IAS 12 Income Tax

1.0 Introduction
In business, organizations pay several taxes imposed by the jurisdictions within which they
operate however, accounting for taxation by organizations has a wide range of treatment and as
such requires specific provisions. Typically, accountants of firms will normally compute taxes
using their accounting policies adopted in preparing the financial hitherto ensuring strict
compliance of the tax collecting agencies in their area of jurisdiction. For instance, in Ghana
entities prepare financial reports (statement of profit or loss) using accounting policies adopted to
treat some specific transaction (e.g. Depreciation policy) but these entities are supposed to
compute their annual tax using the taxation policies prescribed by the tax collecting agency
(Ghana Revenue Authority).
To synchronize the discrepancy in accounting policies adopted by entities and revenue collecting
agencies, the International Accounting Standard (IAS 12) was developed to prescribe guidelines
for the treatment income taxes by firms. It must however be noted that IAS 12 only prescribes
the treatment of taxes in the books of accounts but not the provision of tax rates and their
respective computation. Tax rates are normally issued by various countries in consonance with
their respective tax legislations. In most countries, the rate changes from year-to-year. In effect,
IAS 12 only provides accounting treatment of tax in the preparation of financial statements.
1.2 Scope of IAS 12
The main aim of IAS 12 is to cover the treatment of income taxes for current and future tax
consequences. The standard is mainly concerned with computation and treatment of company
taxes on their annual profits and other transactions. For the purpose of IAS 12, income taxes
include all domestic and foreign taxes which are based on taxable profits. Income taxes also
includes taxes such as withholding taxes, which are payable by a subsidiary, associates or joint
venture on distribution of the reporting entity.
This Standard does not deal with the methods of accounting for government grants (see IAS 20
Accounting for Government Grants and Disclosure of Government Assistance) or investment tax
credits. However, this Standard does deal with the accounting for temporary differences that may
arise from such grants or investment tax credits. In Ghana for instance, IAS 12 does not really
apply to the treatment of value added tax (VAT)/ sales tax.
To avoid the pitfalls in the computation company taxes, it is prudent to distinguish between
current tax and deferred taxes. Before dealing with any pitfall associated with taxes, it is worth
considering some specific definitions associated with the treatment on income statement in
financial statements as per IAS 12.
1.2.1 Key definitions
 Accounting profit is profit or loss for a period before deducting tax expense.
 Taxable profit (tax loss) is the profit (loss) for a period, determined in accordance with
the rules established by the taxation authorities, upon which income taxes are payable
(recoverable).
 Tax expense (tax income) is the aggregate amount included in the determination of profit
or loss for the period in respect of current tax and deferred tax. Tax expense (tax income)
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 comprises current tax expense (current tax income) and deferred tax expense (deferred
tax income).
 Current tax is the amount of income taxes payable (recoverable) in respect of the
taxable profit (tax loss) for a period.
 Deferred tax liabilities are the amounts of income taxes payable in future periods in
respect of taxable temporary differences.
 Deferred tax assets are the amounts of income taxes recoverable in future periods in
respect of:
(a) deductible temporary differences;
(b) the carryforward of unused tax losses; and
(c) the carryforward of unused tax credits.
 Temporary differences are differences between the carrying amount of an asset or
liability in the
statement of financial position and its tax base. Temporary differences may be either:
(a) taxable temporary differences, which are temporary differences that will result in
taxable amounts in determining taxable profit (tax loss) of future periods when the
carrying amount of the asset or liability is recovered or settled; or
(b) deductible temporary differences, which are temporary differences that will result
in amounts that are deductible in determining taxable profit (tax loss) of future
periods when the carrying amount of the asset or liability is recovered or settled.
 The tax base of an asset or liability is the amount attributed to that asset or liability for
tax purposes.

1.2.0 Current Tax

Unlike deferred taxation, the estimation of companies’ current tax does not really pose
difficulties to companies. Current taxes, once estimated, are accounted for in the income
statement and the statement of financial position. Such taxes are estimated based on taxable
income of a company and the rates used to calculate the current tax should be those that have
been enacted by the balance sheet date.
The estimation of a current tax could result in a current tax liabilities and current tax assets. The
standard provides that such current obligations and benefits be recognized in the financial
statement. According to IAS 12, current tax for current and prior periods shall, to the extent
unpaid, be recognized as a liability. If the amount already paid in respect of current and prior
periods exceeds the amount due for those periods, the excess shall 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 recognized as an asset. 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.
1.2.1 Accounting for Current tax

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The normal practice in preparing financial statements at the end of every year is to compute
estimate tax on the taxable profit of a company. This estimate is debited to the income statement
as an expense and reported in the statement of financial position as a current liability on the
balance sheet date. When these tax payables are introduced, the companies:
Debit: Income tax expense (Income statement)
Credit: Tax payable (statement of financial position)
When these estimates are computed and accounting entries treated, the company usually
reconciles it (tax) with the actual tax assessment from the tax authorities. The tax estimate could
either commensurate with assessment received from the tax authorities or differ. In most cases
estimated taxes differ from those received from tax authorities.
If the estimated tax is in excess of the actual tax from the tax authorities, then this could result in
over provision of tax whereas a vice versa will constitute under provision of tax.
Any under/over provision is normally dealt with in a company’s following year’s tax charge. An
under-provision of tax increases the current tax charge whiles over-provision in previous years
decreases the current tax charge. To account for current taxes, a conscious effort is made to
understand the difference between taxable profit and accounting profit.

1.2.2 Accounting profit taxable profit

The discrepancy between accounting profit and taxable profit is normally caused by:
 Permanent differences
 Temporary differences
Permanent Differences
A permanent difference is an accounting transaction that the company reports for book purposes
but that it can’t (and never will be able to) report for tax purposes. In other words, permanent
differences between the financial profit and taxable profit arise when income is not taxable, or
expenses are not allowed for tax. These differences arise because the IFRS allows reporting for a
particular transaction, but the revenue agencies do not. As with temporary differences, quite a
few accounting events lead to a permanent difference. Five common permanent differences are:
 penalties and fines,
 meals and entertainment,
 life insurance proceeds,
 interest on municipal bonds (in some countries), and
 special dividends received deduction.
A government grant may be a gift that is not taxed. Government bonds often provide tax-free
interest income or may be taxed at a lower rate than the standard income tax rate for companies.
Fines paid by an undertaking may not be tax-deductible. Example, your firm receives a tax- free
GH¢4million grant to employ more staff. It is later also fined GH¢1m for environmental misuse,
after illegally discharging chemicals into a river. The fine cannot be deducted for tax.
The financial statements will reflect these items, but your tax computation will exclude them, or
record that no tax is payable nor receivable. Your tax computation will reconcile these
adjustments to the accounting profit. No deferred tax needs to be calculated for permanent
differences. This is because deferred tax is an accrual of tax, and there will be no further tax to

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be accrued.

1.2.3 Computation of taxable profit and Accounting profit

As a normal practice, accounting trainees are usually taught to apply a fixed rate of corporate tax
on the profit before tax to determine the tax payable by firms. Conversely, such treatments will
always conflict with procedure prescribed by tax authorities therefore it is always prudent to
identify the difference between accounting profit and taxable profit. It must be noted that
permanent difference is the cause of most discrepancies between accounting and taxable profit.

Accounting profit is computed using a firm’s accounting policy however tax authorities require
that all taxes are computed on taxable profits, must meet the prescribed guidelines for the
determination of allowable and non-allowable income and expenditure. For instance, whiles
firms will recover the cost of non-current assets used in running the business in their statement of
profit or loss as depreciation, the revenue authorities have their own basis for recovering the cost
of non-current assets.

