Chapter 3 Deferred Taxation
2. Normal tax and deferred tax 1 Current tax versus deferred tax
2.1.4 Basic examples
Consider the following examples:
Example 1A: creating a deferred tax asset (debit balance)
The current tax charged by the tax authority (using the tax legislation) in 20X1 is expected to be C10 000.
The accountant calculates that the tax incurred for 20X1 to be C8 000.
The C2 000 excess will be deferred to future years.
There are no components of other comprehensive income.
Required:
Show the ledger accounts and disclose the tax expense and deferred tax for 20X1.
Solution to example 1A: creating a deferred tax asset (debit balance)
The tax expense that is shown in the statement of comprehensive income must always reflect the tax that is believed to have been incurred for the year, thus C8 000 must be shown as the expense.
Ledger accounts: 20X1
Tax: normal tax (E) Current tax payable: normal tax (L) CTP: NT (1) 10 000 DT (2) 2 000 Tax (1) 10 000 _____ Total c/f 8 000
10 000 10 000 Total b/f 8 000
Deferred tax (A) Tax (2) 2 000
(1) recording the current tax (the estimated amount that will be charged/ assessed by the tax authority).
(2) deferring a portion of the current tax expense to future years so that the balance in the tax expense account is the amount considered to have been incurred (i.e. C8 000). Notice that the deferred tax account has a debit balance of C2 000, meaning that the C2 000 deferred tax is an asset. This tax has been charged but will only be incurred in the future and so it is similar to a prepaid expense.
Disclosure for 20X1:
The disclosure will be as follows (the deferred tax asset note will be ignored at this stage):
Entity name
Statement of comprehensive income For the year ended …20X1
Note 20X1 C
Profit before tax xxx
Taxation expense (current tax: 10 000 – deferred tax: 2 000) 3. 8 000
Profit for the period xxx
Other comprehensive income 0
Total comprehensive income xxx
Entity name
Statement of financial position As at …20X1
ASSETS
20X1 C Non-current Assets
- Deferred tax: normal tax 2 000
Entity name
Notes to the financial statements For the year ended …20X1 3. Taxation expense
20X1 C
Normal taxation expense 8 000
- Current 10 000
- Deferred (2 000)
Example 1B: reversing a deferred tax asset
Use the same information as that given in 1A and the following additional information:
The current tax charged by the tax authorities (based on tax legislation) in 20X2 is expected to be C14 000. The accountant calculates the tax incurred for 20X2 to be C16 000 (the
‘excess tax’ charged in 20X1 is now incurred).
There are no components of other comprehensive income.
Required:
Show the ledger accounts and disclose the tax expense and deferred tax in 20X2.
Solution to example 1B: reversing a deferred tax asset Ledger accounts: 20X2
Tax: normal tax (E) Current tax payable: normal tax
CTP: NT (1) 14 000 Tax (1) 14 000
DT (2) 2 000 16 000
Deferred tax (A)
Balance b/d 2 000 Taxation (2) 2 000
(1) recording the current tax (estimated amount that will be charged by the tax authorities) (2) recording the reversal of the deferred tax asset in the second year. The total tax expense in
20X2 will be the current tax charged for 20X2 plus deferred tax (the portion of the current tax that was not recognised in 20X1, is incurred in 20X2).
Disclosure for 20X2:
Entity name
Statement of comprehensive income For the year ended …20X2
Note 20X2 C
20X1 C
Profit before tax xxx xxx
Taxation expense (20X2: current tax: 14 000 + deferred tax: 2 000)
3. 16 000 8 000
Profit after tax xxx xxx
Other comprehensive income 0 0
Total comprehensive income xxx xxx
Entity name
Statement of financial position As at … 20X2
Notes to the financial statements For the year ended ……20X2 3. Taxation expense
It can be seen that over the period of 2 years, the total current tax of C24 000 (10 000 + 14 000) charged by the tax authorities, is recognised as a tax expense in the accounting records:
• the tax expense in the first year is C8 000; and
• the tax expense in the second year C16 000.
