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Hi,
Could you kindly explain the following to me:
IAS 12 states that a deferred tax asset or liability is not recognized on the initial recognition of an asset or liability which at the time of the transaction affects neither the accounting profit nor the taxable profit.
However, I was reading the essential reading section in the BPP workbook and it says that if it does affect the accounting or taxable profits, it is then recognized.
I do understand the above but could you please explain the following illustration which was given in the BPP workbook (Sep 2019 – Jun 2020) (Page 639 section 3.1.5):
Petros Co intends to use an asset which cost $10,000 in 20X7 through its useful life of five years. Its residual value will then be nil. The tax rate is 40%. Any capital gain on disposal would not be taxable (and any capital loss not deductible). Depreciation of the asset is not deductible for tax purposes.
Required
State the deferred tax consequences in each of years 20X7 and 20X8.Solution
In 20X7, as it recovers the carrying amount of the asset, Petros Co will earn taxable income of $10,000 and pay tax of $4,000. The resulting deferred tax liability of $4,000 would not be recognised because it results from the initial recognition of the asset.As at 20X8, the carrying value of the asset is now $8,000. In earning taxable income of $8,000, the entity will pay tax of $3,200. Again, the resulting deferred tax liability of $3,200 is not recognised, because it results from the initial recognition of the asset.
I am having trouble understanding what is meant by “it results from the initial recognition of the asset”.
I attempted the illustration without looking at the solution first. I did the usual deferred tax working of deducting the tax base from the carrying amount. But I got a very different result.
I got a temporary difference of $2000 and a deferred tax asset of $800 ($2000 × 40%) for both years.
I don’t really like this illustration because it concerns an asset which will never attract tax relief so I would ignore it. The scenario is really what I would call a permanent difference so there will be no deferred tax consequences.
The important thing to understand in terms of current issues is that there seems to be some difference in the way that companies account for the initial recognition of leases. The ED is trying to make sure that when companies recognise a different value for the right of use asset and the lease liability then deferred tax must be taken into account. For example if the lease liability is 500 and the right of use asset it is 550 because of capitalisation of legal costs then we should consider deferred tax.
Hi,
I was wondering whether your reply is for a question asked by another student because you discussed leases, right of use assets and current issues.
I’m quite unsure therefore could you kindly clarify.
I was leasing as an example because that’s the way it tends to be examined.
In the example that you were talking about holding the asset has no tax consequences. It states that depreciation is not deductible for tax purposes. Therefore there will be no deferred tax. There would only be deferred tax if there was a temporary difference. In this case there is no temporary difference.
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