This outcome tests whether you can split the tax charge into current tax and deferred tax under IAS 12. The examiner likes it because one scenario checks taxable profit, temporary differences and the choice of tax rate together.
The rule
Current tax is taxable profit multiplied by the rate for the current year. Taxable profit is accounting profit adjusted for permanent differences (such as non-deductible fines or exempt income) and for temporary differences. Deferred tax is the temporary difference multiplied by the rate enacted or substantively enacted at the reporting date that is expected to apply when the difference reverses. A taxable temporary difference gives a deferred tax liability. A deductible temporary difference gives a deferred tax asset, recognized only if future taxable profit is probable. The tax expense is current tax plus the movement in deferred tax.
Worked example
Profit before tax is $500,000 after a $100,000 warranty provision, which is deductible only when paid in 20X2. Tax allowances exceed depreciation by $60,000. The 20X1 rate is 25%. Legislation enacted before the year end sets the rate at 30% from 20X2.
Taxable profit = $500,000 + $100,000 (provision) - $60,000 (excess allowances) = $540,000.
Current tax = $540,000 × 25% = $135,000.
Deferred tax asset (warranty) = $100,000 × 30% = $30,000.
Deferred tax liability (allowances) = $60,000 × 30% = $18,000.
Net deferred tax asset = $30,000 - $18,000 = $12,000, so a deferred tax credit of $12,000 (opening balance nil).
Total tax expense = $135,000 - $12,000 = $123,000.
Remember: current tax uses the current year's rate on taxable profit, while deferred tax uses the enacted rate expected on reversal applied to the temporary difference.
Where candidates lose marks
Applying the current-year rate to deferred tax when a different rate has been enacted for the year of reversal.
Calculating current tax on accounting profit instead of taxable profit, so provisions, fines and exempt income are not adjusted.
Getting the direction wrong: a net deferred tax liability that increases is a charge, not a credit.
Applying one future rate to the whole difference when it reverses over several years at different enacted rates.
Try it: 4 questions
Lark Co's profit before tax for the year ended 31 December 20X5 was $600,000. This included $20,000 of tax-exempt interest income and $10,000 of fines that are not tax deductible. During 20X5, Lark Co recognised a warranty provision of $50,000, which will be tax deductible when paid in 20X6. Tax allowances exceeded accounting depreciation by $80,000. Both temporary differences will reverse in 20X6 or later. Lark Co had no deferred tax balances at 1 January 20X5 and expects sufficient future taxable profits to recover any deductible temporary differences. The tax rate for 20X5 is 21%. Before 31 December 20X5, legislation was enacted raising the rate to 25% for 20X6 onwards. What are Lark Co's current tax charge and net deferred tax for 20X5?
Answer: A. Taxable profit is $600,000 − $20,000 + $10,000 + $50,000 − $80,000 = $560,000, so current tax is $560,000 × 21% = $117,600. IAS 12 para 47 measures deferred tax at the rates expected to apply on reversal, based on enacted or substantively enacted rates, which is 25%. This gives a liability of $80,000 × 25% = $20,000 less an asset of $50,000 × 25% = $12,500, so the net deferred tax charge is $7,500. $6,300 wrongly applies the current 21% rate. $121,800 omits the deduction for tax-exempt interest from taxable profit. A credit of $7,500 reverses the sign, although the net deferred tax liability increases and so creates a charge.
For the year ended 31 December 20X1, Pine Co reported profit before tax of $800,000. This figure is after charging a $300,000 warranty provision. Warranty costs are deductible for tax only when paid, and Pine Co expects to pay the full amount in 20X2. On 1 November 20X1, legislation was enacted setting the tax rate at 25% for 20X1 and 22% for 20X2 onwards. Pine Co expects sufficient taxable profits in 20X2 to recover any deferred tax asset. There are no other temporary or permanent differences.
What should Pine Co recognise in its financial statements for the year ended 31 December 20X1?
