IAS 12 Income taxes (part 1/2) - FFA/F7

In accounting, income tax is divided into current tax and deferred tax. Deferred tax is not examinable in FFA. Income tax expense is shown below profit before tax.

Current tax (FFA/F7)
Current tax payable is recognised as current liability (debit income tax expenses, credit current tax payable) and current tax recoverable (uncommon) is recognised as current asset. Since company estimates the current tax payable, there may be over or under-provision in prior year. When there is over-provision (credit balance in trial balance), we should debit over-provision, credit income tax expenses (Income statement). When there is under-provision (debit balance in trial balance), we debit income tax expenses (I/S), credit under-provision. Therefore, amount charged to income statement will be current tax payable + under-provision/- over-provision.

Deferred tax (F7)
Deferred tax is the future tax payable or receivable arising from temporary difference. Temporary difference = carrying value of asset/liability - tax base of asset/liability.
Tax base = amount valued for tax purposes. (For example, a machine is depreciated in accounting, but in tax company can claim capital allowance, so cost - depreciation = carrying value, cost - capital allowance = tax base).
You must be able to determine whether there is taxable temporary difference (this multiplies tax rate = deferred tax liability) or deductible temporary difference (this multiples tax rate = deferred tax asset).
A simple way is to arrange your formula of temporary difference like the above and then the temporary difference will be taxable when it is positive and deductible when it is negative.

Example: Carrying value of a machine is $300000 while its tax base is $350000, tax rate is 30%, determine the deferred tax.
Solution: Temporary difference = 300000 - 350000 = ($5000), ie. deductible temporary difference. (This is because in future the claim of capital allowance is more than depreciation, leading to future tax savings)
Deferred tax asset = 30% x 5000 = $1500, debit deferred tax asset (normally non-current asset), credit income tax expenses.

Deferred tax on revaluation (F7)
When an asset is revalued, the carrying value increases so there might be taxable temporary difference arising. In this case, because there is a revaluation reserve account, the deferred tax liability arising on revaluation surplus can be deducted from revaluation reserve, the remaining deferred tax liability is recorded as usual.

In FFA only current tax is examined. In F7 normally deferred tax liability will occur. The next part of this I will be dealing with those examinable in P2 only.