Procedure for computing taxable procedure:

i. Compute profit before tax (accounting profit)

ii. Adjust profit before tax with the following:
 Non-allowable expenses
 Expenses relating to exempt income
 Exempt income
 Capital allowance

Specimen of Taxable profit

GH¢ GH¢
Net profit before tax xxx
Add back:
Non-allowable expenses xxx
Expenses relating to exempt income xxx xxx
Less:
Other deductible expenses xxx
Exempt income xxx
Capital allowance xxx xxx
Taxable profit xxx

Detailed Illustration:

A Statement of profit and loss prepared by a firm on the following assumptions:

 Corporate tax 25% per annum

 Cost of Property, plant & equipment GH12,000
 Depreciation policy: 10% on cost
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  Capital allowance 40% on all property, plant & equipment (by tax authorities)

Revenue 20,000
Cost of Sales 12,000
Gross profit 8,000
General Administrative Expenses:
-wages and salaries 400
-rent 1,000
-depreciation 1,200
-penalties and fines 800
-insurance 600 4,000
Operating profit 4,000
Other income 1,500
Profit before Interest and Tax 5,500
Finance cost 1,100
Profit before tax 4,400
Note: The statement above shows that the profit before tax of GH4,400 was computed by taking
into consideration all expenses including depreciation, penalties and fines which are not
allowable and also recognized by the tax authorities therefore a conscious effort must be made to
compute the taxable profit of this firm in order to compute the current tax payable to the tax
authorities. To compute the tax payable, the following steps must be followed:
i. Compute the taxable profit
ii. Apply the tax rate on the taxable profit to determine the tax payable
iii. Reduce the tax payable form the profit before tax in order to determine the profit after
tax.
Computation of taxable profit
The non-allowable (depreciation & penalties)) must be adjusted:
GH
Profit before tax 4,400
Add back depreciation 1,200
Add back penalties and fines 800
Adjusted profit 6,400
Less capital allowance (40% of GH12,000) 4,800
Taxable profit 1,600
Therefore, tax is computed as follows:

Tax payable 25% @ GH1,600 = GH400

After this computation, the statement of Profit or loss will be presented as follows:

Revenue 20,000
Cost of Sales 12,000
Gross profit 8,000
General Administrative Expenses:
-wages and salaries 400
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 -rent 1,000
-depreciation 1,200
-penalties and fines 800
-insurance 600 4,000
Operating profit 4,000
Other income 1,500
Profit before Interest and Tax 5,500
Finance cost 1,100
Profit before tax 4,400
Tax (25% @ GH1,600) 400
Profit After tax 3,800

Practice Questions

2.2.4 Accounting treatment for Under and Over provision of tax

Due to time lag and other factors, provision for corporate taxes may be under or overestimated
by entities. In most cases, under or over provision occurs when the estimated tax provided for in
the statement of profit or loss is different from the final tax assessment by the tax authorities.

The under/over provision is determinable only after actual payment is usually made when the
financial statements of a particular year are already published, and the subsequent year is already
underway. According to IAS 12, any under or over provision of tax related to previous years are
adjusted in current year’s provision in the income statement.

To account for any under or over provision of tax by entities, a previous year’s under provision
increases the current year’s tax charge in the statement of profit or loss. This is because the
previous year’s remaining provision will be used to increase the current year’s tax provision.
Similarly, any over provision of tax in previous years will be used to reduce the current tax
provision for a particular year.

Illustration 1
A company’s profit before tax at the end of their financial period 31st December 2010 is GS
¢20,000. The relevant corporate tax rate is 30% per annum.
You are require calculate the tax estimate at the end of the year 2010 and show the accounting
entries in the income statement, statement of financial position and the income tax account.
Suggested solution
Corporate tax = 30% @ GS¢20,000 = GS¢6,000
Estimated tax in the income statement as tax expense is GS¢6,000
Income statement for the year ended 31st December, 2010
GS¢
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 Profit before tax 20,000
Less Tax 6,000
Profit for the year 14,000
Statement of financial statement extract
GS¢
Current Liabilities: tax payable 6,000
Financed By:
Net profit 14,000
Income Tax Account
GS¢ GS¢
Balance c/d 6,000 Income statement 6,000

6,000 6,000

Illustration 2
Given the scenario in illustration 1 above, which culminated into an outstanding tax of GS
¢6,000, assuming the actual 2010 tax assessment received and paid during the year 2011 was GS
¢6,200, calculate and show the entries in the financial statement if the current year’s (2011)
profit before tax is GS¢25,000. The tax rate is 30%.
Suggested solution
Current year’s tax estimate: 30% @ GS¢25,000 = GS¢7,500
Income Tax Account
GS¢ GS¢
Bank 6,200 Balance b/d 6,000

Income Statement (under prov.) 200

6,200 6,200

Income Statement for the year ended 2011

GS¢ GS¢
Profit before tax 25,000
Less tax 7,500
Add provision 200 7,700
Net profit 17,300
Statement of financial statement extract

GS¢
Current Liabilities:
Tax payable 7,500
Add under provision 200
7,700
Financed By:
Net profit 17,300

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Practice Questions
Illustration 1 GS¢
Income tax provision for (31/05/2008) 350,000
Income tax paid (28/02/2009) 325,000
Income tax charge at 30% for y/e (31/05/2009) 420,500
Show entries in income tax account and the financial statements the for year to 31/05/2009.
Illustration 2:
At the end of 31st December, 2005 ABC ltd.’s trial balance showed tax (2st January,2005) as an
opening balance of GS¢1,550. The trial balance further showed a tax payment of GS¢120 during
the year 2005. A brief note on the opening tax balance indicated that tax balance outstanding for
2003 amounted to GS¢1,800 whiles tax provision for 2004 was GS¢2,600. Payment of GS¢5,950
was effected to settle the 2003 and 2004 outstanding balances.
Tax liabilities assessed by the tax authorities for 2004 was GS¢3,200 and a provision of GS
¢1,100 is to be made for 2005 corporate tax.
Required:
Show the necessary entries in the financial statement, a tax schedule and prepare an income tax
account.
Illustration 3
A company’s as at 31st December, 2003 shows a debit tax balance of GS¢78,000 as at 1ist
January, 2003. A note attached to the trial balance indicates that the balance on tax account as at
31st January, 2003 includes GS¢12,000 representing tax liabilities on 2002 profit. This amount
was fully settled in March 2003. Additional payments of GS¢66,000 was made to the Internal
Revenue service on provisional assessment of 2003 tax liability. Customers of the company also
deducted 7.5% withholding tax at source giving rise to tax credit of GS¢12,000 in 2003. The
company’s profit before tax was GS¢569,229 and the corporate tax for 2003 is to be provided at
the rate of 30%.
Required:
Show the necessary entries in the financial statement, a tax schedule and prepare an income tax
account.
Illustration 4
Yamansa Ltd prepares its financial statements on 31st December each year. At the end of 2005,
the company recorded a profit before tax of GS¢57,830. The company’s trial balance at 31/12/05
also showed a debit corporate tax of GS¢6,000. During the year 2005, Yamansa Ltd paid
outstanding tax liability of GS¢4,000 and an amount of GS¢5,200 also paid on account of 2005
provisional tax assessment. Tax credit certificates amounting to GS¢800 were obtained by the
company in the year as a result of withholding tax deducted at source by customers. Corporate
tax rate applicable to the company is 30% of net profit.
Required:
Show the necessary entries in the financial statement, a tax schedule and prepare an income tax
account for 2005.

