IAS
12 Income Taxes defines deferred tax
liabilities as the amounts of income taxes payable in future periods in respect
of taxable temporary differences. Temporary differences are differences between
the carrying amount of an asset or liability in the statement of financial
position (balance sheet) and its valuation for tax purposes. These temporary
differences arise when the tax due for a particular accounting period is
deferred because of the impact of capital allowances and other factors.
12 Income Taxes defines deferred tax
liabilities as the amounts of income taxes payable in future periods in respect
of taxable temporary differences. Temporary differences are differences between
the carrying amount of an asset or liability in the statement of financial
position (balance sheet) and its valuation for tax purposes. These temporary
differences arise when the tax due for a particular accounting period is
deferred because of the impact of capital allowances and other factors.
Capital
allowances are tax deductible while depreciation is not tax deductible.
Financial accounting allows for depreciation as an expense which is charged as
a proportion of the cost of a non-current asset but does not allow the
deduction of capital allowance as an expense.
allowances are tax deductible while depreciation is not tax deductible.
Financial accounting allows for depreciation as an expense which is charged as
a proportion of the cost of a non-current asset but does not allow the
deduction of capital allowance as an expense.
On
the other hand, Taxation allows for capital allowances as a tax deductible item
which is charged as the total cost of the asset but does not allow for
depreciation as a tax deductible item.
the other hand, Taxation allows for capital allowances as a tax deductible item
which is charged as the total cost of the asset but does not allow for
depreciation as a tax deductible item.
Depreciation has to be added back in computing the
taxable profit of a company.
taxable profit of a company.
In
the year capital allowance is claimed against the cost of the asset, the
capital allowance is deducted from the profit for the year and the depreciation
is added back. As capital allowance is always higher than the deprecation of
the new non-current asset, you will realise that the tax liability for that
year will be lower than subsequent years where the capital allowance will not
be claimable but the depreciation charge will still need to be added back for
such subsequent years.
the year capital allowance is claimed against the cost of the asset, the
capital allowance is deducted from the profit for the year and the depreciation
is added back. As capital allowance is always higher than the deprecation of
the new non-current asset, you will realise that the tax liability for that
year will be lower than subsequent years where the capital allowance will not
be claimable but the depreciation charge will still need to be added back for
such subsequent years.
For
example, a company made a profit of £171,000 in 20X1 and a qualifying asset was
bought during that year for £100,000 and this will have a useful life of 8
years and no residual value at the end of its useful life. In 20X2, the company
also made a profit of £171,000 and that asset is still in use by the company.
Tax is charged at 20%.
example, a company made a profit of £171,000 in 20X1 and a qualifying asset was
bought during that year for £100,000 and this will have a useful life of 8
years and no residual value at the end of its useful life. In 20X2, the company
also made a profit of £171,000 and that asset is still in use by the company.
Tax is charged at 20%.
Depreciation
on the asset = £100,000/ 8 years = £12,500 per year.
on the asset = £100,000/ 8 years = £12,500 per year.
20X1 £
Profit
171,000
171,000
Add
back depreciation 12,500
back depreciation 12,500
183,500
Less:
Capital allowances (100,000)
Capital allowances (100,000)
Taxable
profit 83,500
profit 83,500
Tax
(20% of £83,500) 16,700
(20% of £83,500) 16,700
20X2 £
Profit
171,000
171,000
Add
back depreciation 12,500
back depreciation 12,500
183,500
Tax
(20% of £183,500) 36,700
(20% of £183,500) 36,700
Difference
in tax liability arising due to capital allowance = £36,700 – £16,700 = £20,000
in tax liability arising due to capital allowance = £36,700 – £16,700 = £20,000
The
tax in 20X1 is less by £20,000 due to capital allowance which has been claimed
but as capital allowance can only be claimed once on each asset, the tax in
20X2 has increased as depreciation still has to be added back.
tax in 20X1 is less by £20,000 due to capital allowance which has been claimed
but as capital allowance can only be claimed once on each asset, the tax in
20X2 has increased as depreciation still has to be added back.
Deferred tax is
a way of applying the accruals concept to accounting for corporation tax.
a way of applying the accruals concept to accounting for corporation tax.
Deferred
tax implies that the tax for an earlier accounting period has been pushed into
later accounting periods. Financial accounting requires that these future
increased tax liability should be recognised as a provision, which
is a liability in the financial statements.
tax implies that the tax for an earlier accounting period has been pushed into
later accounting periods. Financial accounting requires that these future
increased tax liability should be recognised as a provision, which
is a liability in the financial statements.
Accounting
treatment:
treatment:
Dr
– Deferred tax expense in the Statement of profit or loss £20,000
– Deferred tax expense in the Statement of profit or loss £20,000
Cr
– Deferred tax liability in the Statement of financial position (balance sheet) £20,000
– Deferred tax liability in the Statement of financial position (balance sheet) £20,000
In
applying the accruals concept in financial accounting, an aim is made to ensure
that the profit is not overstated in 20X1, hence the expense in the Statement
of profit or loss account is increased and the current liability in the
Statement of financial position (balance sheet) is also increased as this is
tax which is expected to be paid in the next accounting period.
applying the accruals concept in financial accounting, an aim is made to ensure
that the profit is not overstated in 20X1, hence the expense in the Statement
of profit or loss account is increased and the current liability in the
Statement of financial position (balance sheet) is also increased as this is
tax which is expected to be paid in the next accounting period.
Yours Sincerely,
The Friendly Team
The Training Place of Excellence Limited