ADVANCED FINANCIAL

ACCOUNTING I
WOLLEGA UNIVERSITY
ACFN DEPARTMENT
 CHAPTER ONE
Income Taxes (IAS 12)

• Tax expense (income tax) is the aggregate amount included in the determination
of profit or loss for the period in respect of current tax and deferred tax.
Income is defined as every sort of economic benefit including nonrecurring
gains in cash or in kind, from whatever sources.
It includes.
Income tax is a tax on the total income of an assesse for a particular
assessment year.
This implies that;
Income-tax is an annual tax on income
Income of previous year is chargeable to tax in the next following assessment
year at the tax rates applicable for the assessment year.
Cont..

• The term income includes:

Profits and gains
Dividend
Voluntary contributions received by certain institutions
Receipts by employees
Incomes from business
Any capital gains
Any sum earlier allowed as deduction and chargeable to income-tax
Any winnings from lotteries, crossword puzzles, races including horse races,
card games
Any contribution received from employees towards any provident fund
Any sum of money or value of property received as gift
The concept of tax base
A tax base is the total amount of property, consumption, assets,
transactions, income, or other sort of economic activity that is subject to
taxation by an authority, such as the government.
• A narrow tax base is non-neutral and inefficient. A broad tax base
reduces tax administration costs and allows more revenue to be raised
at lower rates. A tax base may be narrow, rather than broad, due to:
 Tax expenditures that result in reduced tax revenue, such as credits, exemptions, and
deductions
 Deductions that reduce taxable income when certain conditions are met
 Exemptions that keep things from being subject to taxation due to category, class, or status
 Tax expenditures such as the standard deduction against taxable income, child tax credits,
and certain sales tax exemptions
 Services, since taxing services is administratively challenging
Example 1
•EXAMPLE1: A machine cost 100. For tax purposes, depreciation of
30 has already been deducted in the current and prior periods and the
remaining cost will be deductible in future periods, either as
depreciation or through a deduction on disposal. Revenue generated by
using the machine is taxable, any gain on disposal of the machine will
be taxable and any loss on disposal will be deductible for tax purposes.
The tax base of the machine is 70
NOTE : 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. In the
case of revenue which is received in advance, the tax base of the resulting liability
is its carrying amount, less any amount of the Tax base concept
The tax base of an asset :
 Amount that will be deductible for tax purposes against any taxable economic benefits
that will flow to an entity when it recovers the carrying amount of the asset.
 If those economic benefits will not be taxable, the tax base of the asset is equal to its
carrying amount.
Example 2
An asset that costs Br 600,000 has a carrying amount of Br 430,000. Cumulative
depreciation for tax purposes is Br 200,000 and the tax rate is 30%.
1. What is the tax base of the asset?
2. What is the temporary difference?
3. Is it taxable or deductible temporary difference?
4. What is the deferred tax?
5. Is it a deferred tax asset or liability?
 Solution
1. Tax Base
= Br 600,000- Br 200,000=400,00
2. What is the temporary difference?
TD= Br 430,000- Br 400,000= 30,000
3. Is it taxable or deductible temporary difference?

Taxable temporary difference

4. What is the deferred tax?
DT= Br 30,000 x 30%= 9,000

5. Is it a deferred tax asset or liability?

Deferred tax liability
Recognition of deferred tax liabilities and
assets.
•Deferred Tax is the amount of Income taxes payable /recoverable in future
periods in respect of taxable/ deductible temporary differences.
•A deferred tax asset is a business tax credit for future taxes, and a deferred
tax liability means the business has a tax debt that will need to be paid in
the future.
•Current tax for current and prior periods shall, to the extent unpaid, be recognized as a
liability.
•When a tax loss is used to recover current tax of a previous period, an entity recognizes
the benefit as an asset in the period in which the tax loss occurs because it is probable
that the benefit will flow to the entity and the benefit can be reliably measured.
 Recognition of Deferred Tax Liabilities
Deferred Tax Liabilities are the amounts of income taxes payable in future
periods in respect of taxable temporary differences.
A deferred tax liability is the result of differences in the way a company
does its financial accounting for reporting purposes.
Deferred taxes arising from temporary differences
Carrying amount - Tax base = Temporary difference
Deferred tax asset/liability = Taxable Temporary Differences * tax rate (future)
A deferred tax liability should be recognized for all taxable temporary differences, unless the deferred tax
liability arises from the initial recognition of goodwill or the initial recognition of an asset or liability in a
transaction which
Is not a business combination and
At the time of transaction, affect neither accounting profit nor taxable profit (or tax loss)
 • Deferred tax liability examples
 Depreciation of assets: The IFRS uses an advanced asset depreciation model
which results in a difference between the company’s balance sheet value and the
value of it for tax purposes. This is the most common example of a deferred tax
liability.
 Tax underpayment: The Company didn’t pay enough tax in the previous cycle, and
will have to make up for it in the next cycle.
 Installment sale: When a product is paid for in installments, the company lists the
full value of the sale in their balance sheet, but only pays taxes for each annual
installment. The company recognizes that they have a deferred tax liability for
future payments on that sale.

