4Accrued income will never be taxable.

4 Accrued income will never be taxable. Illustrative computations and presentation Extracts from statements of financial position and statements of comprehensive income are provided to show the effects on these financial statements of the transactions described below. These extracts do not necessarily conform with all the disclosure and presentation requirements of other Standards. All the examples below assume that the entities concerned have no transaction other than those described. Example 1 – Depreciable assets An entity buys equipment for 10,000 and depreciates it on a straight-line basis over its expected useful life of five years. For tax purposes, the equipment is depreciated at 25% a year on a straight-line basis. Tax losses may be carried back against taxable profit of the previous five years. In year 0, the entity’s taxable profit was 5,000. The tax rate is 40%. The entity will recover the carrying amount of the equipment by using it to manufacture goods for resale. Therefore, the entity’s current tax computation is as follows: - Taxable income 2,000 2,000 2,000 2,000 2,000 - Depreciation for tax purposes 2,500 2,500 2,500 2,500 0 - Taxable profit (tax loss) (500) (500) (500) (500) 2,000 - Current tax expense (income) at 40% (200) (200) (200) (200) 800   The entity recognises a current tax asset at the end of years 1 to 4 because it recovers the benefit of the tax loss against the taxable profit of year 0. The temporary differences associated with the equipment and the resulting deferred tax asset and liability and deferred tax expense and income are as follows: - Carrying amount 8,000 6,000 4,000 2,000 0 - Tax base 7,500 5,000 2,500 0 0 - Taxable temporary difference 500 1,000 1,500 2,000 0 - Opening deferred tax liability 0 200 400 600 800 - Deferred tax expense (income) 200 200 200 200 (800) - Closing deferred tax liability 200 400 600 800 0   The entity recognises the deferred tax liability in years 1 to 4 because the reversal of the taxable temporary difference will create taxable income in subsequent years. The entity’s statement of comprehensive income includes the following: - Income 2,000 2,000 2,000 2,000 2,000 - Depreciation 2,000 2,000 2,000 2,000 2,000 - Profit before tax 0 0 0 0 0 - Current tax expense (income) (200) (200) (200) (200) 800 - Deferred tax expense (income) 200 200 200 200 (800) - Total tax expense (income) 0 0 0 0 0 - Profit for the period 0 0 0 0 0   Example 2 – Deferred tax assets and liabilities The example deals with an entity over the two-year period, X5 and X6. In X5 the enacted income tax rate was 40% of taxable profit. In X6 the enacted income tax rate was 35% of taxable profit. Charitable donations are recognised as an expense when they are paid and are not deductible for tax purposes. In X5, the entity was notified by the relevant authorities that they intend to pursue an action against the entity with respect to sulphur emissions. Although as at December X6 the action had not yet come to court the entity recognised a liability of 700 in X5 being its best estimate of the fine arising from the action. Fines are not deductible for tax purposes. In X2, the entity incurred 1,250 of costs in relation to the development of a new product. These costs were deducted for tax purposes in X2. For accounting purposes, the entity capitalised this expenditure and amortised it on the straight-line basis over five years. At 31/12/X4, the unamortised balance of these product development costs was 500. In X5, the entity entered into an agreement with its existing employees to provide healthcare benefits to retirees. The entity recognises as an expense the cost of this plan as employees provide service. No payments to retirees were made for such benefits in X5 or X6. Healthcare costs are deductible for tax purposes when payments are made to retirees. The entity has determined that it is probable that taxable profit will be available against which any resulting deferred tax asset can be utilised. Buildings are depreciated for accounting purposes at 5% a year on a straight-line basis and at 10% a year on a straight-line basis for tax purposes. Motor vehicles are depreciated for accounting purposes at 20% a year on a straight-line basis and at 25% a year on a straight-line basis for tax purposes. A full year’s depreciation is charged for accounting purposes in the year that an asset is acquired. At 1/1/X6, the building was revalued to 65,000 and the entity estimated that the remaining useful life of the building was 20 years from the date of the revaluation. The revaluation did not affect taxable profit in X6 and the taxation authorities did not adjust the tax base of the building to reflect the revaluation. In X6, the entity transferred 1,033 from revaluation surplus to retained earnings. This represents the difference of 1,590 between the actual depreciation on the building (3,250) and equivalent depreciation based on the cost of the building (1,660, which is the book value at 1/1/X6 of 33,200 divided by the remaining useful life of 20 years), less the related deferred tax of 557 (see paragraph 64 of the Standard).   | Current tax expense | | | | | Accounting profit | 8,775 | | 8,740 | | Add | | | | | Depreciation for accounting purposes | 4,800 | | 8,250 | | Charitable donations | 500 | | 350 | | Fine for environmental pollution | 700 | | – | | Product development costs | 250 | | 250 | | Healthcare benefits | 2,000 | | 1,000 | | | 17,025 | | 18,590 | | Deduct | | | | | Depreciation for tax purposes | (8,100) | | (11,850) | | Taxable profit | 8,925 | | 6,740 | | Current tax expense at 40% | 3,570 | | | | Current tax expense at 35% | | | 2,359 |   - Carrying amounts of property, plant and equipment - Building Motor vehicles Total - Balance at 31/12/X4 50,000 10,000 60,000 - Additions X5 6,000 – 6,000 - Balance at 31/12/X5 56,000 10,000 66,000 - Elimination of accumulated depreciation on revaluation at 1/1/X6 (22,800) – (22,800) - Revaluation at 1/1/X6 31,800 – 31,800 - Balance at 1/1/X6 65,000 10,000 75,000 - Additions X6 – 15,000 15,000 - 65,000 25,000 90,000 - Accumulated depreciation 5% 20% - Balance at 31/12/X4 20,000 4,000 24,000 - Depreciation X5 2,800 2,000 4,800 - Balance at 31/12/X5 22,800 6,000 28,800 - Revaluation at 1/1/X6 (22,800) – (22,800) - Balance at 1/1/X6 – 6,000 6,000 - Depreciation X6 3,250 5,000 8,250 - Balance