IAS 12 - Accounting for income taxes

1
IAS 12 - Accounting for income taxes
2
Executive summary

• Despite the similar approaches to accounting for
  taxation under IFRS and US GAAP, deferred
  taxation is one of the most common areas where
  differences arise. The reason is that a high
  proportion of transactions recognized in either
  the statement of income or balance sheet will
  have consequential effects on deferred taxes.
• US GAAP requires a two-step approach for deferred
  tax assets that involves first recognizing the
  full asset and then reducing the asset to the
  extent that it is more likely than not that the
  deferred tax assets will not be realized. The
  valuation allowance account is used for this.
  IFRS requires a one-step approach that provides
  for recognition of the deferred tax assets only
  to the extent it is probable that they will be
  realized. Although there is no valuation
  allowance account used under IFRS, there should
  not be any differences in the net asset under US
  GAAP versus IFRS.
• US GAAP contains extensive guidance on accounting
  for uncertain tax positions in ASC
  740-10. IFRS does not currently include specific
  guidance on this issue.

3
Executive summary

• Both IFRS and US GAAP require a numerical
  reconciliation to explain the relationship
  between tax expense (income) and pretax
  accounting profit in the footnote disclosures.
  However, there are differences regarding the
  particular tax rate or rates to be used for
  preparing that reconciliation. US GAAP requires
  that the domestic federal statutory rate be used
  as the starting point whereas IFRS allows this
  approach and also allows a statutory rate that
  aggregates domestic rates in various
  jurisdictions to be used.
• IFRS classifies deferred tax assets and
  liabilities as noncurrent in a classified balance
  sheet while US GAAP classifies these items based
  on the classification of the related asset or
  liability, or for tax losses and credit carry
  forwards, based on the expected timing of
  realization. IFRS offsets deferred tax assets
  and liabilities when specific conditions are met
  which includes when an entity has a legally
  enforceable right to offset and when the taxes
  are levied by the same taxing authority for the
  same taxable entity. US GAAP offsets these
  balances and reports them net by current and
  noncurrent classification.

4
Progress on convergence

• The IASB released an Exposure Draft (ED) of an
  IFRS to replace IAS 12 in March 2009. This was
  initially begun as a convergence project.
  However, the IASB has now decided to perform a
  fundamental review of accounting for income taxes
  in the future. The Board has changed the project
  objective to resolve problems in practice under
  IAS 12.
• One of the primary areas that they will address
  is uncertain tax positions. However, they will

• not do this until the revision of IAS 37,
  Provisions, Contingent Liabilities and Contingent
  Assets is finalized. An ED for a revised IAS 37
  was released in January 2010 and the comment
  period ended in May 2010. Discussion on this
  project will not be resumed until after June
  2011.
• In December 2010, the IASB issued Deferred Tax
  Recovery of Underlying Assets (amendments to IAS
  12) concerning the determination of deferred tax
  on investment property measured at fair value.
  The amendments are to provide practical solutions
  for jurisdictions where entities currently find
  it difficult and subjective to determine the
  expected manner of recovery for investment
  property that is measured using the fair value
  model in IAS 40, Investment Property.

5
General
IFRS
US GAAP
Takes an asset-liability approach to accounting
for income taxes and thus records deferred tax
assets and liabilities.
Similar
Despite the similar approaches to accounting for
taxation under US GAAP and IFRS, accounting for
income taxes is one of the most common areas
where differences arise between US GAAP and IFRS.
The reason is that a high proportion of business
transactions that do not have anything directly
to do with income taxes will nonetheless have
consequential effects on the accounting for
income taxes.
6
Temporary differencesGeneral
IFRS
US GAAP
A deferred tax liability or asset generally
should be recognized for the future tax effects
of all temporary differences and carryforwards.
Similar
Deferred taxes are calculated using the asset or
liability approach, which is intended to
recognize, in the balance sheet, the future tax
consequences of events that have been either
recognized in the financial statements or the tax
return. A temporary difference is the difference
between the book and tax basis of an asset or
liability multiplied by the appropriate tax rate.
Similar
7
Temporary differencesGeneral
IFRS
US GAAP
Deferred taxes are measured on an undiscounted
basis.
Similar
8
Temporary differencesDeferred tax liabilities
IFRS
US GAAP
A deferred tax liability is recorded if the book
basis of the underlying asset (liability) is
greater (less) than the tax basis of the
underlying asset (liability).
Similar
Precludes recognition of a deferred tax liability
for the excess of the book basis over the tax
basis of goodwill if it arises at the initial
recognition of goodwill. Allows the recognition
of a deferred tax liability subsequently if the
goodwill is tax deductible.
Similar
9
Temporary differencesDeferred tax assets
IFRS
US GAAP
A deferred tax asset is recorded if the book
basis of the underlying asset (liability) is less
(greater) than the tax basis of the underlying
asset (liability).
Similar
10
Temporary differencesDeferred tax assets

