IAS 12 Income taxes (part 2/2) - P2

Matching
Recognition of deferred tax in income tax expenses will ensure that the income tax as the percentage of profit before tax is consistent with the tax rate.

Rules to note
1. Temporary differences arising on the initial recognition of asset/liability are not subject to deferred tax because they affect neither accounting profit nor taxable profit.
2. Temporary difference arising on goodwill is not subject to deferred tax.
3. Deferred tax asset can only be recognised to the extent that future taxable profit will cover the deductible temporary difference.
4. Discounting is not allowed.
5. Deferred tax is revised whenever the tax rate changed as we should always use the rate expected to apply to the period. This ensures the best estimate of the amount. The adjustment will be shown separately.

Group financial statements
In P2, deferred tax can be examined as part of consolidation, some issues must be noted:
1. Fair value adjustment - the fair value adjustment at date of acquisition may not alter the tax base of subsidiary's net assets, temporary difference will occur. Deferred tax asset/liability will be included in fair value of subsidiary's net asset at acquisition in calculating goodwill.
2. Goodwill - as noted above, it is specifically disallowed to recognise deferred tax liability for temporary difference of goodwill (tax base is nil).
3. Unrealised profits - we remove unrealised profit from inventory which reduced the carrying value, but tax base is based on individual financial statements and so will be at higher transfer price. Deferred tax asset will arise and must be recognised.

Inconsistent with framework
Part of the definition of liability is "present obligation". However deferred tax liability arising on revaluation surplus may not satisfy the definition as there is no present obligation to pay the future tax, because if company did not sell the asset (no present obligation to sell), there will not be future tax payable because of the revaluation. Therefore, deferred tax asset/liability does not necessary meet the definition of asset or liability.

What if tax base is not clear
Sometime tax base may not be given, in this case you might have to ask yourself, "is there future tax payable/receivable?" If there is future tax payable, then there will be a taxable temporary difference, tax base might be zero. Such situation could be when company recorded accrued expenses which tax relief is only available when the expenses are paid, tax base will be zero and taxable temporary difference will arise.

It is all about understanding in P2, you have to think further and more detailed in order to provide good answer for a question. :)