•Deferred tax liability is the deferred tax consequences attributable to

taxable temporary differences. In other words, a deferred tax liability
represents the increase in taxes payable in future years as a result of taxable
temporary differences existing at the end of the current year.
•Deferred tax liability Is a taxable amount in the future. Taxable
amounts increase taxable income in future years.
Taxable income = pretax financial income

Less: taxable temporary difference

Plus: Deductible temporary difference

Current tax expense = taxable income x tax rate

Deferred tax expenses = ending deferred tax liability – beginning deferred tax
liability

Income tax expenses = current tax expense (income tax payable) + deferred tax
expenses

Deferred tax expenses = deferred tax liability – deferred tax asset

 EXAMPLE
At the beginning of 2013, GK Company purchased equipment for Br 200,000. The equipment had
a carrying amount of Br 180,000 at the beginning of 2014 and Br 160,000 at the end of 2014. The
accumulated depreciation of the item as per the income tax law is Br 50,000 at the beginning of
2014 and Br 80,000 at the end of 2014. The tax rate is 30%. The accounting income before tax is
Br 700,000 for 2013 and Br 900,000 for 2014.
1. What was the tax base of the equipment for 2013 and 2014?
2. What is the temporary difference for 2013 and 2014? Is it taxable or deductible temporary
difference?
3. What is the deferred tax for 2013 and 2014? Is it deferred tax asset or deferred tax liability?
4. What is the taxable income for 2013 and 2014?
5. What is the current tax expense for 2013 and 2014?
6. What is the deferred tax expense for 2013 and 2014?
7. What is the appropriate journal entry for 2013 and 2014?
Solution
End of 2013 End of 2014
Carrying value Br 180,000 Br 160,000
Tax base 150,000 120,000
Taxable temporary difference 30,000 40,000
Deferred tax liability (30%) 9,000 12,000
Taxable income 670,000 860,000
Current tax expense 201,000 258,000
Deferred tax expenses 9,000 3,000
Income tax expenses 210,000 261,000

Taxable income = pretax financial income

Less: taxable temporary difference

Plus: Deductible temporary difference

 2013 Taxable income = $700,000
•Deferred tax expenses of 2014 = ending deferred tax
liability of 2014 – beginning deferred tax liability of
Less: $30,000
2013
Plus: 0= $670,000 • = $12,000
2014 taxable income =$ 900,000 – $9,000 =$3,000

-40,000 •Income tax expenses of 2013 = current tax expense

(income tax payable) of 2013 + deferred tax
+0=
expenses of 2013
$ 860,000
• = $201,000+ $9,000 = $210,000
Current tax expense of 2013 = taxable income x tax rate
•ITE of 2014 = $258,000 + $3000 =261,00
= 670,000x 30%= $201,000
•Journal entry at the end of 2013
Current tax expense of 2014 = taxable income x tax rate
•Income tax expense—Current ………. 201,000
= 860,000 x30% = $258,000
•Income tax expense—Deferred ……... 9,000
Deferred tax expenses of 2013 = ending deferred tax liability –
beginning deferred tax liability
• Deferred tax liability………………… 9,000

= $9,000 – 0 = $9,000
• Income taxes payable ………………..201,000
Journal entry at the end of 2014

Income tax expense—Current……………… 258,000

Income tax expense—Deferred ………...... 3,000

Deferred tax liability………………………………………….. 3,000

Income taxes payable …………………………………………258,000

Recognition of Deferred Tax Assets
Deferred Tax assets are the amounts of income taxes recoverable in future period in respect of
Deductible temporary differences.
The carry forward of unused tax losses and
The carry forward of unused tax credits.

