner.
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