• IFRS
• Requires a one-step approach that provides for
  recognition of the deferred tax assets only to
  the extent it is probable that they will be
  realized.
• A difference should not result in determining the
  amount of net deferred tax assets to recognize
  since similar judgment should be applied under
  both standards in the determination of whether
  net deferred tax assets should be recognized and
  their amount.
• Probable is not defined in the IFRS income tax
  standard. Note that it is defined in IAS 37 as a
  likelihood greater than 50.

• US GAAP
• Requires a two-step approach for deferred tax
  assets.
• First, deferred taxes should be recognized in
  full for all temporary differences between the
  book and tax basis of assets and liabilities.
• Second, any net amount of a deferred tax asset is
  assessed to determine whether it should be
  reduced by a valuation allowance to the extent it
  is "more likely than not" that the deferred tax
  asset will not be realized.
• More likely than not is defined as a
  likelihood of more than 50.

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Valuation allowance example

• Example 1
• During the fiscal year ended December 31, 2010,
  KMR Corporation (KMR) experienced a net operating
  loss of 450,000. Since KMR has experienced
  losses in the last several years, it cannot
  utilize a net operating loss carryback. However,
  since KMR has entered into some new profitable
  contracts, the management of KMR expects that it
  is more than 50 likely that they will only be
  able to utilize one-third of the net operating
  loss to offset against future taxable income.
  The tax rate for KMR is 40.

• Show the journal entries for US GAAP and IFRS.

12
Valuation allowance example

• Example 1 solution
• US GAAP
• Deferred tax asset 180,000
• Income tax benefit 180,000
• Income tax benefit 120,000
• Valuation allowance 120,000
• IFRS
• Deferred tax asset 60,000
• Income tax benefit 60,000

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Temporary differencesTax rate considerations
IFRS
US GAAP
Deferred tax liabilities and assets are measured
using the applicable tax rate.
Similar
14
Temporary differencesTax rate considerations

• IFRS
• The enacted or "substantively enacted" tax rates
  and tax laws are used. For current taxes, the
  appropriate rate is determined considering when
  the amount is to be recovered or paid. For
  deferred taxes, the rate is determined
  considering when the asset or liability is
  expected to be realized or settled.
• The interpretation of substantively enacted will
  vary from country to country. To help make this
  assessment, the IASB has published guidelines
  that address the point in time when a tax law
  change is substantively enacted in many of the
  jurisdictions that apply IFRS.

• US GAAP
• The enacted tax rate and tax law are applicable
  when measuring current and deferred taxes.

15
Enacted versus substantively enacted tax rates
example

• Example 2
• KR Bookstores (KRB) operates in three countries
  in addition to the United States. The following
  table reports KRBs taxable income and book
  income in these countries for the year ended
  December 31, 2010 (tax rates are also included in
  the table). All differences between book and
  taxable income are temporary differences that
  arise from assets and liabilities that are
  classified as current. Note that the
  substantively enacted tax rate is not a
  retroactive provision that will apply to the
  current year tax liability.

• Prepare the journal entry under both US GAAP and
  IFRS to record KRBs income tax expense and
  liabilities.

16
Enacted versus substantively enacted tax rates
example

• Example 2 US GAAP solution
• Income tax expense 927,500
• Current tax liability 917,500
• Deferred tax liability current 10,000
• The current tax liability is the taxable income
  multiplied by the enacted tax rates.
• The deferred tax asset or liability is the
  temporary difference multiplied by the enacted
  tax rate.
• The deferred tax liability is presented net
  and is classified as current as the assets and
  liabilities for which the temporary differences
  arise are classified as current.

17
Enacted versus substantively enacted tax rates
example

• Example 2 IFRS solution
• Income tax expense 932,500
• Deferred tax asset non-current 40,000
• Current tax liability 917,500
• Deferred tax liability non-current
  55,000
• The current tax liability is the taxable income
  multiplied by the enacted tax rates.
• The deferred tax asset or liability is the
  temporary difference multiplied by the
  substantively enacted tax rate.
• The total of the deferred tax assets (17,500
  22,500 40,000) and the total of the
  deferred tax liabilities (10,000 45,000
  55,000) are presented (no right of offset and
  differing tax jurisdictions) and classified as a
  non-current.