A deferred tax asset is the deferred tax consequence attributable to deductible temporary differences.
In other words, a deferred tax asset represents the increase in taxes refundable (or saved) in future
years as a result of deductible temporary differences existing at the end of the current year.
A deferred tax asset shall be recognized for all deductible differences to
the extent that it is probable that taxable profit will be available against
which the deductible temporary differences can be utilized
Examples of deferred tax assets
 Net operating loss: The business incurred a financial loss for that
period.
 Tax overpayment: You paid too much in taxes in the previous period.
 Business expenses: When expenses are recognized in one accounting
method but not the other.
 Revenue: Instances where revenue is collected during one accounting
period, but recognized in another.
 Bad debt: Before an unpaid debt is written off as uncollectible, it’s
reported as revenue. When the unpaid receivable is finally recognized,
that bad debt becomes a deferred tax asset.
EXAMPLE: The total income tax expense of $180,000 on the income
statement for 2022 thus consists of two elements—current tax expense of
$200,000 and a deferred tax benefit of $20,000. Hunt makes the following
journal entry at the end of 2022 to record income tax expense, deferred tax
Asset, and income taxes payable.
Income tax expense ---------------------------- 180,000
Deferred tax Asset ---------------------------- --20,000
Income tax payable ----------------------------200,000
1. Future taxable temporary differences Reading assignment
2. Future deductible temporary differences
 Deferred tax

•Current tax

 It is the tax that the entity expects to pay (recover)  IAS 12 focuses on the balance sheet by
in respect of a financial period. It is that recognizing the tax effects of temporary
determined in accordance with the rules differences. Deferred tax liabilities are defined as
established by the tax authorities, upon which
the amounts of income taxes payable in future
income taxes are payable (recoverable)
peri
 IAS 12’s basic requirement is that, to the extent
that current tax for the current and prior reporting  ods in respect of taxable temporary differences.
periods is unpaid, it should be recognized as a [IAS 12:5]
liability. Conversely, if the amount already paid in  Deferred tax assets are defined as the amounts of
respect of current and prior period exceeds the
amount due for those periods, the excess should income taxes recoverable in future periods in
be recognized as an asset (IAS 12:12). respect of:
 Similarly, an asset is recognized if a tax loss can − Deductible temporary differences;
be carried back or recovers the current tax paid in − The carry forward of unused tax losses; and
an earlier period.
− The carry forward of unused tax credits.
 Generally, Current tax is recognized in profit and
loss.  Deferred tax should:
Be recognized in respect of all timing differences that
• In other cases, it is recognized in equity through have originated but not reversed by the balance sheet
other comprehensive income date;
Not be recognized on permanent differences.
 Income tax presentation and disclosures
A. Income tax Presentation
The requirements for Statement of Financial Position are:
− Deferred tax asset and liability and current assets and liabilities should be presented separately from other assets and
liabilities in the Statement of Financial Position
− Deferred tax assets and liabilities should not be classified within current assets and liabilities, if the Statement of Financial
Position makes such a distinction.
•Income tax Disclosures
For each type of temporary difference, the amount of the deferred tax asset and liabilities recognized in the Statement of
Financial Position.
For each type of temporary differences, the amount of the deferred tax income or expense recognized in the Statement of
Comprehensive Income, if the information is not evident from the movement in Statement of Financial Position amounts.
Temporary Difference Reversals: the deferred tax expense relating to the organization or reversal of temporary differences
and changes in tax rates or to the importation of new taxes.
Reduction of taxes: by using previously unrecognized tax loss, tax credit or temporary difference of a prior period.
The written down of a deferred tax asset.
Deductible Temporary Difference: the amount and expiry date (if any) of deductible temporary differences, unused tax
losses, and unused tax credits for which no deferred tax asset is recognized in the Statement of Financial Position.
The aggregate amount of temporary differences related to specific Investments.
Deferred tax relating to items that are charged or credited to equity.
• Future taxable profits: the amount of deferred tax asset and the nature of the evidence supporting its recognition. When its
utilization depends on future taxable profits exceeding
•THE END