Answer: C. The warranty provision creates a deductible temporary difference of $300,000. Taxable profit for 20X1 is $800,000 + $300,000 = $1,100,000, so current tax is $1,100,000 × 25% = $275,000. IAS 12 Income Taxes measures deferred tax at the rate enacted or substantively enacted that is expected to apply on reversal, so the deferred tax asset is $300,000 × 22% = $66,000. Options A and B calculate current tax on accounting profit rather than taxable profit, and option B also uses the 20X1 rate for deferred tax. Option D ignores the IAS 12 requirement to recognise a deferred tax asset where future taxable profits are probable.
Lark Co has no deferred tax balances at 1 January 20X1. It expects sufficient future taxable profits to use any deductible temporary differences. In the year to 31 December 20X1, Lark Co recognised a warranty provision of $120,000 in profit or loss. The warranty costs are deductible for tax only when paid, and all claims are expected to be paid in 20X2. At 31 December 20X1, the carrying amount of Lark Co's plant exceeds its tax base by $200,000 because tax allowances have exceeded depreciation. This difference is expected to reverse by $100,000 in 20X2 and $100,000 in 20X3. Legislation enacted on 15 December 20X1 sets income tax rates of 30% for 20X2 and 28% for 20X3. The tax rate for 20X1 is 25%. The deferred tax balances relate to the same tax authority and may be offset. Ignoring current tax, what deferred tax asset, deferred tax liability, net deferred tax balance (presented as non-current) and deferred tax expense should Lark Co recognise for the year ended 31 December 20X1?
Answer: C. IAS 12 measures deferred tax at the tax rates expected to apply when the asset is realised or the liability is settled, based on rates enacted or substantively enacted by the reporting date. The deferred tax asset is $120,000 × 30% = $36,000. The deferred tax liability is ($100,000 × 30%) + ($100,000 × 28%) = $58,000. This gives a net liability of $22,000, which IAS 1 requires to be presented as non-current, and a deferred tax charge of $22,000 in profit or loss. Option A applies 30% to all of the plant difference, option B uses the current 25% rate throughout, and option D uses 25% for the asset but the future rates for the liability.
At 31 December 20X5, Holt Co has a warranty provision of $900,000 in its statement of financial position. The related expense is deductible for tax only when claims are paid. Holt Co expects to pay $300,000 of claims in 20X6 and $600,000 in 20X7.
Legislation enacted before 31 December 20X5 sets corporate income tax rates of 21% for 20X5, 24% for 20X6 and 26% for 20X7. Sufficient future taxable profits are expected to be available, and deferred tax is not discounted.
Which basis should Holt Co use to measure the related deferred tax asset at 31 December 20X5?
Answer: A. IAS 12 requires deferred tax to be measured at the tax rates expected to apply when the asset is realised, based on rates enacted or substantively enacted by the reporting date. The deferred tax asset is therefore ($300,000 × 24%) + ($600,000 × 26%) = $72,000 + $156,000 = $228,000. Using the current 21% rate confuses the year the difference arises with the year it reverses, giving $189,000. A simple average of 25% ignores the actual pattern of reversal. Applying 26% to the whole difference ignores the $300,000 that reverses in 20X6 at 24%.
88 more FR questions on this outcome, free for life
The full ACCA FR bank, mock exams and written questions marked against the scheme. Email only, no card, no trial.
Which tax rate do I use for deferred tax under IAS 12?
Use the rate enacted or substantively enacted by the reporting date that is expected to apply when the asset is realized or the liability settled. If different rates are enacted for different reversal years, apply each rate to the part that reverses in that year.
How do you calculate taxable profit in ACCA FR?
Start with profit before tax. Add back non-deductible expenses and items taxed or deductible in a different period, such as provisions, and deduct exempt income. Then replace accounting depreciation with tax allowances.
When can a deferred tax asset be recognized?
A deferred tax asset arising from a deductible temporary difference is recognized only to the extent that future taxable profit is probable against which it can be used. Deferred tax balances can be offset if they relate to the same tax authority and there is a legal right of offset.