Income taxes and deferred tax

Q: What is current tax, and why does taxable profit usually differ from accounting profit?

Current tax is the income tax expected to be paid to tax authorities for the current period based on taxable profit, which differs from accounting profit due to differing recognition rules between tax legislation and IFRS.

Q: How are the tax base of an asset and the tax base of a liability defined under IAS 12?

The tax base of an asset is the amount deductible for tax purposes against future taxable economic benefits; the tax base of a liability is its carrying amount less any amounts deductible for tax in future periods: \[ \text{Tax Base} = \text{Carrying Amount} - \text{Future Tax Deductions} \]

Q: What are the "Golden Rules" for determining deferred tax assets and liabilities from temporary differences?

For an asset , $ \text{CA} > \text{TB} $ gives a Deferred Tax Liability (DTL) and $ \text{CA} Deferred Tax Asset (DTA) ; for a liability , \( \text{CA} > \text{TB} $ gives a DTA and \( \text{CA} DTL .

Q: What is the step-by-step process for calculating the deferred tax movement to be recognized in profit or loss?

Determine the carrying amount and tax base, calculate the temporary difference $ |\text{CA} - \text{TB}| $, multiply by the enacted tax rate to obtain the closing balance, and recognize the net change from the opening balance in profit or loss.

Q: Why does accelerated tax depreciation create a deferred tax liability?

Because tax allowances exceed accounting depreciation in early years, the tax base falls below the carrying amount ($ \text{CA} > \text{TB} $), creating a taxable temporary difference and a Deferred Tax Liability .

Q: Where must deferred tax arising from an upward revaluation of property, plant, and equipment be recognized?

It must be recognized in Other Comprehensive Income (OCI) , directly reducing the revaluation surplus in equity.

F2 – Advanced Financial Reporting · CIMA (CGMA Professional Qualification) · 7 min read · Updated: 5 Nov 2026

Introduction to Income Taxes

Welcome to one of the most important chapters in your F2 journey! Income tax is a topic that many students find a bit intimidating at first, but don't worry—once you understand the "why" behind the rules, it all starts to click. In this chapter, we aren't just looking at how much cash a company pays the government. We are looking at Current Tax and Deferred Tax. This ensures our financial statements follow the accruals concept, matching the tax expense to the profits earned in the same period.

Think of it like this: If you earn a bonus today but don't have to pay tax on it until next year, your accounts today should still show that you "owe" that tax. That is the essence of deferred tax!

1. Current Tax

Current tax is the amount of income tax a company expects to pay to the tax authorities for the current year. It is based on the taxable profit, which is usually different from the accounting profit because tax laws and accounting standards (IFRS) have different rules about what counts as income or an expense.

How to calculate the Current Tax charge

To find the total tax expense in the Statement of Profit or Loss (P&L), we usually need to do a small calculation involving three steps:

1. Estimate the tax for the current year.
2. Look at the prior year. Did we overestimate or underestimate our tax last year?
3. Combine these figures.

The Formula:
$ \text{Tax Expense} = \text{Current Year Estimate} + \text{Under-provision from last year} $
OR
$ \text{Tax Expense} = \text{Current Year Estimate} - \text{Over-provision from last year} $

Quick Review Box:
If the trial balance shows a debit balance for tax, it means we underpaid last year (Under-provision). This increases this year's expense.
If the trial balance shows a credit balance for tax, it means we overpaid last year (Over-provision). This reduces this year's expense.

2. The Concept of Deferred Tax

Deferred tax is an accounting adjustment to deal with temporary differences. It recognizes the future tax consequences of transactions that have happened today.

Why does it happen?
A classic example is the difference between Depreciation (accounting) and Capital Allowances / Tax Depreciation (tax laws).
- Accounting: We spread the cost of a machine over 10 years.
- Tax Law: The tax authority might allow a 100% tax deduction in Year 1 to encourage capital investment.

This creates a timing gap. Deferred tax bridges that gap so the tax expense in the P&L matches the accounting profit shown.