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1.3.0 Deferred tax
Deferred tax has been described as the “problem child” in recognizing and dealing with tax
computations. The pitfalls associated with deferred tax are normally precipitated by the
difference between accounting profit and taxable profit. A deferred tax “is the estimated future
tax consequences of transactions and events recognized in the financial statement of the current
and previous periods”.

The main motive of IAS 12 is to provide guidance on accounting for current and future tax
consequences of the recovery or settlement of assets, liabilities and other transactions that have
occurred in the same period. To achieve this, deferred taxations is used as basis for allocating tax
charges to particular accounting periods. The key distinctive features which necessitate deferred
taxation lies in two different concepts of computing profit, thus:

 the accounting profit reported by a company on the basis of accounting policies/basis

adopted by those companies. IAS 12 (5) defines accounting profit as the profit (loss) for a
period before deducting profit.
 the taxable profit, which is the amount on which tax authorities uses as a base for their
tax computation. IAS 12 (5) defines taxable profit (tax loss) as the profit (loss) for a
period, determined in accordance with the rules established by the taxation authorities,
upon which income taxes are payable (recoverable).

Recognition in Income Statement

The general principle is that all changes in current and deferred tax are recognised in profit or
loss. Two exceptions are applicable. The first relates to transactions recognised in other
comprehensive income. The current and deferred tax related to items recognised in other
comprehensive income and equity should also be recognised in other comprehensive income and
equity. Secondly the initial deferred tax recognised on assets and liabilities acquired in a business
combination are recognised as an adjustment to good will or any gain on a bargain purchase.
Calculation of Deferred Tax Asset or Liability
While conceptually the application of the liability method is straightforward, in the application of
IAS 12 a number of complexities need to be addressed. The following process needs to be
followed to calculate and measure deferred tax assets and liabilities:
1. Identification of temporary differences.
2. Identification of exceptions.
3. Identification of unused tax losses or tax credits.
4. Calculation and measurement of deferred tax assets or deferred tax liabilities.
5. Limitations on the recognition of deferred tax assets.

1.3.1 Temporary Difference

IAS 12 defines temporary differences as differences between the carrying amount of an asset or
liability in the statement of financial position and its tax base. In effect, deferred tax liability will
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only arise when the carrying value an asset is greater than its tax base or when the carrying
amount of a liability is less than its tax base. The standard outlines two main kinds of temporary
differences as:

 taxable temporary differences: Taxable temporary differences represent a liability and are
defined as temporary differences that will result in taxable amounts in determining
taxable profits of future periods when the carrying amount of the asset or liability is
recovered or settled. It results in the payment of tax when the carrying amount of an asset
or liability is settled.
For instance, if the carrying value of an asset exceeds its tax base, the company must
make provision for deferred. In this circumstance, the difference is said to a taxable
temporary difference. For example, if a machine has a carrying value in the financial
statements of GS¢50,000 and its tax base is GS¢20,000, then the difference of GS
¢30,000 (GS¢50,000 – GS¢20,000) represents a taxable temporary difference.
 deductible temporary differences: Deductible temporary differences represent an asset
and are defined as temporary differences that will result in amounts that will be
deductible in determining the taxable profits of future periods when the carrying amount
of the asset or liability is recovered or settled.

Deductible and taxable temporary differences are thus based on the future taxable effect
explained in the following examples:

i. Revenue recognised for financial reporting purposes before being recognised for
tax purposes. Examples include revenue accounted for by the instalment method
for tax purposes, but reflected in income currently; certain construction-related
revenue recognised on a completed-contract method for tax purposes, but on a
percentage-of-completion basis for financial reporting; earnings from investees
recognised by the equity method for accounting purposes but taxed only when
later distributed as dividends to the investor. These are taxable temporary
differences because the amounts are taxable in future periods, which give rise to
deferred tax liabilities
ii. Revenue recognised for tax purposes prior to recognition in the financial
statements. These include certain types of revenue received in advance, such as
prepaid rental income and service contract revenue that is taxable when received.
Referred to as deductible temporary differences, these items give rise to deferred
tax assets.
iii. Expenses that are deductible for tax purposes prior to recognition in the financial
statements. This results when accelerated depreciation methods or shorter useful
lives are used for tax purposes, while straight-line depreciation or longer useful
economic lives are used for financial reporting; and when there are certain pre-
operating costs and certain capitalized interest costs that are deductible currently

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 for tax purposes. These items are taxable temporary differences and give rise to
deferred tax liabilities.
iv. Expenses that are reported in the financial statements prior to becoming
deductible for tax purposes. Certain estimated expenses, such as warranty costs,
as well as such contingent losses as accruals of litigation expenses, are not tax
deductible until the obligation becomes fixed. These are deductible temporary
differences, and accordingly give rise to deferred tax assets.

Identification of Temporary Differences

The preponderance of the typical reporting entity’s revenue and expense transactions are treated
identically for tax and financial reporting purposes. Some transactions and events, however, will
have different tax and accounting implications. In many of these cases, the difference relates to
the period in which the income or expense will be recognised. Under earlier iterations of IAS 12,
the latter differences were referred to as timing differences and were said to originate in one
period and to reverse in a later period. The current IAS12 introduced the concept of temporary
differences, which is a somewhat more comprehensive concept than that of timing differences.
Temporary differences include all the categories of items defined under the earlier concept, and
add a number of additional items, as well. Temporary differences are defined to include all
differences between the carrying amount and the tax base of assets and liabilities.

The tax base of an asset or liability is defined as the amount attributable to that asset or liability
for tax purposes. The following principles are included in IAS 12 to determine the tax base of
assets and liabilities:

Element Tax base

Asset The amount that would be deductible for tax purposes when the carrying
amount of the asset is recovered. If the economic benefits recovered from
the asset are not taxable, the tax base of the asset is equal to its carrying
amount.

Liability The carrying amount less any amount that will be deductible for tax
purposes in respect of the liability in future periods. In the case of revenue
received in advance, the tax base is the carrying amount less any amount
of the revenue that will not be taxed in future periods.

The tax base can also be determined for transactions not recognised in the statement of financial
position. For example if an amount is expensed, but the amount is only deductible for tax
purposes in the future, the tax base will be equal to the amount deductible in the future. When the
tax base of an item is not immediately apparent, the following general principle of IAS 12 must
be followed to determine the tax base:

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  Recognise a deferred tax asset when recovery or settlement of the carrying amount will
reduce future taxable income, and
 a deferred tax liability when the recovery or settlement of the carrying amount will
increase future taxable income. Once the tax base is determined the related temporary
difference is calculated as the difference between carrying value and the tax base.

Other examples of temporary differences include:

 Reductions in tax-deductible asset bases arising in connection with tax credits. Under tax
provisions in certain jurisdictions, credits are available for certain qualifying investments
in plant assets. In some cases, taxpayers are permitted a choice of either full accelerated
depreciation coupled with a reduced investment tax credit, or a full investment tax credit
coupled with reduced depreciation allowances. If the taxpayer chose the latter option, the
asset basis is reduced for tax depreciation, but would still be fully depreciable for
financial reporting purposes. Accordingly, this election would be accounted for as a
taxable timing difference and give rise to a deferred tax liability.
 Increases in the tax bases of assets resulting from the indexing of asset costs for the
effects of inflation. Occasionally, proposed and sometimes enacted by taxing
jurisdictions, such a tax law provision allows taxpaying entities to finance the
replacement of depreciable assets through depreciation based on current costs, as
computed by the application of indices to the historical costs of the assets being
remeasured. This re-evaluation of asset costs gives rise to deductible temporary
differences that would be associated with deferred tax benefits.
 Certain business combinations accounted for by the acquisition method. Under certain
circumstances, the costs assignable to assets or liabilities acquired in purchase business
combinations will differ from their tax bases. The usual scenario under which this arises
is when the acquirer must continue to report the predecessor’s tax bases for tax purposes,
although the price paid was more or less than book value. Such differences may be either
taxable or deductible and, accordingly, may give rise to deferred tax liabilities or assets.
These are recognised as temporary differences by IAS 12.
 Assets that are revalued for financial reporting purposes although the tax bases are not
affected. This is analogous to the matter discussed in the preceding paragraph. Under
certain IFRS (such as IAS 16 and IAS 40), assets may be upwardly adjusted to current
fair values (revaluation amounts), although for tax purposes these adjustments are
ignored until and unless the assets are disposed of. The discrepancies between the
adjusted book carrying values and the tax bases are temporary differences under IAS 12,
and deferred taxes are to be provided on these variations. This is required even if there is
no intention to dispose of the assets in question, or if, under the salient tax laws,
exchanges for other similar assets (or reinvestment of proceeds of sales in similar assets)
would effect a postponement of the tax obligation.

