IAS 12 Deferred Tax: Simple Practical Example
Deferred tax exists because the balance sheet and the tax return disagree about when things count. One equipment item and one provision are enough to see how it works. Tax rate: 25%.
1. Compare carrying amount and tax base
| Item | Carrying amount | Tax base | Difference | Type |
|---|---|---|---|---|
| Equipment (asset) | 200,000 | 140,000 | 60,000 | Taxable |
| Warranty provision (liability) | 40,000 | 0 | 40,000 | Deductible |
The equipment has been depreciated faster for tax than in the books, so less tax deduction is left for the future: a taxable temporary difference. The provision is an expense in the books now but only deductible when paid: a deductible temporary difference.
2. Apply the tax rate
The asset is recognised only to the extent that future taxable profits are probable. Here we assume they are.
3. Journal entries
Assuming no opening balances, the whole movement goes to profit or loss.
Net deferred tax expense: £5,000. The asset and liability can be presented net only if the offsetting conditions are met, for example the same tax authority and a legally enforceable right to set off.
Common mistakes
- Comparing the carrying amount with fair value instead of the tax base.
- Treating permanent differences as temporary.
- Recognising every deferred tax asset without testing recoverability.