What is Deferred Taxation?
Deferred taxation involves setting aside amounts in the accounts of an organization that will become payable as tax in a different period than the one being reviewed. These obligations typically arise from timing differences between when income or expenses are recognized according to accounting conventions versus tax regulations.
Examples:
- Depreciation vs. Capital Allowances: Depreciation of an asset might be recorded differently for accounting purposes versus tax reporting purposes, creating a deferred tax liability or asset.
- Revenue Recognition: Revenue that is recognized in accounting books at a different time than when it is taxable can create deferred tax liabilities or assets.
- Provisions for Bad Debts: Accounting conventions might require setting aside provisions for bad debts which are not immediately deductible for tax purposes.
Frequently Asked Questions (FAQs)
What causes deferred taxation?
Deferred taxation is caused by timing differences between tax rules and accounting conventions. These differences occur when income or expenses are recognized in different periods for tax purposes compared to accounting purposes.
How is deferred tax accounted for?
Deferred tax is accounted for by recognizing deferred tax assets or liabilities on the balance sheet, depending on whether the timing differences will result in taxable or deductible amounts in future periods.
What is the relevance of IAS 12 to deferred taxation?
IAS 12 provides guidelines on how to account for income taxes, including deferred tax liabilities and assets, highlighting the importance of deferred tax accounting in financial reporting.
Are deferred tax assets the same as deferred tax liabilities?
No, deferred tax assets arise from timing differences that will result in tax deductions in the future, while deferred tax liabilities arise from timing differences that will lead to tax payments in the future.
How does a company decide when to recognize a deferred tax asset or liability?
A company recognizes a deferred tax asset or liability based on whether it expects to have taxable profits or deductions in the future that result from current timing differences.
- Capital Allowances: Deductions that businesses can claim for depreciation of certain types of assets under tax rules, often differing from accounting depreciation.
- Depreciation: The systematic reduction in the book value of an asset over its useful life for accounting purposes.
- Financial Reporting Standard: Regulations that stipulate how financial statements should be prepared and presented.
- IAS 12 (International Accounting Standard 12): The standard that prescribes the accounting treatment for income taxes, including current and deferred tax assets and liabilities.
Online References
- IFRS Foundation: IAS 12 Income Taxes
- Financial Reporting Council (FRC): Accounting Standards in the UK
- Harvard Business Review: Deferred Taxes and Financial Reporting
Suggested Books for Further Studies
- Intermediate Accounting by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- Financial Accounting by Robert Libby, Patricia Libby, and Frank Hodge
- Accounting for Income Taxes: A Comprehensive Guide by Dennis R. Beresford and James A. Norville
Accounting Basics: “Deferred Taxation” Fundamentals Quiz
### When does deferred taxation typically arise?
- [x] Due to timing differences between tax rules and accounting conventions.
- [ ] When a business has incurred a net operating loss.
- [ ] At the end of the fiscal year when dividend distributions are recorded.
- [ ] Only in international companies.
> **Explanation:** Deferred taxation arises because of timing differences between how revenue and expenses are recognized under tax rules compared to accounting conventions.
### Which of the following can create deferred tax liabilities?
- [ ] Only the recognition of revenue.
- [ ] Immediate recognition of expenses for tax purposes.
- [x] The difference between capital allowances and accounting depreciation.
- [ ] Cash flow timing issues.
> **Explanation:** Deferred tax liabilities can result from differences between how capital allowances (tax depreciation) and accounting depreciation are calculated.
### What standard provides guidelines on deferred taxation?
- [ ] IAS 15
- [x] IAS 12
- [ ] FASB 13
- [ ] GAAP 18
> **Explanation:** IAS 12, known as International Accounting Standard 12, provides guidelines on how to account for income taxes, including deferred tax liabilities and assets.
### Deferred tax assets represent:
- [ ] Future taxable amounts.
- [x] Future deductible amounts.
- [ ] Immediate tax liabilities.
- [ ] Tax savings from past periods.
> **Explanation:** Deferred tax assets represent amounts that will be deductible for tax purposes in future periods due to timing differences.
### Which factors can impact the recognition of deferred tax?
- [x] Expected future taxable profits.
- [ ] Current cash flow.
- [ ] Market valuation of the company.
- [ ] Shareholder equity levels.
> **Explanation:** The recognition of deferred tax assets or liabilities depends on the expectation of future taxable profits to utilize the deferred amounts.
### How are deferred tax liabilities presented in the financial statements?
- [x] As a non-current liability on the balance sheet.
- [ ] As an expense on the income statement.
- [ ] Within the owner's equity section.
- [ ] As a revenue in the financial projections.
> **Explanation:** Deferred tax liabilities are presented as non-current liabilities on the balance sheet, reflecting future tax obligations due to timing differences.
### When should a company assess its deferred tax assets for impairment?
- [ ] Only at year-end.
- [ ] Annually, regardless of period.
- [x] Each reporting period.
- [ ] When requested by auditors.
> **Explanation:** A company should assess its deferred tax assets for impairment at each reporting period to ensure they are realizable based on expected future taxable profits.
### One main reason for deferred taxation is the difference between:
- [x] Capital allowances and depreciation.
- [ ] Cash inflow and outflow.
- [ ] Fixed assets and current assets.
- [ ] Long-term loans and short-term credit lines.
> **Explanation:** The difference between capital allowances (tax depreciation) and accounting depreciation is a common reason for deferred taxation.
### Deferred tax accounts must align with:
- [x] The period in which the income or expense is recognized.
- [ ] The physical asset valuation date.
- [ ] The audit completion date.
- [ ] The company's dividend payment schedule.
> **Explanation:** Deferred tax should be allocated to the same period in which the relevant amount of income or expenditure is shown, aligning with accounting principles.
### Is deferred tax reflected in cash flow statements?
- [x] No, it is not a cash item.
- [ ] Yes, under operating activities.
- [ ] Yes, under investing activities.
- [ ] Yes, under financing activities.
> **Explanation:** Deferred tax is not a cash item but rather an accounting adjustment reflecting future tax obligations or benefits.
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