Example 2A: creating a deferred tax liability (credit balance)
The current tax expected to be charged by the tax authorities (based on tax legislation) is C10 000 in 20X1. The accountant calculates that the tax incurred for 20X1 to be C12 000.
There are no components of other comprehensive income.
Required:
Show the ledger accounts and disclose the tax expense and deferred tax in 20X1.
Solution to example 2A: creating a deferred tax liability (credit balance)
The tax shown in the statement of comprehensive income must always be the amount incurred for the year rather than the amount charged, thus C12 000 must be shown as the tax expense.
Ledger accounts: 20X1
Tax: normal tax (E) Current tax payable: normal tax
CTP: NT(1) 10 000 Tax (1) 10 000
DT(2) 2 000 12 000
Deferred tax (L)
Tax (2) 2 000
(1) Recording the current tax (the estimated amount that will be charged by the tax authorities).
(2) Providing for extra tax that has been incurred but which will only be charged/assessed by the tax authorities in future years (tax owing to the tax authorities in the long term): we have only been charged C10 000 in the current year, but have incurred C12 000, thus there is an amount of C2 000 that will have to be paid sometime in the future. Notice that the deferred tax account has a credit balance of C2 000, (a deferred tax liability).
Disclosure for 20X1:
Entity name
Statement of comprehensive income For the year ended …20X1
20X1 C
Profit before tax xxx
Taxation expense (current tax: 10 000 + deferred tax: 2 000) 3. 12 000
Profit for the year xxx
Other comprehensive income 0
Total comprehensive income xxx
Entity name
Statement of financial position As at ……..20X1
LIABILITIES
20X1 C Non-current Liabilities
- Deferred tax: 2 000
Entity name
Notes to the financial statements For the year ended ……20X1 3. Taxation expense
20X1 C
Normal taxation expense 12 000
- Current 10 000
- Deferred 2 000
Example 2B: reversing a deferred tax liability
Use the same information as that given in example 2A as well as the following information:
• The tax authority is expected to charge C14 000 for 20X2 but the tax incurred is calculated to be C12 000.
• There are no components of other comprehensive income.
Required:
Show the ledger accounts and disclose the tax expense and deferred tax in 20X2.
Solution to example 2B: reversing a deferred tax liability
The deferred tax liability (a non-current liability) will have to be reversed out in 20X2 since the amount will now form part of the current tax payable liability instead (a current liability).
Ledger accounts: 20X2
Tax: normal tax (E) Current tax payable: normal tax CTP: NT (1) 14 000 DT (2) 2 000 Tax (1) 14 000 Total 12 000
Deferred tax (L)
Tax (2) 2 000 Balance b/f 2 000
(1) recording the current tax (charged by the tax authority) (2) recording the reversal of the deferred tax in the second year.
Disclosure for 20X2:
Entity name
Statement of comprehensive income For the year ended …..20X2
20X2 C
20X1 C
Profit before tax xxx xxx
Taxation expense (current tax and deferred tax) 3. 12 000 12 000
Profit for the year xxx xxx
Other comprehensive income 0 0
Total comprehensive income xxx xxx
Entity name
Statement of financial position As at ……..20X2
LIABILITIES
20X2 C
20X1 C Non-current Liabilities
- Deferred Tax 0 2 000
Entity name
Notes to the financial statements For the year ended …20X2 3. Taxation expense
20X2 C
20X1 C
Normal taxation expense 12 000 12 000
- current 14 000 10 000
- deferred (2 000) 2 000
It can be seen that over the period of 2 years, the total current tax of C24 000 (10 000 + 14 000) charged by the tax authority is recognised as a tax expense in the accounting records:
• the tax expense in the first year is C12 000 and
• the tax expense in the second year is C12 000.