OBJECTIVES
After this chapter, the student will know how to:
§ Calculate and account for Corporation Tax
§ Calculate and account for Deferred Tax
§ Determine the nature of employee benefits and to account for them
INTRODUCTION
IAS 12 on Income Taxes deals with two main types of taxes;
• Corporation Tax
• Deferred Tax
The main bulk of the standard is on deferred tax as it has detailed guidelines on the approach to be used in computing deferred tax, accounting for the deferred tax and disclosure requirements.
IAS 19 Employee benefits:
This is a very difficult area because employee benefit costs are inherently complex and their accounting is both problematic and controversial.
IAS 19 (revised) Employee benefits has replaced the previous IAS 19 Retirement benefits costs.
Note the increased scope of the new standard, which covers all employee benefit costs, except share – based payment, not only retirement benefit (pension) costs. Before we look at IAS 19, we should consider the nature of employee benefit costs and why there is an accounting problem which must be addressed by a standard.
DEFINITION OF KEY TERMS
Corporation tax is the tax payable by a company as a result of generating profits from trading.
STUDYTEXT
Deferred tax is the corporation tax that is likely to be incurred on the activities of a company during a particular period but, because of differences between the way activities are included in the accounting profit and taxable income, will be paid in another period.
Temporary differences include differences between the fair values and the tax values of assets and liabilities acquired and the effect of revaluing assets and liabilities acquired and the effect of revaluing assets for accounting purposes.
Timing Differences are items reported in the accounts in periods different from those in which they are reflected in tax computations. These differences originate in one period and reverse in one or more subsequent periods.
Employee benefits are all forms of consideration given by an entity in exchange for service rendered by employees.
Short-term employee benefits are employee benefits (other than termination benefits) which fall due wholly within twelve months after the end of the period in which the employees render the related service.
Post-employment benefits are formal or informal arrangements under which an entity provides post employment benefits for one or more employees.
EXAM CONTEXT
In past examinations, the examiner has tested the students’ knowledge on:
• Corporation tax
• Deferred tax
• Employee benefits
Students should therefore understand these topics.
INDUSTRY CONTEXT
Profit making organisations calculate corporation taxes and, therefore, this chapter enables them to know the various ways to calculate their corporation taxes and also to account for them.
Organisations learn how tocalculate deferred tax which is important in the following ways:
§ The figures used to calculate stock market indicators such EPS and P/E ratio require the computation of profit-after tax.
§ Deferred tax is important in establishing the relationship between shareholder’s funds and other sources of finance.
§ It also ensures compliance with the fundamental accounting concept of accruals.
§ It reports a tax liability which is likely to arise in the future.
§ It provides the post-tax profits that can be used to assess a suitable dividend declaration.
STUDYTEXT
3.1 CORPORATION TAX
FAST FORWARD: IAS 12 does not prescribe how this tax should be computed as this is determined by the various tax rules and regulations of a country.
Corporation tax is the tax payable by a company as a result of generating profits from trading.
Once the tax has been computed the standard gives the specific accounting treatment of the amount. IAS 12 requires that the tax payable should be shown as a separate item in the income statement and referred to as income tax expense. If part of the amount is unpaid by the year end then it should be shown in the balance sheet as a current liability and referred to as current tax.
In practice many firms use an estimate for the corporation tax for the purpose of preparing and finalizing on the financial statements. In the next or subsequent financial period, when the firm agrees with the tax authorities the actual tax payable, then there may arise an under or over provision of previous years tax. IAS 12 requires that this under or over provision to be treated like a change in accounting estimate as per IAS 8. This means that an under provision of previous years’ tax will be added to the current years income tax expense while an over provision will be deducted.
>>> Example
Assume that a company had estimated that during the year ended 2004, the corporation tax payable was Sh 1000,000 and this amount remained unpaid as at 31 December 2004. On 30 June 2005 the company agrees with the tax authorities on the amount due and this is paid on the same date. Meanwhile during the year ended 31 December 2005, the firm estimates that the corporation tax payable for the year as sh. 1,200, 000. The company had made installment tax payments for year 2005 for sh. 800,000.
Required
Compute the income tax expense and the balance sheet liability for the year 2005 assuming that the actual tax liability for 2004 agreed with the tax authority was:
1. Sh 1,100,000 2. Sh.900,000
a) There is an under provision for previous years’ tax because the firm had provided for only Sh.1,100,000 while the amount agreed is Sh.1,100,000. The income tax expense for 2005 will be given as current years estimate plus the under provision
(Sh.1, 200,000 + 100,000). = 1,300,000.
b) There is an over provision for previous years’ tax because the firm had provided for Sh.1,100,000 while the amount agreed is only Sh.900,000. The income tax expense for 2005 will be given as current years estimate less the over provision
(Sh.1, 200,000 - 100,000). = 1,100,000
The balance sheet liability in both cases will be the current years’ tax less the installment taxes for the year 2005 (1,200,000 – 800,000) = Sh.400,000.
STUDYTEXT
3.1.1 DEFERRED TAX
This section is concerned with the determination of the amount of the charge against income in respect of an accounting period and the presentation of such an amount in the financial statements. We will also discuss accounting for the tax effect of revaluation of assets.
In short, we will explore the accounting principles and practices for deferred taxation.