at 31/12/X6 3,250 11,000 14,250 - Carrying amount - 31/12/X4 30,000 6,000 36,000 - 31/12/X5 33,200 4,000 37,200 - 31/12/X6 61,750 14,000 75,750   - Tax base of property, plant and equipment - Building Motor vehicles Total - Cost - Balance at 31/12/X4 50,000 10,000 60,000 - Additions X5 6,000 – 6,000 - Balance at 31/12/X5 56,000 10,000 66,000 - Additions X6 – 15,000 15,000 - Balance at 31/12/X6 56,000 25,000 81,000 - Accumulated depreciation 10% 25% - Balance at 31/12/X4 40,000 5,000 45,000 - Depreciation X5 5,600 2,500 8,100 - Balance at 31/12/X5 45,600 7,500 53,100 - Depreciation X6 5,600 6,250 11,850 - Balance 31/12/X6 51,200 13,750 64,950 - Tax base - 31/12/X4 10,000 5,000 15,000 - 31/12/X5 10,400 2,500 12,900 - 31/12/X6 4,800 11,250 16,050   - Deferred tax assets, liabilities and expense at 31/12/X4 - Product development costs 500 – 500 - Property, plant & equipment 36,000 15,000 21,000 - TOTAL ASSETS 72,000 50,500 21,500 - Current income taxes payable 3,000 3,000 – - Fines payable – – – - Liability for healthcare benefits – – – - Long-term debt 20,000 20,000 – - Deferred income taxes 8,600 8,600 – - TOTAL LIABILITIES 32,100 32,100 - Revaluation surplus – – – - Retained earnings 34,900 13,400 - TOTAL LIABILITIES/EQUITY 72,000 50,500 - TEMPORARY DIFFERENCES 21,500 - Deferred tax liability 21,500 at 40% 8,600 - Deferred tax asset – – - Net deferred tax liability 8,600   - Deferred tax assets, liabilities and expense at 31/12/X5 - Product development costs 250 – 250 - Property, plant & equipment 37,200 12,900 24,300 - TOTAL ASSETS 72,950 48,400 24,550 - Current income taxes payable 3,570 3,570 – - Fines payable 700 700 – - Liability for healthcare benefits 2,000 – (2,000) - Long-term debt 12,475 12,475 – - Deferred income taxes 9,020 9,020 - TOTAL LIABILITIES 28,265 26,265 (2,000) - Revaluation surplus – – – - Retained earnings 39,685 17,135 - TOTAL LIABILITIES/EQUITY 72,950 48,400 - TEMPORARY DIFFERENCES 22,550 - Deferred tax liability 24,550 at 40% 9,820 - Deferred tax asset 2,000 at 40% (800) - Net deferred tax liability 9,020 - Less: Opening deferred tax liability (8,600) - Deferred tax expense (income) related to the origination and reversal of temporary differences 420   - Deferred tax assets, liabilities and expense at 31/12/X6 - Product development costs – – – - Property, plant & equipment 75,750 16,050 59,700 - TOTAL ASSETS 111,250 51,550 59,700 - Current income taxes payable 2,359 2,359 – - Fines payable 700 700 - Liability for healthcare benefits 3,000 – (3,000) - Long-term debt 12,805 12,805 – - Deferred income taxes 19,845 19,845 – - TOTAL LIABILITIES 39,209 36,209 (3,000) - Revaluation surplus 19,637 – – - Retained earnings 47,404 10,341 - TOTAL LIABILITIES/EQUITY 111,250 51,550 - TEMPORARY DIFFERENCES 56,700 - Deferred tax liability 59,700 at 35% 20,895 - Deferred tax asset 3,000 at 35% (1,050) - Net deferred tax liability 19,845 - Less: Opening deferred tax liability (9,020) - Adjustment to opening deferred tax liability resulting from reduction in tax rate 22,550 at 5% 1,127 - Deferred tax attributable to revaluation surplus 31,800 at 35% (11,130) - Deferred tax expense (income) related to the origination and reversal of temporary differences 822 Illustrative disclosure The amounts to be disclosed in accordance with the Standard are as follows: Major components of tax expense (income) (paragraph 79) | Current tax expense | 3,570 | | 2,359 | | Deferred tax expense relating to the origination and reversal of temporary differences: | 420 | | 822 | | Deferred tax expense (income) resulting from reduction in tax rate | – | | (1,127) | | Tax expense | 3,990 | | 2,054 |   Income tax relating to the components of other comprehensive income (paragraph 81(ab)) | Deferred tax relating to revaluation of building | – | | (11,130) | In addition, deferred tax of 557 was transferred in X6 from retained earnings to revaluation surplus. This relates to the difference between the actual depreciation on the building and equivalent depreciation based on the cost of the building. Explanation of the relationship between tax expense and accounting profit (paragraph 81(c)) The Standard permits two alternative methods of explaining the relationship between tax expense (income) and accounting profit. Both of these formats are illustrated below. (i) a numerical reconciliation between tax expense (income) and the product of accounting profit multiplied by the applicable tax rate(s), disclosing also the basis on which the applicable tax rate(s) is (are) computed - X5 X6 - Accounting profit 8,775 8,740 - Tax at the applicable tax rate of 35% (X5: 40%) 3,510 3,059 - Tax effect of expenses that are not deductible in determining taxable profit: - Charitable donations 200 122 - Fines for environmental pollution 280 – - Reduction in opening deferred taxes resulting from reduction in tax rate – (1,127) - Tax expense 3,990 2,054 The applicable tax rate is the aggregate of the national income tax rate of 30% (X5: 35%) and the local income tax rate of 5%. (ii) a numerical reconciliation between the average effective tax rate and the applicable tax rate, disclosing also the basis on which the applicable tax rate is computed - X5 % X6 % - Applicable tax rate 40.0 35.0 - Tax effect of expenses that are not deductible for tax purposes: - Charitable donations 2.3 1.4 - Fines for environmental pollution 3.2 – - Effect on opening deferred taxes of reduction in tax rate – (12.9) - Average effective tax rate (tax expense divided by profit before tax) 45.5 23.5 The applicable tax rate is the aggregate of the national income tax rate of 30% (X5: 35%) and the local income tax rate of 5%. An explanation of changes in the applicable tax rate(s) compared to the previous accounting period (paragraph 81(d)) In X6, the government enacted a change in the national income tax rate from 35% to 30%. In respect of each type of temporary difference, and in respect of each type of unused tax losses and unused tax credits: (i) the amount of the deferred tax assets and liabilities recognised in the statement of financial position for each period presented; (ii) the amount of the deferred tax income or expense recognised in profit or loss for each period presented, if this is not apparent from the changes in the amounts recognised in the statement of financial position (paragraph 81(g)). | Accelerated depreciation for tax purposes | 9,720 | | 