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Permanent differences
IFRS
US GAAP
If an item is included in the computation of
taxable income but it is never included in book
income, or if it is included in the computation
of book income but never in taxable income, then
it gives rise to a permanent difference.
Similar
19
Net operating losses
IFRS
US GAAP
An asset (tax receivable or deferred tax asset)
and a tax benefit are recognized in the period
that a company experiences a net operating loss
that it will carry back or carry forward. In
the case of a deferred tax asset recognized in
conjunction with a net operating loss carryback,
the asset needs to be measured and, thus, might
be reduced to zero if no future benefit is
expected.
Similar
20
Uncertain tax positions
IFRS
US GAAP
Tax contingencies are reported as a liability on
the balance sheet.
Similar
Both US GAAP and IFRS report tax contingencies as
a liability on the balance sheet.  A contingent
liability is created for an unrecognized tax
benefit because it represents an enterprises
potential future obligation to the taxing
authority for a tax position that was taken. An
entity that presents a classified statement of
financial position classifies a liability
associated with an unrecognized tax benefit as a
current liability, to the extent the enterprise
anticipates payment (or receipt) of cash within
one year or the operating cycle, if longer. The
liability for unrecognized tax benefits should
not be combined with deferred tax liabilities or
assets.
Similar
21
Uncertain tax positions

• IFRS
• Does not address uncertain tax positions.
• Under IAS 12, tax assets and liabilities should
  be measured at the amount expected to be paid. In
  practice, this frequently results in the
  recognition principles in IAS 37, Provisions,
  Contingent Liabilities and Contingent Assets,
  being applied.
• IAS 12 clarifies that, while IAS 37 generally
  excludes income taxes from its scope, its
  principles may be relevant to tax-related
  contingent assets and contingent liabilities.
  This is not intended to imply that such items
  fall within the scope of IAS 37 because,
  ultimately, such assets and liabilities are a
  measurement of current tax.

• US GAAP
• ASC 740-10 provides extensive guidance on
  accounting for uncertain tax positions.
• A two-step approach to uncertain tax positions
  first is the decision whether to recognize and
  second is the determination of the measurement.
• A benefit is recognized when it is more likely
  than not to be sustained based on the technical
  merits of the position. The amount of the benefit
  to be recognized is based on the largest amount
  of tax benefit that is greater than 50 likely of
  being realized upon ultimate settlement.
  Detection risk is precluded from being considered
  in the analysis by the assumption that the
  regulators have knowledge of all relevant facts
  and information.

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Financial statement presentation
IFRS
US GAAP
The total income tax expense reported on the
statement of income is the sum of the current tax
expense and the deferred tax expense. Both the
current and deferred tax expenses do not include
any tax expense that is recognized directly in
equity.
Similar
Certain items may be accounted for directly in
equity instead of going through the statement of
income (e.g., excess tax benefits arising from
stock compensation arrangements,
available-for-sale investments and certain
transactions with shareholders). The tax effects
of those items also are recognized directly in
equity in the period they arise.
Similar
23
Backward tracing example

• Example 5
• Bad Investments Incorporated (BII) holds equity
  investments at a cost basis of 250,000. It
  accounts for these investments as
  available-for-sale securities. At the end of
  2010, the market value of these investments has
  declined to 220,000. Consequently, BII reports
  an unrealized loss for financial reporting
  purposes of 30,000 through OCI which creates a
  temporary tax difference.
• As of December 31, 2010, BII determines that it
  is more likely than not that it will be able to
  deduct these capital losses for tax purposes if
  they are realized. As of December 31, 2011, BII
  changes its assessment as to whether it can
  utilize this deduction and determines that it is
  more likely than not that it will not be able to
  take the deduction for the capital loss. BIIs
  tax rate is 40.

• Show the necessary journal entries for 2010 and
  2011 under both US GAAP and IFRS.

