Accounting for Income Tax - Essay Example

? Accounting for Income Tax Inserts His/Her Inserts Grade Inserts Inserts Here (Day, Month, Year) Accounting for Income Tax Requirement of IAS 12 The purpose of IAS 12 is to give guidelines regarding the way income taxes should be treated. The fundamental concept of this standard pertaining to accounting for income taxes is reflecting a way of accounting for the current and future tax in respect to the following aspects: i. The actions of the current period, including the transactions, which are recognised in financial statement of an entity. ii. The future settlement (recovery) of the carrying amount of liabilities and assets, which are recognised in the financial statement of a particular entity. In situations where transactions are accounted for outside profits or loss, this standard has offered specific provisions. In case of the transactions that are recognised directly in equity, any associated tax implications are also recognised directly in equity, while those that are recognised in comprehensive income have their associated tax implications recognised in comprehensive income. In the same way, the recognition of deferred tax liabilities and assets in combination of an entity has implications on the extent of goodwill that is realised in the recognised bargain purchase gain or in such an entity combination. Other areas that are dealt with by this standard include the recognition of differed tax assets that are generated from unused tax credits or unused tax losses, and the disclosure of income taxes information and the presentation of income taxes in the financial statements (EFRAG, 2011). According to IAS 12, the way, a liability is settled or the way an asset is recovered can have implications on either the item’s tax base or the relevant tax rate, or both. For example, if a vehicle is sold, indexation can be applied on it, in addition to tax deductions against the proceeds of its original cost. In other words, the tax base of the vehicle would act as the vehicle’s indexed cost. On the other hand, if the vehicle is used to run business with the purpose of making taxable profits, corporation tax allowances are not provided, and in that note, its tax base would be zero. It is, however, essential to know that the tax rates applied on use of an item or on sales differ from one jurisdiction to the other (EFRAG, 2011). Difficulties of applying and understanding IAS12 and provide examples. The standards are perceived by the users of financial statements as complex, incomplete and non-standardised. In particular, the information regarding the deferred tax is considered, by users, to be to be insufficient to an extent that it is difficult to forecast the future tax cash flows, accurately. Incidentally, it would have been much helpful if the users are able to understand the strategy applied by an entity, which should be coupled with clear clarifications on the treatment of tax expenses because users do not have the technical accounting knowledge to understand accounting irregularities and complex tax issues that characterise the financial statements. These limitations originate from lack of reflection of the economics of transactions by the accounting method, and from the current standard’s exceptions to the principles - IAS 12 requirements to recognise deferred tax on assets estimated at fair value, and long leasehold investment assets does not reveal the economic implications of recovering the property (EFRAG, 2011). In some jurisdictions, the seller is prohibited from deducting the cost of the property against the income following its use. In such a situation, the fair value of the property will show the present value of future cash flows minus the payments of future tax. Although the current provisions by IAS12 may not reveal the economic impacts of getting back the carrying amount in such situations, when the property is valued at fair value, the deferred tax liability reproduces a tax impact that is perhaps already featured in the fair value. The present owner of the property is in similar circumstances as a possible buyer since none of them is liable to receive a tax deduction for the property’s fair value (EFRAG, 2011). In addition, measuring deferred taxes in a manner that reveals the way the management hopes to recover the carrying amount of the property is sometimes difficult – especially in fields where capital gains and incomes are taxed independently. The disclosure draft tackles these genuine issues and also forms an exception that does not reveal the economic impacts of some actions - for instance, when some property is recovered significantly but not wholly, by being used. It is also a matter of concern that exceptions can create additional difficulties and the risk of inadvertent implications. Citi Investment Research (2008) has affirmed that the corporate are reluctant to disclose particulars of their tax planning approach, further than what is disclosed in the financial statements - this limits the attention from the investors. This is despite the fact that the majorities of the users of financial statements have limited accounting knowledge and hence can hardly decipher complex tax issues. According to the CFA Institute (2009), it is extremely important to