10,322 | | Liabilities for healthcare benefits that are deducted for tax purposes only when paid | (800) | | (1,050) | | Product development costs deducted from taxable profit in earlier years | 100 | | – | | Revaluation, net of related depreciation | – | | 10,573 | | Deferred tax liability | 9,020 | | 19,845 | (note: the amount of the deferred tax income or expense recognised in profit or loss for the current year is apparent from the changes in the amounts recognised in the statement of financial position) Example 3 – Business combinations On 1 January X5 entity A acquired 100 per cent of the shares of entity B at a cost of 600. At the acquisition date, the tax base in A’s tax jurisdiction of A’s investment in B is 600. Reductions in the carrying amount of goodwill are not deductible for tax purposes, and the cost of the goodwill would also not be deductible if B were to dispose of its underlying business. The tax rate in A’s tax jurisdiction is 30 per cent and the tax rate in B’s tax jurisdiction is 40 per cent. The fair value of the identifiable assets acquired and liabilities assumed (excluding deferred tax assets and liabilities) by A is set out in the following table, together with their tax bases in B’s tax jurisdiction and the resulting temporary differences. - Amount recognised at acquisition Tax base Temporary differences - Property, plant and equipment 270 155 115 - Accounts receivable 210 210 – - Inventory 174 124 50 - Retirement benefit obligations (30) – (30) - Accounts payable (120) (120) – - Identifiable assets acquired and liabilities assumed, excluding deferred tax 504 369 135 The deferred tax asset arising from the retirement benefit obligations is offset against the deferred tax liabilities arising from the property, plant and equipment and inventory (see paragraph 74 of the Standard). No deduction is available in B’s tax jurisdiction for the cost of the goodwill. Therefore, the tax base of the goodwill in B’s jurisdiction is nil. However, in accordance with paragraph 15(a) of the Standard, A recognises no deferred tax liability for the taxable temporary difference associated with the goodwill in B’s tax jurisdiction. The carrying amount, in A’s consolidated financial statements, of its investment in B is made up as follows: | Fair value of identifiable assets acquired and liabilities assumed, excluding deferred tax | 504 | | Deferred tax liability (135 at 40%) | (54) | | Fair value of identifiable assets acquired and liabilities assumed | 450 | | Goodwill | 150 | | Carrying amount | 600 | Because, at the acquisition date, the tax base in A’s tax jurisdiction, of A’s investment in B is 600, no temporary difference is associated in A’s tax jurisdiction with the investment. During X5, B’s equity (incorporating the fair value adjustments made as a result of the business combination) changed as follows: | At 1 January X5 | 450 | | Retained profit for X5 (net profit of 150, less dividend payable of 80) | 70 | | At 31 December X5 | 520 | A recognises a liability for any withholding tax or other taxes that it will incur on the accrued dividend receivable of 80. At 31 December X5, the carrying amount of A’s underlying investment in B, excluding the accrued dividend receivable, is as follows: | Net assets of B | 520 | | Goodwill | 150 | | Carrying amount | 670 | The temporary difference associated with A’s underlying investment is 70. This amount is equal to the cumulative retained profit since the acquisition date. If A has determined that it will not sell the investment in the foreseeable future and that B will not distribute its retained profits in the foreseeable future, no deferred tax liability is recognised in relation to A’s investment in B (see paragraphs 39 and 40 of the Standard). Note that this exception would apply for an investment in an associate only if there is an agreement requiring that the profits of the associate will not be distributed in the foreseeable future (see paragraph 42 of the Standard). A discloses the amount of the temporary difference for which no deferred tax is recognised, ie 70 (see paragraph 81(f) of the Standard). If A expects to sell the investment in B, or that B will distribute its retained profits in the foreseeable future, A recognises a deferred tax liability to the extent that the temporary difference is expected to reverse. The tax rate reflects the manner in which A expects to recover the carrying amount of its investment (see paragraph 51 of the Standard). A recognises the deferred tax in other comprehensive income to the extent that the deferred tax results from foreign exchange translation differences that have been recognised in other comprehensive income (paragraph 61A of the Standard). A discloses separately: (a) the amount of deferred tax that has been recognised in other comprehensive income (paragraph 81(ab) of the Standard); and (b) the amount of any remaining temporary difference which is not expected to reverse in the foreseeable future and for which, therefore, no deferred tax is recognised (see paragraph 81(f) of the Standard). Example 4 – Compound financial instruments An entity receives a non-interest-bearing convertible loan of 1,000 on 31 December X4 repayable at par on 1 January X8. In accordance with AASB 132 Financial Instruments: Presentation the entity classifies the instrument’s liability component as a liability and the equity component as equity. The entity assigns an initial carrying amount of 751 to the liability component of the convertible loan and 249 to the equity component. Subsequently, the entity recognises imputed discount as interest expense at an annual rate of 10% on the carrying amount of the liability component at the beginning of the year. The tax authorities do not allow the entity to claim any deduction for the imputed discount on the liability component of the convertible loan. The tax rate is 40%. The temporary differences associated with the liability component and the resulting deferred tax liability and deferred tax expense and income are as follows: - X4 X5 X6 X7 - Carrying amount of liability component 751 826 909 1,000 - Tax base 1,000 1,000 1,000 1,000 - Taxable temporary difference 249 174 91 – - Opening deferred tax liability at 40% 0 100 70 37 - Deferred tax charged to equity 100 – – – - Deferred tax expense (income) – (30) (33) (37) - Closing deferred tax liability at 40% 100 70 37 –   