Identification of Exemptions
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Two exemptions are applicable to the recognition of deferred tax, namely goodwill and initial
recognition exception.

Goodwill No deferred tax liability should be recognised on the initial recognition of goodwill.
Although goodwill represents an asset, no deferred tax is considered to arise since goodwill is
measured as a residual of the value of net assets acquired in a business combination. The
deferred tax recognised on the acquired net assets of the business combination, however, affects
the value of goodwill as the residual. IAS 12 also clarifies that no deferred tax effects are
applicable to the later impairment of goodwill.

If goodwill or again on a bargain purchase is not deductible or taxable, respectively, in a given

tax jurisdiction (that is, it is a permanent difference), in theory its tax base is zero, and thus there
is a difference between tax and financial reporting bases, to which one would logically expect
deferred taxes would be attributed. However, given the residual nature of goodwill or a gain on a
bargain purchase, recognition of deferred taxes would in turn create yet more goodwill, and thus
more deferred tax, etc. There would be little purpose achieved by loading up the statement of
financial position with goodwill and related deferred tax in such circumstances, and the
computation itself would be quite challenging. Accordingly, IAS 12 prohibits grossing up
goodwill in such a fashion. Similarly, no deferred tax benefit will be computed and presented in
connection with the financial reporting recognition of a gain on a bargain purchase.

However, IAS 12 states that if the carrying amount of goodwill under a business combination is
less than its tax base, a deferred tax asset should be recognised. This will be in jurisdictions
where future tax deductions are available for goodwill. The deferred tax assets will only be
recognised to the extent that it is probable that future taxable profits will be available to utilize
the deduction. Initial recognition exemption

No deferred tax liability or asset is recognised on the initial recognition of an asset or liability
that is not part of a business combination, and at the time of the transaction, affects neither
accounting profit nor taxable pro fits. IAS 12, for example, states that an asset which is not
depreciated for tax purposes will be exempt under this initial recognition exemption, provided
that any capital gain or loss on the disposal of the asset will also be exempt for tax purposes.

In some tax jurisdictions, the costs of certain assets are never deductible in computing taxable
profit. For accounting purposes such assets may be subjected to depreciation or amortization.
Thus, the asset in question has a differing accounting base than tax base and this results in a
temporary difference. Similarly, certain liabilities may not be recognised for tax purposes
resulting in a temporary difference.

While IAS 12 accepts that these represent temporary differences, a decision was made to not
permit recognition of deferred tax on these. The reason given is that the new result would be to
“gross up” the recorded amount of the asset or liability to offset the recorded deferred tax
liability or benefit, and this would make the financial statements “less transparent.” It could also
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be argued that when an asset has, as one of its attributes, non-deductibility for tax purposes, the
price paid for this asset would have been affected accordingly, so that any such “gross-up” would
cause the asset to be reported at an amount in excess of fair value.

Illustrative Questions
Illustration 1
An entity, Davi, provides the following information regarding its assets and liabilities as at 31
December 2018.
i. An equipment costing GH¢10,000. Depreciation of GH¢1,800 has been charged to date.
Tax allowances of GH¢3,000 have been claimed.
ii. Interest receivable in the statement of financial position is GH¢100. The interest will be
taxed when received.
iii. Trade receivables have a carrying amount of GH¢1,000. The revenue has already been
included in taxable profit.
iv. Inventory has been written down by GH¢50 to GH¢450 in the financial statements. The
reduction is ignored for tax purposes until the inventory is sold.
v. Current liabilities include accrued expenses of GH¢100. This is deductible for tax on a
cash paid basis.
vi. Accrued expenses have a carrying amount of GH500. The related expense has been
deducted for tax purposes.
Required:
a) You are to determine the carrying amount, tax base and temporary difference for each of
the assets and liabilities.
b) Using the information calculate Davi's deferred tax balance as at 31 December 2019. The
applicable tax rate is 30%.
Suggested solution
a)
i. Davi’s carrying amount of the equipment is GH¢8,200 (GH¢10,00-GH¢1,800)
whiles their tax base is GH¢7,000 (GH¢10,000-GH¢3,000). The timing difference is
GH¢1,200 (GH¢8,200-GH¢1,200).
ii. Carrying amount of the interest receivable is GH¢100 whiles the tax base is zero
because interest is only charged when tax is received. The timing/temporary
difference is therefore GH¢100.
iii. The carrying amount of the trade receivable is GH¢1,000 and the tax base is GH
¢1,000 therefore the timing difference is zero. This is because the revenue has been
included in the taxable profit.
iv. The carrying amount of the inventory is GH¢450 (GH¢500-GH¢50) but the tax base
is GH¢500 therefore temporary difference will amount to negative fifty (GH¢50).
v. The carrying amount for the accrued expenses is negative one hundred GH¢100 but
the cash base is zero therefore the temporary difference is negative one hundred
cedis (GH¢100).
vi. The carrying amount of the accrued expenses is negative five hundred cedis (GH
¢500) whiles the tax base is also negative five hundred cedis (GH¢500) therefore the
temporary difference is zero.
b) The net temporary difference as at the reporting date is given below:
14
 Equipment 1,200
Interest receivable 100
Trade receivable -
Inventory (50)
Accrual (100)
Accrual -
Net temporary difference 1,150
From the above computation, there will be a deferred tax because the carrying value of the net
assets and liabilities exceeds their respective net tax base therefore the deferred tax is GH¢345
(30% of GH¢1,150).

Illustration 2
On 1st January 2017, Jesus Loves you Enterprise purchased a motor vehicle for GS¢400,000 that
had an anticipated useful economic life of four years but qualified for immediate tax relief of
100% of the cost of the asset.
The company prepares its financial statement to December 31, each year and for the year ending
31 December 2017, the draft financial statement of the company showed a profit before tax of
GS¢1,000,000. The company pays tax at a rate of 30% per annum.
Assuming the company makes the same level of profit over the next four-year life span of the
motor vehicle, account for the annual tax liabilities as well as the deferred tax.
Suggested solution
Step 1: Calculate the Depreciation on the Motor vehicle/Capital allowance
2017 2018 2019 2020
GH¢’000 GH¢’000 GH¢’000 GH¢’000
Depreciation 400,000/4 100 100 100 100
Capital allowance (100% ˟ 400,000) 400 - - -
Note: The above schedule shows a major discrepancy between the depreciation value and the
capital allowance of the motor vehicle. Whiles accounting policy adopted by the entity for the
depreciation of the motor vehicle will be exhausted at the end of the forth year, the rate provided
for the motor vehicle by the revenue agency will write off the entire amount at the end of the first
year. This will eventually create a time lag between the recovery of the asset and will therefore
give rise to a deferred tax liability.

