ACCA AAA INT Syllabus D. Audit of Historical Financial Information - Deferred tax basics - Notes 27 / 41
The basic idea
Deferred tax is all about matching.
If the accounts show the income, then they must also show any related tax.
This is normally not a problem as both the accounts and taxman often charge amounts in the same period
The problem occurs when they don’t.
We saw how the accounts may show income when the performance occurs, while the taxman only taxes it (tax base) when the money is received.
In this case, as financial reporters we must make sure we match the income and related expense.
So this was a case of the accounts showing ‘more income’ then the tax man in the current year (he will tax it the following year when the money is received).
So we had to bring in ‘more tax’ ourselves by creating a deferred tax liability
Hopefully you can see then that the opposite also applies:
| Difference | Tax effect | Deferred Tax |
| More expense in I/S | less tax needed | Asset |
Double entry
Dr Deferred tax asset
Cr Tax (I/S)
In fact, the following table all applies:
| Difference | Tax effect | Difference | |
| 1 | More Income | More tax | Liability |
| 2 | Less income | Less tax | Asset |
| 3 | More expense | Less tax | Asset |
| 4 | Less expense | More tax | Liability |
Remember this more income etc is from the point of view of IFRS.
The accounts are showing more income, as the taxman does not tax it until next year
Principal audit procedures – recoverability of deferred tax asset
Obtain a copy of current tax computation and deferred tax calculations and agree figures to any relevant tax correspondence and/or underlying accounting records.
Develop an independent expectation of the estimate to corroborate the reasonableness of management’s estimate.
Obtain forecasts of profitability and agree that there is sufficient forecast taxable profit available for the losses to be offset against.
Evaluate the assumptions used in the forecast against business understanding.
In particular consider assumptions regarding the growth rate of taxable profit in light of the underlying detrimental trend in profit before tax.
Assess the time period it will take to generate sufficient profits to utilise the tax losses.
If it is going to take a number of years to generate such profits, it may be that the recognition of the asset should be restricted.
Using tax correspondence, verify that there is no restriction on the ability of Company to carry the losses forward and to use the losses against future taxable profits.