As explained in paragraph 23 of the Standard, at 31 December X4, the entity recognises the resulting deferred tax liability by adjusting the initial carrying amount of the equity component of the convertible liability. Therefore, the amounts recognised at that date are as follows: | Liability component | 751 | | Deferred tax liability | 100 | | Equity component (249 less 100) | 149 | | | 1,000 | Subsequent changes in the deferred tax liability are recognised in profit or loss as tax income (see paragraph 23 of the Standard). Therefore, the entity’s profit or loss includes the following: - X4 X5 X6 X7 - Interest expense (imputed discount) – 75 83 91 - Deferred tax expense (income) – (30) (33) (37) - – 45 50 54 Example 5 – Share-based payment transactions In accordance with AASB 2 Share-based Payment, an entity has recognised an expense for the consumption of employee services received as consideration for share options granted. A tax deduction will not arise until the options are exercised, and the deduction is based on the options’ intrinsic value at exercise date. As explained in paragraph 68B of the Standard, the difference between the tax base of the employee services received to date (being the amount the taxation authorities will permit as a deduction in future periods in respect of those services), and the carrying amount of nil, is a deductible temporary difference that results in a deferred tax asset. Paragraph 68B requires that, if the amount the taxation authorities will permit as a deduction in future periods is not known at the end of the period, it should be estimated, based on information available at the end of the period. If the amount that the taxation authorities will permit as a deduction in future periods is dependent upon the entity’s share price at a future date, the measurement of the deductible temporary difference should be based on the entity’s share price at the end of the period. Therefore, in this example, the estimated future tax deduction (and hence the measurement of the deferred tax asset) should be based on the options’ intrinsic value at the end of the period. As explained in paragraph 68C of the Standard, if the tax deduction (or estimated future tax deduction) exceeds the amount of the related cumulative remuneration expense, this indicates that the tax deduction relates not only to remuneration expense but also to an equity item. In this situation, paragraph 68C requires that the excess of the associated current or deferred tax should be recognised directly in equity. The entity’s tax rate is 40 per cent. The options were granted at the start of year 1, vested at the end of year 3 and were exercised at the end of year 5. Details of the expense recognised for employee services received and consumed in each accounting period, the number of options outstanding at each year-end, and the intrinsic value of the options at each year-end, are as follows: | | Employee services expense | Number of options at year-end | | Intrinsic value per option | | --- | --- | --- | --- | --- | | Year 1 | 188,000 | 50,000 | | 5 | | Year 2 | 185,000 | 45,000 | | 8 | | Year 3 | 190,000 | 40,000 | | 13 | | Year 4 | 0 | 40,000 | | 17 | | Year 5 | 0 | 40,000 | | 20 | The entity recognises a deferred tax asset and deferred tax income in years 1–4 and current tax income in year 5 as follows. In years 4 and 5, some of the deferred and current tax income is recognised directly in equity, because the estimated (and actual) tax deduction exceeds the cumulative remuneration expense. - Year 1 - Deferred tax asset and deferred tax income: - (50,000 × 5 × 1/3(a) × 0.40) = 33,333 - (a) The tax base of the employee services received is based on the intrinsic value of the options, and those options were granted for three years’ services. Because only one year’s services have been received to date, it is necessary to multiply the option’s intrinsic value by one-third to arrive at the tax base of the employee services received in year 1. The deferred tax income is all recognised in profit or loss, because the estimated future tax deduction of 83,333 (50,000 × 5 × 1/3) is less than the cumulative remuneration expense of 188,000.   - Year 2 - Deferred tax asset at year-end: - (45,000 × 8 × 2/3 × 0.40) = 96,000 - Less deferred tax asset at start of year (33,333) - Deferred tax income for year 62,667* - * This amount consists of the following: - Deferred tax income for the temporary difference between the tax base of the employee services received during the year and their carrying amount of nil: - (45,000 × 8 × 1/3 × 0.40) 48,000 - Tax income resulting from an adjustment to the tax base of employee services received in previous years: - (a) increase in intrinsic value: (45,000 × 3 × 1/3 × 0.40) 18,000 - (b) decrease in number of options: (5,000 × 5 × 1/3 × 0.40) (3,333) - Deferred tax income for year 62,667 The deferred tax income is all recognised in profit or loss, because the estimated future tax deduction of 240,000 (45,000 × 8 × 2/3) is less than the cumulative remuneration expense of 373,000 (188,000 + 185,000).   | Year 3 | | | Deferred tax asset at year-end: | | | (40,000 × 13 × 0.40) = | 208,000 | | Less deferred tax asset at start of year | (96,000) | | Deferred tax income for year | 112,000 | The deferred tax income is all recognised in profit or loss, because the estimated future tax deduction of 520,000 (40,000 × 13) is less than the cumulative remuneration expense of 563,000 (188,000 + 185,000 + 190,000).   - Year 4 - Deferred tax asset at year-end: - (40,000 × 17 × 0.40) = 272,000 - Less deferred tax asset at start of year (208,000) - Deferred tax income for year 64,000 - The deferred tax income is recognised partly in profit or loss and partly directly in equity as follows: - Estimated future tax deduction (40,000 × 17) = 680,000 - Cumulative remuneration expense 563,000 - Excess tax deduction 117,000 - Deferred tax income for year 64,000 - Excess recognised directly in equity (117,000 × 0.40) = 46,800 - Recognised in profit or loss 17,200   | Year 5 | | | | | Deferred tax expense (reversal of deferred tax asset) | 272,000 | | | | Amount recognised directly in equity (reversal of cumulative deferred tax income recognised directly in equity) | 46,800 | | | | Amount recognised in profit or loss | | | 225,200 | | Current tax income based on intrinsic value of options at exercise date (40,000 × 20 × 0.40) = | 320,000 | | | | Amount recognised in profit or loss (563,000 × 0.40) = | 225,200 | | | | Amount recognised directly in equity | | | 94,800 | Summary - Statement of comprehensive income Statement of financial position - Employee services expense Current tax expense (income) Deferred tax expense (income) Total tax expense (income) Equity Deferred tax asset - Year 1 188,000 0 (33,333) (33,333) 0 33,333 - Year 2 185,000 0 (62,667) (62,667) 0 96,000 - Year 3 190,000 0 (112,000) (112,000) 0 208,000 - Year 4 0 0 (17,200) (17,200) (46,800) 272,000 - Year 5 0 (225,200) 225,200 0 46,800 0 - (94,800) - Totals 563,000 (225,200) 0 (225,200) (94,800) 0 Example 6 – Replacement awards in a business combination On 1 January 20X1 Entity A acquired 100 per cent of Entity B. Entity A pays cash consideration of CU400 to the former owners of Entity B. At the acquisition date Entity B had outstanding employee share options with a market-based measure of CU100. The share options were fully vested. As part of the business combination Entity B’s outstanding share options are replaced by share options of Entity A (replacement awards) with a market-based measure of CU100 and an intrinsic value of CU80. The replacement awards are fully vested. In accordance with paragraphs B56–B62 of AASB 3 Business Combinations, the replacement awards are part of the consideration transferred for Entity B. A tax deduction for the replacement awards will not arise until the options are exercised. The tax deduction will be based on the share options’ intrinsic value at that date. Entity A’s tax rate is 40 per cent. Entity A recognises a deferred tax asset of CU32 (CU80 intrinsic value × 40%) on the replacement awards at the acquisition date. Entity A measures the identifiable net assets obtained in the business combination (excluding deferred tax assets and liabilities) at CU450. The tax base of the identifiable net assets obtained is CU300. Entity A recognises a deferred tax liability of CU60 ((CU450 – CU300) × 40%) on the identifiable net assets at the acquisition date. Goodwill is calculated as follows: | | CU | | Cash consideration | 400 | | Market-based measure of replacement awards | 100 | | Total consideration transferred | 500 | | Identifiable net assets, excluding deferred tax assets and liabilities | (450) | | Deferred tax asset | 32 | | Deferred tax liability | 60 | | Goodwill | 78 | Reductions in the carrying amount of goodwill are not deductible for tax purposes. In accordance with paragraph 15(a) of the Standard, Entity A recognises no deferred tax liability for the taxable temporary difference associated with the goodwill recognised in the business combination. The accounting entry for the business combination is as follows: - CU CU - Dr Goodwill 78 - Dr Identifiable net assets 450 - Dr Deferred tax asset 32 - Cr Cash 400 - Cr Equity (replacement awards) 100 - Cr Deferred tax liability 60 On 31 December 20X1 the intrinsic value of the replacement awards is CU120. Entity A recognises a deferred tax asset of CU48 (CU120 × 40%). Entity A recognises deferred tax income of CU16 (CU48 – CU32) from the increase in the intrinsic value of the replacement awards. The accounting entry is as follows: - CU CU - Dr Deferred tax asset 16 - Cr Deferred tax income 16 If the replacement awards had not been tax-deductible under current tax law, Entity A would not have recognised a deferred tax asset on the acquisition date. Entity A would have accounted for any subsequent events that result in a tax deduction related to the replacement award in the deferred tax income or expense of the period in which the subsequent event occurred. Paragraphs B56–B62 of AASB 3 provide guidance on determining which portion of a replacement award is part of the consideration transferred in a business combination and which portion is attributable to future service and thus a post-combination remuneration expense. Deferred tax assets and liabilities on replacement awards that are post-combination expenses are accounted for in accordance with the general principles as illustrated in Example 5. Example 7 – Debt instruments measured at fair value Debt instruments At 31 December 20X1, Entity Z holds a portfolio of three debt instruments: | Debt Instrument | Cost (CU) | | Fair value (CU) | | Contractual interest rate | | --- | --- | --- | --- | --- | --- | | A | 2,000,000 | | 1,942,857 | | 2.00% | | B | 750,000 | | 778,571 | | 9.00% | | C | 2,000,000 | | 1,961,905 | | 3.00% |   Entity Z acquired all the debt instruments on issuance for their nominal value. The terms of the debt instruments require the issuer to pay the nominal value of the debt instruments on their maturity on 31 December 20X2. Interest is paid at the end of each year at the contractually fixed rate, which equalled the market interest rate when the debt instruments were acquired. At the end of 20X1, the market interest rate is 5 per cent, which has caused the fair value of Debt Instruments A and C to fall below their cost and the fair value of Debt Instrument B to rise above its cost. It is probable that Entity Z will receive all the contractual cash flows if it continues to hold the debt instruments. At the end of 20X1, Entity Z expects that it will recover the carrying amounts of Debt Instruments A and B through use, ie by continuing to hold them and collecting contractual cash flows, and Debt Instrument C by sale at the beginning of 20X2 for its fair value on 31 December 20X1. It is assumed that no other tax planning opportunity is available to Entity Z that would enable it to sell Debt Instrument B to generate a capital gain against which it could offset the capital loss arising from selling Debt Instrument C. The debt instruments are measured at fair value through other comprehensive income in accordance with AASB 9 Financial Instruments (or AASB 139 Financial Instruments: Recognition and Measurement[[1]](#_ftn1)). Tax law The tax base of the debt instruments is cost, which tax law allows to be offset either on maturity when principal is paid or against the sale proceeds when the debt instruments are sold. Tax law specifies that gains (losses) on the debt instruments are taxable (deductible) only when realised. Tax law distinguishes ordinary gains and losses from capital gains and losses. Ordinary losses can be offset against both ordinary gains and capital gains. Capital losses can only