Lecture Video 1

Lecture 1: Overview of Principles Underlying Deferred Tax

Welcome to your first lecture on IAS12. This standard is on accounting for income taxes in its entirety, not just deferred tax. Although we will spend 90% of our time discussing deferred tax. For a lot of you, you've heard of deferred tax and either you don't know what it is or it scares the pants off of you. 

Today we're going to start the process of fixing that. So, a couple of concepts just to remember here is that we do have accounting profit, which we account for in terms of our accounting standards. In this course, we're using IFRS (International Financial Reporting Standards). Each company or each country also has its own tax legislation, and you will land up having to work out a taxable income in order to work out how much tax will be levied for your company. We'll just refer to this as taxable income or tax profits. Remember this is not IFRS, this is your tax legislation and country’s specific rules.

So IAS12 says we must use the statement of financial position approach. Realistically what is the balance sheet or financial position statement? That is the cumulative totals. Whereas the income statement or statement of profit and loss, is just the movement between last year and this year. So it’s the movement between two balances. We're going to focus on the closing balances first and then work out the movement between. 

However, before we do that I need you just to refresh what is an asset. An asset is future economic benefits in terms of the framework. So future economic benefits; you have a timeline, and you have an asset PPE. A machine, for instance, and it's going to be earning you income in the form of operating profit today - at your reporting date. Liabilities, similar concept, but here we’re talking future outflows. Yes, it has to be a present obligation etc. In terms of the framework though, conceptually it's a future outflow recorded at today's value. But now, we have an item of PPE, which has future economic benefits, all before tax. So these future benefits are all recorded before tax.  

What you need to do about the tax effect. We're going to discuss that, and in essence, the issue comes up where your accounting profit does not always equal your tax profit. So there are going to be temporary differences between when you should have a tax expense in your books if you're looking purely at accounting, versus when you actually put the tax expense into your books because of tax legislation.

Okay so let's just have a quick look at assets. Again we try to cover the basic understandings here. So as I very roughly drew on the previous slide - an asset today, whether its PPE, inventory, debtors, consist of future economic benefits. Which are basically discounted back to today's value and recorded at such an amount. The question was that I asked you, what about the future tax effects? So these future benefits, which in this case will be income, will result in future tax outflows. All we say here, in IAS12, is that we must record the tax liability in order to record the tax expense in the correct period. 

And then for the liabilities, a similar thought process. Future outflows to recognise a liability, an accrual, or some type of financial liability today. And those will have future tax deductions probably. So we must recognise the future benefits from the tax deduction, as well as the future outflows for the current recognition of the liability. So underlining concepts here - we must technically match the tax expense to accounting profit before tax, in terms of which period. That's the accrual concept. I'm not talking about changing the actual tax return, but what we're going to have to do is realise that there will be two components in our accounting records. 

Mainly, we will have both current tax, as well as the deferred tax. Now the current tax is what you put into your tax return. The deferred tax is technically where you are applying the accrual concept, or matching your tax expense to the accounting profit before tax. Just remember there are also two elements we are going to talk about here or two statements. We will talk about tax expense, which is, I'm always going to refer to as the movements, and that's going to both either be in profit and loss or other comprehensive income. Whereas then we'll also have our tax assets and liabilities, being the balances, and that will be in the statement of financial position. Remember there will be current, as well as the deferred tax balances. 

Please just remember -  the principle here is that our accounting profit before tax does not necessarily equal our tax profits or taxable income. What we do need to do, is we need to recognise the tax expense in the correct period for accounting records. So there we are talking about the accrual concept as being highly important. Now, the easiest way to do this is to look at numbers. 

So the next video I'm going to do a very basic video, going through a basic example for an illustration of these basic temporary differences. Please watch that to get a grip of what we just discussed. Thank you.

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