Analogy: The Credit Card
Imagine you buy a luxury dinner on a credit card. You've enjoyed the meal (the profit), but you haven't paid the cash yet (the tax). Deferred Tax is like the "pending" transaction on your banking app. You haven't paid it yet, but you know you will have to settle it eventually!

3. The Balance Sheet Approach (IAS 12)

IAS 12 uses the balance sheet liability method. We compare the values of assets and liabilities on the Statement of Financial Position with their tax bases.

Key Terms:

Carrying Amount (CA): The value of an asset or liability in the financial statements.
Tax Base (TB): The value attributed to that asset or liability for tax purposes.

Temporary Difference: The difference between the Carrying Amount and the Tax Base.

The Golden Rules for Temporary Differences:

For Assets:
1. If Carrying Amount > Tax Base = Taxable Temporary Difference $ \implies $ Deferred Tax Liability (DTL).
2. If Carrying Amount < Tax Base = Deductible Temporary Difference $ \implies $ Deferred Tax Asset (DTA).

For Liabilities:
1. If Carrying Amount > Tax Base = Deductible Temporary Difference $ \implies $ Deferred Tax Asset (DTA).
2. If Carrying Amount < Tax Base = Taxable Temporary Difference $ \implies $ Deferred Tax Liability (DTL).

Tax Base of a Liability:
The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods: $ \text{Tax Base} = \text{Carrying Amount} - \text{Future Tax Deductions} $.

4. Step-by-Step: Calculating Deferred Tax

Follow these five steps every time:

Step 1: Identify the Carrying Amount (CA) of the asset or liability.
Step 2: Identify the Tax Base (TB).
Step 3: Calculate the Temporary Difference: $ \text{Temporary Difference} = |\text{CA} - \text{TB}| $.
Step 4: Multiply the temporary difference by the enacted or substantively enacted Tax Rate. This gives the Closing Balance for the Statement of Financial Position.
Step 5: Compare this Closing Balance to the Opening Balance. The net movement is recognised in profit or loss (unless the underlying item was recognised in OCI or equity).

5. Key Syllabus Scenarios

A. Accelerated Tax Depreciation

When tax allowances are granted faster than accounting depreciation, the tax base of the asset drops below its carrying amount ($ \text{CA} > \text{TB} $). This creates a taxable temporary difference and a Deferred Tax Liability.

Example: A machine has a carrying amount of \$100,000 and a tax base of \$70,000. The tax rate is 20%.
1. Difference = $ \$100,000 - \$70,000 = \$30,000 $
2. Deferred Tax Liability = $ \$30,000 \times 20\% = \$6,000 $.
If opening deferred tax was nil, the P&L charge is \$6,000.

B. Accrued Expenses

An entity accrues an expense (e.g. employee bonus or warranty provision) of \$20,000, creating a liability of \$20,000. Under local tax law, the expense is only deductible when actually paid in cash in the subsequent year.
- Carrying Amount of liability = \$20,000.
- Tax Base of liability = $ \$20,000 - \$20,000 = \$0 $.
Because $ \text{CA} > \text{TB} $ for a liability, there is a deductible temporary difference of \$20,000. At a 20% tax rate, this gives a Deferred Tax Asset of $ \$20,000 \times 20\% = \$4,000 $.

C. Accrued Income

An entity accrues interest income of \$10,000 receivable at year end (an asset). Under tax law, interest is taxed only on a cash receipts basis.
- Carrying Amount of asset = \$10,000.
- Tax Base of asset = \$0 (since the recovery will be taxed when cash arrives).
Because $ \text{CA} > \text{TB} $ for an asset, this is a taxable temporary difference of \$10,000. At a 20% tax rate, this creates a Deferred Tax Liability of $ \$10,000 \times 20\% = \$2,000 $.