Step 2: Determine the taxable profit

2017 2018 2019 2020
GH¢’000 GH¢’000 GH¢’000 GH¢’000
Profit before tax (accounting profit) 1,000 1,000 1,000 1,000
Add back depreciation 100 100 100 100
Adjusted profit 1,100 1,100 1,100 1,100
Less capital allowances (400) - - -
Taxable profit 700 1,100 1,100 1,100
15
Current tax @ 30% 210 330 330 330

Step 3: Calculate the deferred tax liability

2017 2018 2019 2020
GH¢’000 GH¢’000 GH¢’000 GH¢’000
Cost of Asset 400 400 400 400
Depreciation 100 200 300 400
Carrying amount (A) 300 200 100 -
Tax Base:
Cost of asset 400
Capital Allowance 400 - - -
Tax base (B) NILL NILL NILL NILL
Timing difference (A-B) 300 200 100 -
Closing deferred tax liability @ 30% 90 60 30 0
Opening deferred tax liability 0 90 60 30
Difference charge to SOPL 90 (30) (30) (30)
Note: From the above computation, it is observed that whiles the capital allowance of hundred
percent sought to write off the entire motor vehicle at the end of the first year, the effect of the
entity’s policy implies that they will have to write off the motor vehicle over a four-year period.
It also means that the entity would have taken the entire 100% tax credit on the asset but the
asset is still in use by the entity therefore, the deferred tax of GH¢90,000 will be written off over
the remaining economic lifespan of the motor vehicle.
This further reiterate the fact the deferred tax is just a guidance on accounting for the current and
future tax consequences of the future recovery or settlement of assets and liabilities, and
transaction and other events that have occurred in the same period.
It must also be noted that deferred tax has no cash flow implications and has nothing to do with
payment or liability to tax authorities.
Step 3: Prepare the Statement of Profit & Loss
2017 2018 2019 2020
GH¢’000 GH¢’000 GH¢’000 GH¢’000
Profit before tax (accounting profit)(A) 1,000 1,000 1,000 1,000
Current tax (computed in step 2) (210) (330) (330) (330)
Deferred Tax (computed in step 3) (90) 30 30 30
Tax Expense (B) (300) (300) (300) (300)
Profit after tax (A-B) 700 700 700 700

Step 4: Prepare the Statement of Financial Position (extract)

2017 2018 2019 2020
GH¢’000 GH¢’000 GH¢’000 GH¢’000
16
Property, plant & equipment
Cost of Asset 400 400 400 400
Depreciation 100 200 300 400
Net book values 300 200 100 -
Non-current liabilities:
Deferred liabilities 90 60 30 -

1.3.2 Recognition and measurement of deferred tax liabilities and assets

Recognition: In accordance with IAS 12, deferred tax should be provided for on all taxable
temporary differences, unless the deferred tax liability arises from:
 goodwill, for which amortization is not tax deductible
 the initial recognition of an item that affects neither accounting profit nor taxable profit,
and which does not result from a business combination.
Deferred tax assets should be recognised on all deductible temporary differences unless:
 the exceptions above apply;
 insufficient taxable profits are expected to be available in the future against which the
deductible temporary difference can be utilized.
Measurement: The tax rate in force (or expected to be in force) when the asset is realized or the
liability is settled, should be applied to the temporary difference to calculate the deferred tax
balance. IAS 12 specifies that this rate must be based on legislation enacted or substantively
enacted by the reporting date.
Deferred tax assets and liabilities are not discounted to present value. The entry to profit or loss
and other comprehensive income in respect of deferred tax is the difference between the net
liability (or asset) at the beginning of the year and the net liability (or asset) at the end of the
year. It is important to note that:
 If the item giving rise to the deferred tax is dealt with in profit or loss, the related
deferred tax should also be presented in profit or loss;
 If the item giving rise to the deferred tax is dealt with in other comprehensive income, the
related deferred tax should also be recorded in other comprehensive income and held
within equity.
1.3.3 Offsetting of deferred tax assets and liabilities
IAS 12 notes that it is appropriate to offset deferred tax assets and liabilities in the statement of
financial position as long as:
 the entity has a legally enforceable right to set off current tax assets and current tax
liabilities;
 the deferred tax assets and liabilities relate to tax levied by the same tax authority.

1.3.4 Specific tax transactions

Apart from temporary differences arising from depreciation and allowance of an entity’s assets,
below are the examples of some transactions that may give rise to temporary differences with
deferred tax implications:

17
Provision for impairment of receivables;
Fair value of investment property
Revaluation of Property, plant and equipment
In accordance with IAS 12, deferred tax should be recognised on the revaluation of property,
plant and equipment even if:
i. there is no intention to sell the asset;
ii. any tax due on the gain made on any sale of the asset can be deferred by being ‘rolled
over’ against the cost of a replacement asset.
Note: Revaluation gains are recorded in other comprehensive income and so any deferred tax
arising on the revaluation must also be recorded in other comprehensive income.
Illustration
A firm acquired property, plant and equipment several years when the original cost of the PP&E
was GH10,000. Accumulated depreciation of GH4,000 has been charged up to the reporting date
of 31 December 2018. The firm has claimed total capital allowance of GH5,000 as at the
reporting date. On 31 December 2018, the asset was revalued to GH9,000. The tax rate is 30%.
Required: Show how deferred tax will be computed and treated in the books of the firm
Suggested solution:
Carrying amount after revaluation 9,000
Tax base (10,000-5,000) 5,000
Temporary difference 4,000
Deferred tax (30% @ GH4,000) 1,200
The carrying value of the asset is GH¢9,000 and the tax base is GH5,000 (GH10,000 –
GH5,000). The carrying value exceeds the tax base by GH4,000 (GH9,000 – GH5,000).
This temporary difference will give rise to a deferred tax liability of $12,000 ($40,000 × 30%).
Prior to the revaluation, the carrying amount of the asset was GH6,000. The asset was then
revalued to GH9,000. Therefore, GH3,000 (GH9,000 – GH$6,000) of the temporary difference
relates to the revaluation. Revaluation gains are recorded in other comprehensive income and so
the deferred tax charge relating to this gain should also be recorded in other comprehensive
income. This means that the tax charged to other comprehensive income is GH900 (GH3,000 ×
30%).
Accounting Entries
 Dr Other comprehensive income GH900
 Dr Profit or loss (bal. fig.) GH300
 Cr Deferred tax liability GH1,200

Unused tax losses

The existence of unused tax losses is strong evidence that future taxable profit may not be
available. Deferred tax assets arising from unused tax losses or tax credits are recognised only to
the extent that:
i. the entity has sufficient taxable temporary differences, or
ii. there is convincing other evidence that sufficient taxable profit will be available against
18
 which the unused tax losses or unused tax credits can be utilized by the entity
At the end of each reporting period, an entity re-assesses unrecognized deferred tax assets. The
entity recognizes a previously unrecognized deferred tax asset to the extent that it has become
probable that future taxable profit will allow the deferred tax asset to be recovered, e.g. an
improvement in trading conditions
Example: Below are transactions which took place within a two-year period:
First year: A Company made an accounting loss of GH¢100,000. There were no temporary
differences and the tax loss is also GH¢100,000.
Second year: The Company made an accounting profit of GH¢200,000. Taxable profit is GH
¢100,000 (i.e. GH¢200,000 accounting profit less GH¢100,000 unutilized tax losses brought
forward)
Step 1: The current tax charge will be as follows:
Year 1 Year 2 Total
GH¢ GH¢ GH¢
Accounting and tax (loss)/profit (100,000) 200,000 100,000
Unutilized tax losses cf/(bf) 100,000 (100,000) -
Chargeable income - 100,000 100,000
Current tax charge @ 35% - 35,000 35,000
Current tax as a % of accounting (loss)/profit 0.0% 17.5% 35.0%

