IAS 12

Can you accept that, over time, the cost of all assets is written off against profits? The mechanics of this is called depreciation

But the taxman doesn’t like the idea of depreciation because different entities will use different rates and that leads to unnecessary difficulties for the taxman

So instead the taxman says “I’m not going to let you write off this asset against profits using your arbitrary depreciation rate! What I WILL allow is for you to write this asset off against profits using a standard rate of capital allowances”

Hence the timing differences

We are using 25% straight line and the tax man is using 25% reducing balance

So an asset that cost $1,000 will have the following profiles, column one is carrying value and column 2 is tax written down value:

1,000 1,000
( 250) ( 250)
750 750 difference $nil
( 250) ( 187)
500 563 difference $63
( 250) ( 141)
250 422 difference $172
( 250) ( 105)
Nil 317 difference $317

Those differences arise because our rate of depreciation differs from the rate of capital allowances and these differences will arise whenever the depreciation rate of the entity as applied to its assets differs from the related rate of capital allowances

In the above example we have a deferred tax asset of $317 after year 4 (unusual and most unlikely in the exam)

When do we owe the taxman this money? Well, we don’t really. The concept of deferred taxation is that any movement within the provision for deferred tax is written off to the current tax account and therefore the charge for the current tax in each year’s statement of profit or loss takes account of the amounts that we ‘owe to’ or are ‘owed by’ the taxman

Does that make it any clearer?