D. Revaluations

When an item of property, plant, and equipment is revalued upwards, its carrying amount increases, but its tax base remains unchanged. This creates a taxable temporary difference ($ \text{CA} > \text{TB} $) and a Deferred Tax Liability.
Accounting treatment: Because the revaluation gain itself is recognised in Other Comprehensive Income (OCI) and accumulated in the revaluation surplus, IAS 12 requires the related deferred tax charge to also be recognised in OCI, directly reducing the revaluation surplus.

E. Unused Tax Losses

When a company incurs a tax loss that can be carried forward to offset future taxable profits, the loss behaves like a deductible temporary difference. A Deferred Tax Asset is recognised for the carryforward of unused tax losses to the extent that it is probable that future taxable profit will be available against which the unused tax losses can be utilised.

6. Summary and Quick Checklist

Before moving on to the next chapter, make sure you can:

• Calculate the current tax expense including prior-year under- or over-provisions.
• Determine the Tax Base of both assets and liabilities.
• Apply the golden rules to identify Taxable Temporary Differences (DTL) and Deductible Temporary Differences (DTA).
• Account for deferred tax across the five key syllabus situations: accelerated tax depreciation, accrued expenses, accrued income, revaluations, and unused tax losses.
• Recognise deferred tax in P&L by default, but in Other Comprehensive Income when it relates to items recognised in OCI (such as revaluation surplus).

References

Management level Examination Blueprint — AICPA & CIMA

Quick check

Can you answer these now?

Open each question to check the key ideas from this chapter.

What is current tax, and why does taxable profit usually differ from accounting profit?

Current tax is the income tax expected to be paid to tax authorities for the current period based on taxable profit, which differs from accounting profit due to differing recognition rules between tax legislation and IFRS.

How is the total current tax expense in the Statement of Profit or Loss calculated when there is a prior-year adjustment?

\[ \text{Tax Expense} = \text{Current Year Estimate} + \text{Prior-Year Under-provision} \] (or minus a prior-year over-provision).

What is the fundamental purpose of accounting for deferred tax under IAS 12?

Deferred tax accounts for the future tax consequences of current transactions, adhering to the accruals concept by matching tax expense to the accounting profit in the period it is earned.

How are the tax base of an asset and the tax base of a liability defined under IAS 12?

The tax base of an asset is the amount deductible for tax purposes against future taxable economic benefits; the tax base of a liability is its carrying amount less any amounts deductible for tax in future periods: \[ \text{Tax Base} = \text{Carrying Amount} - \text{Future Tax Deductions} \]

What are the "Golden Rules" for determining deferred tax assets and liabilities from temporary differences?

For an asset, $ \text{CA} > \text{TB} $ gives a Deferred Tax Liability (DTL) and $ \text{CA} < \text{TB} $ gives a Deferred Tax Asset (DTA); for a liability, $ \text{CA} > \text{TB} $ gives a DTA and $ \text{CA} < \text{TB} $ gives a DTL.

What is the step-by-step process for calculating the deferred tax movement to be recognized in profit or loss?

Determine the carrying amount and tax base, calculate the temporary difference $ |\text{CA} - \text{TB}| $, multiply by the enacted tax rate to obtain the closing balance, and recognize the net change from the opening balance in profit or loss.

Why does accelerated tax depreciation create a deferred tax liability?

Because tax allowances exceed accounting depreciation in early years, the tax base falls below the carrying amount ($ \text{CA} > \text{TB} $), creating a taxable temporary difference and a Deferred Tax Liability.

How does an accrued expense that is deductible only on a cash paid basis give rise to a deferred tax asset?

The liability has $ \text{Tax Base} = \$0 $, meaning $ \text{CA} > \text{TB} $, which creates a deductible temporary difference and a Deferred Tax Asset.

Where must deferred tax arising from an upward revaluation of property, plant, and equipment be recognized?

It must be recognized in Other Comprehensive Income (OCI), directly reducing the revaluation surplus in equity.

Under what condition may an entity recognize a deferred tax asset for carryforward unused tax losses?

A deferred tax asset is recognized only to the extent that it is probable that future taxable profit will be available against which the unused tax losses can be utilized.

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