Step 2: The deferred tax (credit)/charge will be as follows:

Year 1 Year 2 Total
GH¢ GH¢ GH¢
Unutilised tax losses (100,000) - -
Movement in unutilised tax losses (100,000) 100,000 -
Deferred tax (credit)/charge @ 35% (3,500) 35,000

Step 3: The effect of recording deferred tax is as follows:

Year 1 Year 2 Total
GH¢ GH¢ GH¢
Accounting (loss)/profit (100,000) 200,000 100,000
Current tax charge - 35,000 35,000
Deferred tax (credit)/charge (35,000) 35,000 -
Tax (income)/expense (35,000) 70,000 35,000
Tax (income)/expense as a % of profit 35.0% 35.0% 35.0%

Investment properties and deferred tax

When investment property is fair valued, besides taking the movement in fair value of the

19
investment property in profit or loss, an adjustment is required for the tax liability that would be
incurred on its disposal.
Illustration
A firm acquired investment property in 2012. The carrying amount at commencement of current
year is GH¢240,000, being the value determined from a valuation carried out in the previous
year. At the end of the year, the fair value is established at GH260,000 (fair value gain, credited
to profit or loss, is therefore GH20,000).
Deferred tax will be charged to profit or loss @ 10% of the fair value gain of GH20,000, i.e. GH
¢2,000. The deferred tax liability, which stood at GH¢24,000 at the commencement of the
current year (i.e. 10% of previous fair value of GH¢240,000) will now increase to GH¢26,000.
Property value Deferred tax
GH¢ GH¢
Balance at 1 January 240,000 24,000
Fair value increase during the year 20,000 2,000
Balance at 31 December 260,000 26,000
Accounting entries for the year:
 Dr Deferred tax charge (P&L) 2,000
 Cr Deferred tax liability (B/S) 2,000
Illustration 2
A firm has an investment property, which is measured using the fair value model in accordance
with IAS 40, comprising the following cost items:
Cost Fair value
GH’000 GH’000
Land 800 1,200
Building 1,200 1,800
––––– –––––
2,000 3,000
––––– –––––
Additional information:
i. Accumulated tax allowances claimed on the building to date are GH¢600,000.
ii. Unrealized changes in the carrying value of investment property do not affect taxable
profit.
iii. If an investment property is sold for more than cost, the reversal of accumulated tax
allowances will be included in taxable profit and taxed at the standard rate.
iv. The standard rate of tax is 30%, but for asset disposals in excess of cost, the tax rate is
20%, unless the asset has been held for less than two years, when the tax rate is 25%.
Required:
Calculate the firm’s deferred tax liability required if:
(a) The firm expects to hold the investment property for more than two years.
(b) The firm expects to sell the investment property within two years.

20
Business combination and deferred tax
When a business combination occurs, new or adjusted deferred tax balances can arise from the
following sources:
 Fair value adjustments on consolidation resulting in carrying amounts of assets or
liabilities in the consolidated financial statements that differ from the carrying amounts in
the acquiree’s financial statement and consequently from their tax bases when equivalent
adjustments are not recognised for tax purposes;
 Additional assets or liabilities recognized on acquisition that are not recognised in the
financial statements of the acquire;
 Inclusion of retained earnings of subsidiaries (associates and joint arrangements) in the
consolidated statement of retained earnings but income taxes will be payable only if the
profits are distributed to the reporting parents;
 Elimination of unrealized profit/losses arising from intra-group transactions

Illustration 1:Temporary difference arising on computation of Goodwill

On 1st January 2018, a parent acquired 100% equity interest in another company for purchase
consideration of GH60,000 cash. The subsidiary had not accounted for deferred taxation up to
the date of its acquisition. The tax rate is 40% and the following information is relevant in
respect of the subsidiary;
FV @ date of Tax base Temporary
Acquisition difference
GH¢ GH¢ GH¢
Property, plant & equipment 27,000 15,500 11,500
Account receivable 21,000 21,000 -
Inventory 17,400 12,400 5,000
Retirement benefit obligations (3,000) - (3,000)
Accounts payable (12,000) (12,000) -
50,400 13,500
Computation of Goodwill
Purchase consideration 60,000
Fair value of assets 50,400
Deferred tax (40% ˟ 13,500) (5,400) 45,000
Goodwill 15,000

Illustration 2: Fair value

On 30 June 2018 a firm acquired 100% of the shares of another firm for GH¢300,000. At this
date, the carrying amount of the net assets of the acquiree were GH¢250,000. Included in this net
asset figure is inventory which cost GH¢50,000 but which had a replacement cost of GH¢55,000.
The applicable tax rate is 30%.
Required: Explain the deferred tax implications of the above in the consolidated financial
statements of the group.
21
Suggested solution:
According to IFRS 3, the net assets of the subsidiary at the acquisition date must be consolidated
at fair value. The carrying amount of the inventory in the group financial statements will be GH
¢55,000. The tax base of the inventory is based on it carrying amount of GH¢50,000 in the
individual financial statements. Therefore, there is a temporary difference of GH¢5,000 that
arises on consolidation.
A deferred tax liability must be recognised in the consolidated financial statements for GH¢1,500
(GH¢5,000 × 30%). This is treated as a reduction in the subsidiary’s net assets at the acquisition
date, which will increase the goodwill arising on acquisition.
GH¢ GH¢
Consideration 300,000
Net assets: Carrying amount 250,000
Fair value uplift 5,000
Deferred tax liability (1,500) (253,500)
Goodwill at acquisition 46,500
Illustration on Inter-company transactions
In accordance with IFRS 10, unrealized profits or losses arising on inter-company trading must
be eliminated on consolidation. Consequently, such adjustments may give rise to temporary
difference. For instance, when a group entity sells goods to another group entity, the seller
recognizes profits made on those sales in its individual financial statement. If those goods are
still held in inventories by the purchaser at the end of the year, the profit recognized by the seller,
when viewed from the group point of view has not been earned until the goods are eventually
sold outside the group.
On consolidation, the unrealized profit on the closing inventories is eliminated from the group’s
profit and the closing inventory is recognised at cost to the group however, the tax consequences
to the seller (both current and deferred if any) are not eliminated. If tax charged on the results of
individual entities and not the group, the seller would pay tax on any report generated from the
inter-group sales, even though some of those profits may be unrealized from the group’s
perspective. Such consolidation adjustments may have deferred tax impact in the consolidated
financial statements
Illustration 1:
A subsidiary sold goods to its parent for GH7,000 however, the original cost of the inventory to
the subsidiary was GH6,000. The subsidiary has therefore made a profit of GH1,000 on the
transaction therefore it will be liable to tax on this amount at 30% (assuming a tax rate of 30%).
The subsidiary will show a profit of GH1,000 and a tax expense of GH300 (30% @ GH1,000) in
its financial statement.
If the parent has not sold the inventory at the year-end, it will include it in its closing inventory at
a cost of GH7,000. On consolidation, the unrealized profit is eliminated by:
Debiting Profit or loss GH¢1,000
Crediting Inventory GH¢1,000
In the consolidated financial statements, the inventory will be measured at GH6,000 (GH7,000-
22
GH1,000) but its tax base still remains GH7,000. There is a deductible difference of GH1,000.
This requires the recognition of a deferred tax assets of GH300 (30% ˟ GH1,000).
The flip side of the entry to set this up will be a credit to profit or loss statement to remove the
effect of the tax on the transaction.
In the event of foreign subsidiary, the tax rate to use is that of the parent’s country which the
financial statement is been presented. For instance, if the parent operated in different tax
environment (40%), the deferred tax asset would be GH400 (40% ˟ GH1,000).
Tax on Investments in Subsidiaries, Associates and Joint Ventures
In terms of the general rule deferred tax should also be recognised on investments in subsidiaries,
associates and joint ventures similar to other assets. In an important exception to the general rule,
IAS 12 provides that when the parent, investor or joint venturer can prevent the taxable event
from occurring, deferred taxes are not recognised. Specifically, under IAS 12, two conditions
must both be satisfied to justify not reflecting deferred taxes in connection with the earnings of a
subsidiary (a control situation), branches and associates (significant influence) and joint ventures.
These are:
i. that the parent, investor or venturer is able to control the timing of the reversal of the
temporary difference and
ii. it is probable that the difference will not reverse in the foreseeable future. Unless both
conditions are met, the tax effects of these temporary differences must be given
recognition.