24
Backward tracing example

• Example 5 solution
• US GAAP
• The entry for 2010 is as follows
• Unrealized loss OCI 30,000
• Allowance to reduce AFS securities to
  market 30,000
• Deferred tax asset 12,000
• Income tax expense OCI 12,000
• The entry for 2011 is as follows
• Income tax expense 12,000
• Valuation allowance 12,000

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Backward tracing example

• Example 5 solution (continued)
• IFRS
• The entry for 2010 is as follows
• Unrealized loss OCI 30,000
• Allowance to reduce AFS securities to
  market 30,000
• Deferred tax asset 12,000
• Income tax expense OCI 12,000
• The entry for 2011 is as follows
• Income tax expense OCI 12,000
• Deferred tax asset 12,000

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Financial statement presentationClassification
and netting of deferred tax assets and liabilities

• IFRS
• In a classified balance sheet, deferred tax
  assets and liabilities are only classified as
  non-current.
• Deferred tax assets and liabilities are offset
  when specific conditions are met which includes
  when an entity has a legally enforceable right to
  offset and when the taxes are levied by the same
  taxing authority for the same taxable entity.

• US GAAP
• In a classified balance sheet, deferred tax
  assets and liabilities are generally classified
  based on the classification of the related asset
  or liability, or for tax losses and credit
  carryforwards, based on the expected timing of
  realization.
• The net deferred current tax amount is reported
  on the face of the balance sheet and the net
  deferred non-current tax amount is reported on
  the face of the balance sheet.

27
Financial statement presentation
28
Classification and netting of deferred tax assets
and liabilities example

• Example 6
• Fun Flowers Consolidated (FFC), has the following
  deferred tax assets and liabilities

• FFC has the legal right of offset for the
  deferred tax assets and liabilities applicable to
  the US taxing jurisdiction.
• Provide the financial presentation for the
  deferred tax assets and liabilities for FFI under
  US GAAP and IFRS.

29
Classification and netting of deferred tax assets
and liabilities example

• Example 6 US GAAP solution
• Under US GAAP, deferred tax assets and
  liabilities are generally classified based on the
  classification of the related asset or liability,
  or for tax losses and credit carryforwards, based
  on the expected timing of realization.
  Additionally, the balances determined as current
  are offset and the balances determined as
  non-current are offset. Therefore, for FFC, a
  5,000 current deferred tax asset is reported and
  a 32,000 non-current deferred tax asset is also
  reported.

30
Classification and netting of deferred tax assets
and liabilities example

• Example 6 IFRS solution
• Under IFRS, deferred tax assets and liabilities
  are only classified as noncurrent and are offset
  when specific conditions are met which includes
  when an entity has a legally enforceable right to
  offset and when the taxes are levied by the same
  taxing authority for the same taxable entity.
  Therefore, for FFC, a 62,000 non-current
  deferred tax asset is reported and a 25,000
  non-current deferred tax liability.

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Disclosures
IFRS
US GAAP

• Requires disclosure of
• The components of the deferred tax liabilities
  and deferred tax assets.
• The components of tax expense.
• The amounts and expiration dates of operating
  loss and tax credit carryforwards for which tax
  benefits have not been recognized.
• The amounts of temporary differences that arent
  recorded due to the permanent reinvestment of
  undistributed foreign earnings.

Similar
32
Disclosures
Both US GAAP and IFRS require a numerical
reconciliation to explain the relationship
between tax expense (income) and pretax
accounting profit. However, there are differences
regarding the particular tax rate or rates to be
used for preparing that reconciliation.

• IFRS
• IAS 12, paragraph 85, states that Often, the
  most meaningful rate is the domestic rate of tax
  in the country in which the enterprise is
  domiciled, aggregating the tax rate applied for
  national taxes with the rates applied for any
  local taxes which are computed on a substantially
  similar level of taxable profit (tax loss).
  However, for an enterprise operating in several
  jurisdictions, it may be more meaningful to
  aggregate separate reconciliations prepared using
  the domestic rate in each individual
  jurisdiction."

• US GAAP
• ASC 740-10-50-12 requires use of "domestic
  federal statutory tax rates" based on the premise
  that those rates provide the most meaningful
  information for domestic users of an enterprise's
  financial statements. An aggregation of separate
  reconciliations using foreign tax rates is not
  permitted.

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Disclosures

• IFRS
• Requires, in certain circumstances, disclosure of
  "the nature of the evidence" supporting
  recognition of certain deferred tax assets.
  Scheduling the future reversals of temporary
  differences and carryforwards often will be
  necessary to develop the information required to
  comply with that disclosure requirement.
• Also requires considerable disclosures regarding
  unrecognized tax benefits. The requirements are
  found in IAS 37, paragraphs 84 through 92.

• US GAAP
• Does not have this requirement.
• Requires considerable disclosures regarding any
  unrecognized tax benefits. The specific
  requirements vary from those under IFRS. The
  requirements for US GAAP can be found in
  paragraphs 15 and 15A of ASC 740-10-50.