be offset against capital gains. Capital losses can be carried forward for 5 years and ordinary losses can be carried forward for 20 years. Ordinary gains are taxed at 30 per cent and capital gains are taxed at 10 per cent. Tax law classifies interest income from the debt instruments as ‘ordinary’ and gains and losses arising on the sale of the debt instruments as ‘capital’. Losses that arise if the issuer of the debt instrument fails to pay the principal on maturity are classified as ordinary by tax law. General On 31 December 20X1, Entity Z has, from other sources, taxable temporary differences of CU50,000 and deductible temporary differences of CU430,000, which will reverse in ordinary taxable profit (or ordinary tax loss) in 20X2. At the end of 20X1, it is probable that Entity Z will report to the tax authorities an ordinary tax loss of CU200,000 for the year 20X2. This tax loss includes all taxable economic benefits and tax deductions for which temporary differences exist on 31 December 20X1 and that are classified as ordinary by tax law. These amounts contribute equally to the loss for the period according to tax law. Entity Z has no capital gains against which it can utilise capital losses arising in the years 20X1–20X2. Except for the information given in the previous paragraphs, there is no further information that is relevant to Entity Z’s accounting for deferred taxes in the period 20X1–20X2. Temporary differences At the end of 20X1, Entity Z identifies the following temporary differences:   - Carrying amount (CU) Tax base (CU) Taxable temporary differences (CU) Deductible temporary differences (CU) - Debt Instrument A 1,942,857 2,000,000 57,143 - Debt Instrument B 778,571 750,000 28,571 - Debt Instrument C 1,961,905 2,000,000 38,095 - Other sources Not specified 50,000 430,000 The difference between the carrying amount of an asset or liability and its tax base gives rise to a deductible (taxable) temporary difference (see paragraphs 20 and 26(d) of the Standard). This is because deductible (taxable) temporary differences are differences between the carrying amount of an asset or liability in the statement of financial position and its tax base, which will result in amounts that are deductible (taxable) in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled (see paragraph 5 of the Standard). Utilisation of deductible temporary differences With some exceptions, deferred tax assets arising from deductible temporary differences are recognised to the extent that sufficient future taxable profit will be available against which the deductible temporary differences are utilised (see paragraph 24 of the Standard). Paragraphs 28–29 of AASB 112 identify the sources of taxable profits against which an entity can utilise deductible temporary differences. They include: (a) future reversal of existing taxable temporary differences; (b) taxable profit in future periods; and (c) tax planning opportunities. The deductible temporary difference that arises from Debt Instrument C is assessed separately for utilisation. This is because tax law classifies the loss resulting from recovering the carrying amount of Debt Instrument C by sale as capital and allows capital losses to be offset only against capital gains (see paragraph 27A of the Standard). The separate assessment results in not recognising a deferred tax asset for the deductible temporary difference that arises from Debt Instrument C because Entity Z has no source of taxable profit available that tax law classifies as capital. In contrast, the deductible temporary difference that arises from Debt Instrument A and other sources are assessed for utilisation in combination with one another. This is because their related tax deductions would be classified as ordinary by tax law. The tax deductions represented by the deductible temporary differences related to Debt Instrument A are classified as ordinary because the tax law classifies the effect on taxable profit (tax loss) from deducting the tax base on maturity as ordinary. In assessing the utilisation of deductible temporary differences on 31 December 20X1, the following two steps are performed by Entity Z. Step 1: Utilisation of deductible temporary differences because of the reversal of taxable temporary differences (see paragraph 28 of the Standard) Entity Z first assesses the availability of taxable temporary differences as follows: - (CU) - Expected reversal of deductible temporary differences in 20X2 - From Debt Instrument A 57,143 - From other sources 430,000 - Total reversal of deductible temporary differences 487,143 - Expected reversal of taxable temporary differences in 20X2 - From Debt Instrument B (28,571) - From other sources (50,000) - Total reversal of taxable temporary differences (78,571) - Utilisation because of the reversal of taxable temporary differences (Step 1) 78,571 - Remaining deductible temporary differences to be assessed for utilisation in Step 2 (487,143 – 78,571) 408,572 In Step 1, Entity Z can recognise a deferred tax asset in relation to a deductible temporary difference of CU78,571. Step 2: Utilisation of deductible temporary differences because of future taxable profit (see paragraph 29(a) of the Standard) In this step, Entity Z assesses the availability of future taxable profit as follows: | | | (CU) | | Probable future tax profit (loss) in 20X2 (upon which income taxes are payable (recoverable)) | | (200,000) | | Add back: reversal of deductible temporary differences expected to reverse in 20X2 | | 487,143 | | Less: reversal of taxable temporary differences (utilised in Step 1) | | (78,571) | | Probable taxable profit excluding tax deductions for assessing utilisation of deductible temporary differences in 20X2 | | 208,572 | | Remaining deductible temporary differences to be assessed for utilisation from Step 1 | | 408,572 | | Utilisation because of future taxable profit (Step 2) | | 208,572 | | Utilisation because of the reversal of taxable temporary differences (Step 1) | | 78,571 | | Total utilisation of deductible temporary differences | | 287,143 | | | | | The tax loss of CU200,000 includes the taxable economic benefit of CU2 million from the collection of the principal of Debt Instrument A and the equivalent tax deduction, because it is probable that Entity Z will recover the debt instrument for more than its carrying amount (see paragraph 29A of the