understand the impact of the differences between financial statement's income and taxable income, for example, the effect of significant non-recurring transactions. Without a transparent disclosure, users find it very difficult and time-consuming to understand these implications. How the requirements of reporting for income tax as set out in IAS12, could be improved. In view of the difficulties that the users of financial statements experience when struggling to understand the disclosures that are reported in accordance with IAS12, it is fundamentally important to address a number of tax information in the financial statements in a manner that could be beneficial to the users. This information can be put into the following categories: (1) clarity on tax risk position; (2) tax strategies and objectives; (3) a sensible value of deferred tax assets; (4) enhanced comprehension of the effective tax rate; (5) an apparent clarification of the differences between charge made, and tax paid in the income statement; (6) an apparent explanation as to why the accounting profit is not equivalent to the current tax charge at the statutory taxation rate; (7) future tax cash flows and cash tax. Clear strategies regarding tax as well as a disclosure in its respect, which is easy to get, is important because its availability would enhance use of other disclosures that are related to tax issues. Furthermore, this will help the users because it would give them more information regarding the effect of tax on an entity (PWC, 2010). In addition, the globalisation of business exposes the operations of a business to many uncertainties, which exposes the business to more risk. In particular, the tax uncertainties are usually related to application of tax law that is not clear, and hence it will be essential to ensure that the users are provided with clear explanations of any material tax risks that the business is exposed to. Notably, cash tax payments are very essential transactions that many users and analysts would be interested with. To some extent, users dismiss the information that is prepared under IAS 12 because it does not allow them to assess the timing of cash figures and future tax cash flows. Therefore, it is recommendable that explanation about these timings and the possibility of such figures in causing implications on the position of cash tax is made clear (CRUF, 2010). The relationship between the cash paid for taxes during the current period and the current tax expenses, which is reported in the income statement is a difficult issue that many users usually focus on (CRUF, 2010). To address this issue, it would be important to provide the reconciliation of the current tax expenses and the taxes paid. This would make it clear for the users to understand the items that bring about the difference between the cash tax paid and the current tax expenses. In respect to the discrepancies between the accounting profit and the current tax charge, it would be essential to provide users with a clear-cut disclosures and tax notes in very simple language (EFRAG, 2011). An enhanced understanding of the effective tax rate can be possible if the users can be provided with a practically comprehensible tax rate that might be used to predict future cash flows. Finally, in respect to the value of differed tax assets, can be provided in a more detailed disclosure, including featuring details such as maturity schedules, geographical breakdown, and losses carried forwards among other restrictions. Conclusion In conclusion, it is notable that some changes should be made to IAS 12, specifically those that would help address the users’ perceived information needs. It is also recommendable that some exceptions and anomalies, which cause complications, are revisited and adjusted accordingly. The purpose of resolving most of these technical hitches is focused on improving the measurement of deferred tax liabilities and assets hence making the information more relevant to the users of financial statements, including improving its predictive relevance. That having been said, it is not clear whether making the recommended changes will adequately enhance the financial statements without opening more loop holes, but this stands to be a subject of further investigation (PWC, 2010). References CFA Institute (2009). Comment Letter on Exposure Draft on Income Taxes. London: IASB. Citi Investment Research (2008). Eight for ’08. Our guide to the Eight Key Tax Issues Facing Investors in 2008 (Online) Available at: < https://www.citigroupeo.com/pdf/SEU12416.pdf.> (Accessed March 3rd 2013). CRUF (2010). Accounting for Tax. Information Required by Investment professional; PWC: Investor view, 2010, page 2; PWC: Tax Transparency Framework, 2008, page 26; PWC: Tax transparency: Communicating the Tax Companies Pay, 2010, page 8. EFRAG (2011). Improving the Financial Reporting of Income Tax. ASB discussion paper, December 2011. PricewaterhouseCoopers (2010). Tax transparency: Communicating the Tax Companies Pay (Online) Available at: (Accessed March 3rd 2013) PWC (2010). PwC Comments on Exposure Draft: Deferred Tax: Recovery of Underlying Assets (Proposed amendments to IAS 12) (Online). Available from: http://www.pwc.com/us/en/cfodirect/publications (Accessed March 3rd 2013) Read More