When a parent company that has the ability to control the dividend and other policies of its
subsidiary determines that dividends will not be declared, and thus that the undistributed profit of
the subsidiary will not be taxed at the parent company level, no deferred tax liability is to be
recognised. If this intention is later altered, the tax effect of this change in estimate would be
reflected in the current period’s tax provision. On the other hand, an investor, even one having
significant influence, cannot absolutely determine the associate’s dividend policy. Accordingly, it
has to be presumed that earnings will eventually be distributed and that these will create taxable
income at the investor company level. Therefore, deferred tax liability must be provided for the
reporting entity’s share of all undistributed earnings of its associates for which it is accounting
by the equity method, unless there is a binding agreement for the earnings of the investee to not
be distributed within the foreseeable future.
In the case of joint ventures there are a wide range of possible relationships between the
venturers, and in some cases the reporting entity has the ability to control the payment of
dividends. As in the foregoing, if the reporting entity has the ability to exercise this level of
control and it is probable that distributions will not be made within the foreseeable future, no
deferred tax liability will be reported. In all these various circumstances, it will be necessary to
assess whether distributions within the foreseeable future are probable. The standard does not
define “foreseeable future” and thus this will remain a matter of subjective judgement. The
criteria of IAS 12, while subjective, are less ambiguous than under the original standard, which
permitted nonrecognition of deferred tax liability when it was “reasonable to assume that (the
associate’s) profits will not be distributed.”
Illustration
Assume that Parent Company owns 30% of the outstanding ordinary shares of an Associate
23
Company and 70% of the ordinary shares of a Subsidiary Company. Additional data for the year
2018 are as follows:
Associate Company Subsidiary Company
Net income GH¢50,000 GH¢100,000
Dividends paid GH¢20,000 GH¢60,000
How the foregoing data are used to recognize the tax effects of the stated events is discussed
below:
Investment in associate company: The investment in the associate company will be equity
accounted. The equity income capitalized will be the net income less the dividend received. The
investments in the associate will thus increase with GH9,000 (30% × (GH50,000 GH20,000)).
Deferred tax needs to be created on the increase of the investment of GH9,000. The increase in
the carrying amount could be recovered through dividends or through the ultimate sale of the
associate. Dividend income might be taxed at a different rate than the capital gains on the sale of
the associate. Assume that only 20% of the dividend is subject to tax of 34% and the capital
gains tax rate is also 34%. Based on recovery through dividends the deferred tax will be GH612
(20% × 34% × GH9,000). Based on the recovery through sale the deferred tax will be GH3,060
(34% × GH9,000). Investment in subsidiary company. Normally an investment in a subsidiary
company will be recorded at cost in the records of the parent company. No deferred tax will
therefore be recognised. However, if the option is followed to fair value the investment, deferred
tax must be created using the appropriate rate of recovery of the investment, unless the exception
to the general rule applies.
However, in the consolidated financial statements the investment in the subsidiary will be
replaced by the assets and liabilities. Therefore, any deferred tax created on the investment in the
subsidiary company in the parents’ own financial statements should also be reversed.
Unremitted Earnings
A temporary difference arises when the carrying amount of investments in subsidiaries,
associates or joint ventures is different from the tax base.
i. The carrying amount in consolidated financial statements is the investor’s share of the net
assets of the investee, plus purchased goodwill. The tax base is usually the cost of the
investment. The difference is the unremitted earnings (i.e. undistributed profits) of the
subsidiary, associate or joint venture.
ii. IAS 12 says that deferred tax should be recognised on this temporary difference except
when:
 the investor controls the timing of the reversal of the temporary difference and
 it is probable that the profits will not be distributed in the foreseeable future.
iii. An investor can control the dividend policy of a subsidiary, but not always that of other
types of investment. This means that deferred tax does not arise on investments in
subsidiaries but may arise on investments in associates and joint ventures.
Financial assets may give rise to deferred tax if they are revalued.
Share-Based Payment Transactions
Share-based payment transactions are similar to other transactions subject to deferred tax if the
carrying amount differs from the tax base. For example, the expense for the share options
granted as compensations is recognised over the vesting period of the share options. For tax
purposes assume the amount is only deducted when the options are granted; the tax base will be
24
the expense recognised in equity that is only deducted for tax in future periods. A deferred tax
asset is created for the amount that is deducted in the future. The following pro-forma can be
used to calculate the deferred tax asset arising on an equity-settled share-based payment scheme:
GH¢ GH¢
Carrying amount of share-based payment Nil
Less:
Tax base of the share-based payment* (XXX)
× Tax rate % XXX
Deferred tax asset XXX
* The tax base is the expected future tax relief (based on the intrinsic value of the options) that
has accrued by the reporting date. Where the amount of the estimated future tax deduction
exceeds the accumulated remuneration expense, this indicates that the tax deduction relates
partly to the remuneration expense and partly to equity. Therefore, the deferred tax must be
recognised partly in profit or loss and partly in equity.
Illustration
An entity established a share option scheme for its four directors. This scheme commenced on 1
July 2018. Each director will be entitled to 25,000 share options on condition that they remain
with Splash for four years, from the date the scheme was introduced.
Information regarding the share options is provided below:
Fair value of option at grant date GH10
Exercise price of option GH5
The fair value of the shares at 30 June 2019 was GH17 per share.
A tax deduction is only given for the share options when they are exercised. The allowable
deduction will be based on the intrinsic value of the options. Assume a tax rate of 30%.
Required:
Calculate and explain the amounts to be included in the financial statements of Splash for the
year ended 30 June 2019, including explanation and calculation of any deferred tax implications.
Suggested solution:
The expense recognised for an equity-settled share-based payment scheme is calculated based on
the fair value of the options at the grant date. This expense is spread over the vesting period. At
each reporting date, the entity should reassess the number of options expected to vest.
The expense for the scheme in the year ended 30 June 2019 is GH250,000 (4 × 25,000 × GH10 ×
1/4).
For tax purposes, tax relief is allowed based on the intrinsic value of the options at the date they
are exercised.
At the reporting date, the shares have a market value of GH17, but the options allow the holders
to purchase these shares for GH5. The options therefore have an intrinsic value of GH12 (GH17-
GH5).
The deferred tax asset is calculated as follows:
GH¢ GH¢
Carrying value of share-based payment Nil
25
Tax base of the share-based payment:
(4 × 25,000 × (GH17 – GH5) × 1/4) (300,000)
× Tax rate 30% (300,000)
Deferred tax asset 90,000

Where the amount of the estimated future tax deduction exceeds the accumulated remuneration
expense, this indicates that the tax deduction relates partly to the remuneration expense and
partly to equity.
In this case, the estimated future tax deduction is GH300,000 whereas the accumulated
remuneration expense is GH250,000. Therefore, GH50,000 of the temporary difference is
deemed to relate to an equity item, and the deferred tax relating to this should be credited to
equity.
The following entry is required:
Dr Deferred tax asset GH90,000
Cr Equity (GH50,000 × 30%) GH15,000
Cr Profit or loss (GH250,000 × 30%) GH75,000
If the deferred tax asset is to be recognised, it must be capable of reliable measurement and also
be regarded as recoverable.