Standard). The utilisation of deductible temporary differences is not, however, assessed against probable future taxable profit for a period upon which income taxes are payable (see paragraph 5 of the Standard). Instead, the utilisation of deductible temporary differences is assessed against probable future taxable profit that excludes tax deductions resulting from the reversal of deductible temporary differences (see paragraph 29(a) of the Standard). Assessing the utilisation of deductible temporary differences against probable future taxable profits without excluding those deductions would lead to double counting the deductible temporary differences in that assessment. In Step 2, Entity Z determines that it can recognise a deferred tax asset in relation to a future taxable profit, excluding tax deductions resulting from the reversal of deductible temporary differences, of CU208,572. Consequently, the total utilisation of deductible temporary differences amounts to CU287,143 (CU78,571 (Step 1) + CU208,572 (Step 2)). Measurement of deferred tax assets and deferred tax liabilities Entity Z presents the following deferred tax assets and deferred tax liabilities in its financial statements on 31 December 20X1: | | | (CU) | | Total taxable temporary differences | | 78,571 | | Total utilisation of deductible temporary differences | | 287,143 | | Deferred tax liabilities (78,571 at 30%) | | 23,571 | | Deferred tax assets (287,143 at 30%) | | 86,143 | The deferred tax assets and the deferred tax liabilities are measured using the tax rate for ordinary gains of 30 per cent, in accordance with the expected manner of recovery (settlement) of the underlying assets (liabilities) (see paragraph 51 of the Standard). Allocation of changes in deferred tax assets between profit or loss and other comprehensive income Changes in deferred tax that arise from items that are recognised in profit or loss are recognised in profit or loss (see paragraph 58 of the Standard). Changes in deferred tax that arise from items that are recognised in other comprehensive income are recognised in other comprehensive income (see paragraph 61A of the Standard). Entity Z did not recognise deferred tax assets for all of its deductible temporary differences at 31 December 20X1, and according to tax law all the tax deductions represented by the deductible temporary differences contribute equally to the tax loss for the period. Consequently, the assessment of the utilisation of deductible temporary differences does not specify whether the taxable profits are utilised for deferred tax items that are recognised in profit or loss (ie the deductible temporary differences from other sources) or whether instead the taxable profits are utilised for deferred tax items that are recognised in other comprehensive income (ie the deductible temporary differences related to debt instruments classified as fair value through other comprehensive income). For such situations, paragraph 63 of the Standard requires the changes in deferred taxes to be allocated to profit or loss and other comprehensive income on a reasonable pro rata basis or by another method that achieves a more appropriate allocation in the circumstances. Example 8 – Leases Lease An entity (Lessee) enters into a five-year lease of a building. The annual lease payments are CU100 payable at the end of each year. Before the commencement date of the lease, Lessee makes a lease payment of CU15 (advance lease payment) and pays initial direct costs of CU5. The interest rate implicit in the lease cannot be readily determined. Lessee’s incremental borrowing rate is 5% per year. At the commencement date, applying AASB 16 Leases, Lessee recognises a lease liability of CU435 (measured at the present value of the five lease payments of CU100, discounted at the interest rate of 5% per year). Lessee measures the right-of-use asset (lease asset) at CU455, comprising the initial measurement of the lease liability (CU435), the advance lease payment (CU15) and the initial direct costs (CU5). Tax law The tax law allows tax deductions for lease payments (including those made before the commencement date) and initial direct costs when an entity makes those payments. Economic benefits that will flow to Lessee when it recovers the carrying amount of the lease asset will be taxable. A tax rate of 20% is expected to apply to the period(s) when Lessee will recover the carrying amount of the lease asset and will settle the lease liability. After considering the applicable tax law, Lessee concludes that the tax deductions it will receive for lease payments relate to the repayment of the lease liability.[[2]](#_ftn2) Deferred tax on the advance lease payment and initial direct costs Lessee recognises the advance lease payment (CU15) and initial direct costs (CU5) as components of the lease asset’s cost. The tax base of these components is nil because Lessee already received tax deductions for the advance lease payment and initial direct costs when it made those payments. The difference between the tax base (nil) and the carrying amount of each component results in taxable temporary differences of CU15 (related to the advance lease payment) and CU5 (related to the initial direct costs). The exemption from recognising a deferred tax liability in paragraph 15 does not apply because the temporary differences arise from transactions that, at the time of the transactions, affect Lessee’s taxable profit (that is, the tax deductions Lessee received when it made the advance lease payment and paid initial direct costs reduced its taxable profit). Accordingly, Lessee recognises a deferred tax liability of CU3 (CU15 × 20%) and CU1 (CU5 × 20%) for the taxable temporary differences related to the advance lease payment and initial direct costs, respectively. Deferred tax on the lease liability and related component of the lease asset’s cost At the commencement date, the tax base of the lease liability is nil because Lessee will receive tax deductions equal to the carrying amount of the lease liability (CU435). The tax base of the related component of the lease asset’s cost is also nil because Lessee will receive no tax deductions from recovering the carrying amount of that component of the lease asset’s cost (CU435). The differences between the carrying amounts of the lease liability and the related component of the lease asset’s cost (CU435) and their tax bases of nil result in the following temporary differences at the commencement date: (a) a taxable temporary difference of CU435 associated with the lease asset; and (b) a deductible temporary difference of CU435 associated with the lease liability. The exemption from recognising a deferred tax asset and liability in paragraphs 15 and 24 does not apply because the transaction gives rise to equal taxable and deductible temporary differences. Lessee concludes that it is probable that taxable profit will be available against which the deductible temporary difference can be utilised. Accordingly, Lessee recognises a deferred tax asset and a deferred tax liability, each of CU87 (CU435 × 20%), for the deductible and taxable temporary differences. Summary of recognised deferred tax The table below summarises the deferred tax that Lessee recognises on initial recognition of the lease (including the advance lease payment and initial direct costs): - Carrying amount Tax base Deductible / (taxable) temporary difference Deferred tax asset / (liability) - Lease asset - – advance lease payment 15 — (15) (3) - – initial direct costs 5 — (5) (1) - – the amount of the initial measurement of the lease liability 435 — (435) (87) - Lease liability 435 — 435 87   Applying paragraph 22(b) of AASB 112, Lessee recognises deferred tax assets and liabilities as illustrated in this example and recognises the resulting deferred tax income or expense in profit or loss.   Compilation details Accounting Standard AASB 112 Income Taxes (as amended) Compilation details are not part of AASB 112. This compiled Standard applies to annual periods beginning on or after 1 January 2023 that end on or after 30 September 2023.  It takes into account amendments up to and including 14 September 2023 and was prepared on 23 October 2023 by the staff of the Australian Accounting Standards Board (AASB). This compilation is not a separate Accounting Standard made by the AASB.  Instead, it is a representation of AASB 112 (August 2015) as amended by other Accounting Standards, which are listed in the table below. Table of Standards | Standard | Date made | FRL identifier | Commence-ment date | Effective date (annual periods … on or after …) | Application, saving or transitional provisions | | --- | --- | --- | --- | --- | --- | | AASB 112 | 7 Aug 2015 | F2015L01601 | 31 Dec 2017 | (beginning) 1 Jan 2018 | see (a) below | | AASB 16 | 23 Feb 2016 | F2016L00233 | 31 Dec 2018 | (beginning) 1 Jan 2019 | see (b) below | | AASB 2016-1 | 24 Feb 2016 | F2016L00231 | 31 Dec 2016 | (beginning) 1 Jan 2017 | see (c) below | | AASB 1058 | 9 Dec 2016 | F2017L00042 | 31 Dec 2018 | (beginning) 1 Jan 2019 | see (b) below | | AASB 2016-7 | 9 Dec 2016 | F2017L00043 | 31 Dec 2016 | (beginning) 1 Jan 2017 | see (d) below | | AASB 2018-1 | 14 Feb 2018 | F2018L00157 | 31 Dec 2018 | (beginning) 1 Jan 2019 | see (e) below | | AASB 2019-1 | 21 May 2019 | F2019L00966 | 31 Dec 2019 | (beginning) 1 Jan 2020 | see (f) below | | AASB 1060 | 6 Mar 2020 | F2020L00288 | 30 Jun 2021 | (beginning) 1 Jul 2021 | see (g) below | | AASB 2021-5 | 22 Jun 2021 | F2021L00963 | 31 Dec 2022 | (beginning) 1 Jan 2023 | see (h) below | | AASB 2023-2 | 22 Jun 2023 | F2023L00949 | 29 Jun 2023 | (beginning) 1 Jan 2023 that end on or after 30 Jun 2023 | see (i) below | | AASB 2023-4 | 14 Sep 2023 | F2023L01301 | 29 Sep 2023 | (beginning) 1 Jan 2023 that end on or after 30 Sep 2023 | see (j) below | (a)           Entities may elect to apply this Standard to periods beginning after 24 July 2014 but before 1 January 2018. (b)           Entities may elect to apply this Standard to annual periods beginning before 1 January 2019, provided that AASB 15 Revenue from Contracts with Customers is also applied to the same period. (c)           Entities may elect to apply this Standard to annual periods beginning before 1 January 2017. (d)           AASB 2016-7 deferred the effective date of AASB 15 (and its consequential amendments in AASB 2014-5) for not-for-profit entities to annual reporting periods beginning on or after 1 January 2019, instead of 1 January 2018.  However, earlier application of AASB 112 (2015) incorporating the text that relates to AASB 15 is permitted, provided that AASB 15 is also applied. (e)           Entities may elect to apply this Standard to annual periods beginning before 1 January 2019. (f)            Entities may elect to apply this Standard to annual periods beginning before 1 January 2020. (g)           Entities may elect to apply this Standard to annual periods beginning before 1 July 2021. (h)           Entities may elect to apply this Standard to annual periods beginning before 1 January 2023. (i)            Entities may elect to apply this Standard to annual periods ending before 30 June 2023. (j)            Entities may elect to apply this Standard to annual periods ending before 30 September 2023. Table of amendments to Standard | Paragraph affected | How affected | By … [paragraph/page] | | AusCF1 | added | AASB 2019-1 [page 19] | | 4 | amended | AASB 1058 [page 23] | | Aus4.1 | added | AASB 1058 [page 23] | | 4A | added | AASB 2023-2 [page 5] | | 15 | amended | AASB 2021-5 [page 6] | | 20 | amended | AASB 16 [page 49] | | 22 | amended | AASB 2021-5 [page 6] | | 22A | added | AASB 2021-5 [page 7] | | 24 | amended | AASB 2021-5 [page 7] | | 26 (example) | added | AASB 2016-1 [page 6] | | 27A | added | AASB 2016-1 [page 6] | | 29 | amended | AASB 2016-1 [page 7] | | 29A | added | AASB 2016-1 [page 7] | | Aus33.1 | amended | AASB 1058 [page 23] | | 52B | deleted | AASB 2018-1 [page 6] | | 52B (example) | amended | AASB 2018-1 [page 7] | | 57A | added | AASB 2018-1 [page 7] | | 88A-88D (and preceding heading) | added | AASB 2023-2 [page 6] | | 98G | added | AASB 16 [page 50] | | 98H | added | AASB 2016-1 [page 7] | | 98I | added | AASB 2018-1 [page 7] | | 98J-98L | added | AASB 2021-5 [page 7] | | 98M | added | AASB 2023-2 [page 6] | | Aus99.1 | repealed | Legislation Act 2003, s. 48D | | Appendix A | replaced | AASB 1060 [page 62] | | AusA1 | amended | AASB 2023-4 [8] | Table of amendments to illustrative examples - Paragraph affected How affected By … [paragraph/page] - Illustrative computations and presentation - Example 7 added AASB 2016-1 [page 8] - Example 8 added AASB 2021-5 [page 8]   Deleted IAS 12 text Deleted IAS 12 text is not part of AASB 112.