Trial Questions
Question 2
Prudent prepares financial statements to 31 December each year. On 1 January 20X0, the entity
purchased a noncurrent asset for GS¢1.6 million that had an anticipated useful life of four years.
This asset qualified for immediate tax relief of 100% of the cost of the asset. For the year ending
31 December 20X0, the draft accounts showed a profit before tax of GH¢2 million. The directors
anticipate that this level of profit will be maintained for the foreseeable future.
Prudent pays tax at a rate of 30%. Apart from the differences caused by the purchase of the non-
current asset in 20X0, there are no other differences between accounting profit and taxable profit
or the tax base and carrying amount of net assets.
You are required to compute the pre, and posttax profits for Prudent for each of the four years
ending 31 December 20X0–20X3 inclusive and for the period as a whole assuming:
A) that no deferred tax is recognised
B) that deferred tax is recognised.

Question 3
Jonquil Co buys equipment for GS¢50,000 and depreciates it on a straight-line basis over its
expected useful life of five years. For tax purposes, the equipment is depreciated at 25% per
annum on a straight-line basis. Tax losses may be carried back against taxable profit of the
previous five years. In year 20X0, the entity's taxable profit was GS¢25,000. The tax rate is 40%.
Required
26
Assuming nil profits/losses after depreciation in years 20X1 to 20X5 show the current and
deferred tax impact in years 20X1 to 20X5 of the acquisition of the equipment

Deductible difference
Question 4
Paraku Company ltd recognizes a liability of GS¢100,000 for accrued product warranty costs on
31 December 20X7. These product warranty costs will not be deductible for tax purposes until
the entity pays claims. The tax rate is 25%.
Required
State the deferred tax implications of this situation.

Deferred tax on acquired subsidiary

Question 5
In 20X2 Jacko Co acquired a subsidiary, Jilly Co, which had deductible temporary differences of
GS¢3m. The tax rate at the date of acquisition was 30%. The resulting deferred tax asset of GS
¢0.9m was not recognised as an identifiable asset in determining the goodwill of GS¢5m
resulting from the business combination. Two years after the acquisition, Jacko Co decided that
future taxable profit would probably be sufficient for the entity to recover the benefit of all the
deductible temporary differences.
Required
(a) Consider the accounting treatment of the subsequent recognition of the deferred tax asset
in 20X4.
(b) What would happen if the tax rate had risen to 40% by 20X4 or decreased to 20%?

Question 6
Red is a private limited liability company and has two 100% owned subsidiaries, Blue and
Green, both themselves private limited liability companies. Red acquired Green on 1 January
20X2 for GS¢million when the fair value of the net assets was GS¢4 million, and the tax base of
the net assets was GS¢3.5 million. The acquisition of Green and Blue was part of a business
strategy whereby Red would build up the 'value' of the group over a three-year period and then
list its existing share capital on the stock exchange.
(a) The following details relate to the acquisition of Green, which manufactures electronic
goods.
(i) Part of the purchase price has been allocated to intangible assets because it relates
to the acquisition of a database of key customers from Green. The
recognition and measurement criteria for an intangible asset under IFRS 3 Business
combinations/IAS 38 Intangible assets do not appear to have been
met but the directors feel that the intangible asset of GS¢0.5 million will be
allowed for tax purposes and have computed the tax provision accordingly.
However, the tax authorities could possibly challenge this opinion.
(ii) Green has sold goods worth GS¢3 million to Red since acquisition and made a
profit of GS¢1 million on the transaction. The inventory of these goods
recorded in Red's statement of financial position at the year end of 31 May
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20X2 was GS¢1.8 million.
(iii) The balance on the retained earnings of Green at acquisition was GS¢2 million.
The directors of Red have decided that, during the three years to the date
that they intend to list the shares of the company, they will realise earnings through
future dividend payments from the subsidiary amounting to GS¢500,000 per
year. Tax is payable on any remittance or dividends and no dividends have been
declared for the current year.
(b) Blue was acquired on 1 June 20X1 and is a company which undertakes various projects
ranging from debt factoring to investing in property and commodities. The following
details relate to Blue for the year ending 31 May 20X2.
(i) Blue has a portfolio of readily marketable government securities which are held as
current assets. These investments are stated at market value in the statement of
financial position with any gain or loss taken to profit or loss for the year.
These gains and losses are taxed when the investments are sold. Currently the
accumulated unrealised gains are GS¢4 million.
(ii) Blue has calculated that it requires a specific allowance of GS¢2 million against
loans in its portfolio. Tax relief is available when the specific loan is
written off.
(iii) When Red acquired Blue it had unused tax losses brought forward. At 1 June
20X1, it appeared that Blue would have sufficient taxable profit to realise
the deferred tax asset created by these losses but subsequent events have
proven that the future taxable profit will not be sufficient to realise all of the
unused tax loss.
The current tax rate for Red is 30% and for public companies is 35%.
Required
Write a note suitable for presentation to the partner of an accounting firm setting out the
deferred tax implications of the above information for the Red Group of companies.

Question 7
You are the accountant of Payit. Your assistant is preparing the consolidated financial statements
of the year ended 31 March 20X2. However, he is unsure how to account for the deferred tax
effects of certain transactions as he has not studied IAS 12. These transactions are given below.
Transaction 1
During the year, Payit sold goods to a subsidiary for GS¢10 million, making a profit of 20% on
selling price. 25% of these goods were still in the inventories of the subsidiary at 31 March
20X2. The subsidiary and Pay it are in the same tax jurisdiction and pay tax on profits at 30%.
Transaction 2
An overseas subsidiary made a loss adjusted for tax purposes of GS¢8 million (GS¢ equivalent).

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The only relief available for this tax loss is to carry it forward for offset against future taxable
profits of the overseas subsidiary. Taxable profits of the oversees subsidiary suffer tax at a rate of
25%.
Required
Compute the effect of both the above transactions on the deferred tax amounts in the
consolidated statement of financial position of Payit at 31 March 20X2. You should provide
a full explanation for your calculations and indicate any assumptions you make in
formulating your answer

Past questions
Question one (ICAG, May 2017)
Cartier Ltd, a multinational operating in Ghana purchased a plant for GH¢600,000 on 1
January 2015. Cartier Ltd depreciates its plant using the straight-line method over 15 years,
assuming a residual value of 10% of original cost. Cartier Ltd claims all available tax
depreciation allowances. On 1 January 2016, Cartier Ltd revalued the plant and increased its
carrying value by GH¢50,000. The asset’s useful life was not affected. Assume there were no
other temporary differences in the period.
Required:
i) Calculate the amount of Cartier Ltd’s deferred tax balance at 31 December 2016 in
accordance with IAS 12 Income Taxes.

ii) Calculate the change in Cartier Ltd’s deferred tax balance for the year ended 31 December
2016 and explain how the change would be treated in Cartier Ltd’s statement of profit or
loss for the year to 31 December 2016.
(Note: Assume an applicable tax rate of 25% and capital allowance of 50% of carrying
amount in the first year and 25% in the second year).

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