Accounting Science

Review of IAS 12 Standard: Income Taxes

Posted by

mariam elghandour

March 15, 2025

On February 17, 2025

IAS 12 Standard, “Income Taxes,” governs how to account for taxes in an entity’s financial statements. This standard, one of the key International Financial Reporting Standards (IFRS), addresses the recognition, measurement, presentation, and disclosure of income taxes, including both current and deferred taxes. In this article, we will provide a comprehensive review of IAS 12 Standard, discussing its objectives, scope, and key requirements, focusing on the concept of deferred tax and how to calculate it, as well as highlighting the importance of this standard and its impact on financial statements.

What are Income Taxes?

Income taxes are taxes levied on an entity’s taxable profit. Taxable profit is calculated according to the tax laws applicable in the country where the entity operates and may differ from the accounting profit determined in accordance with IFRS.

What is IAS 12 Standard: Income Taxes?

IAS 12 Standard is an international accounting standard that specifies how to account for income taxes in the financial statements. This includes the recognition, measurement, presentation, and disclosure of both:

Current Tax: The amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period.
Deferred Tax: The amounts of income taxes payable or recoverable in future periods, usually arising from temporary differences between accounting profit and taxable profit.

Objectives of IAS 12 Standard:

Specify How to Account for Income Taxes: IAS 12 Standard provides guidance on how to recognize, measure, present, and disclose income taxes in the financial statements.
Provide Useful Information to Users of Financial Statements: IAS 12 Standard aims to provide information that enables users of financial statements to understand the impact of income taxes on the entity’s financial position, financial performance, and cash flows.
Enhance Transparency and Reliability: IAS 12 Standard helps enhance the transparency and reliability of financial information related to income taxes.
Improve Comparability: IAS 12 Standard contributes to improving the comparability of financial statements of companies by standardizing how income taxes are accounted for.

Scope of IAS 12 Standard:

IAS 12 Standard applies to all types of income taxes, domestic and foreign, that are based on taxable profits. The standard does not apply to government grants (see IAS 20) or investment tax credits.

Key Concepts in IAS 12 Standard:

Accounting Profit: Profit or loss for a period before deducting income tax expense, calculated in accordance with IFRS.
Taxable Profit (Tax Loss): The profit (loss) for a period, determined in accordance with the rules established by the taxation authorities, upon which income taxes are payable (recoverable).
Income Tax Expense (Income): The aggregate amount included in the determination of profit or loss for the period in respect of current tax and deferred tax.
Temporary Differences: Differences between the carrying amount of an asset or liability in the statement of financial position and its tax base.
Tax Base: The amount attributed to an asset or liability for tax purposes.

Types of Temporary Differences:

Taxable Temporary Differences: Temporary differences that will result in taxable amounts in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. These give rise to deferred tax liabilities.
Deductible Temporary Differences: Temporary differences that will result in amounts that are deductible in determining taxable profit (tax loss) of future periods when the carrying amount of the asset or liability is recovered or settled. These give rise to deferred tax assets.

Recognition of Current Tax:

An entity must recognize current tax for the current and prior periods to the extent that it remains unpaid. If the amount already paid in respect of current and prior periods exceeds the amount due for those periods, the excess must be recognized as an asset.

Recognition of Deferred Tax:

Deferred Tax Assets:
- A deferred tax asset must be recognized for all deductible temporary differences, unused tax losses, and unused tax credits, to the extent that it is probable that taxable profit will be available against which they can be utilized.
- The carrying amount of a deferred tax asset must be reviewed at each reporting date and reduced if it is no longer probable that sufficient taxable profit will be available.
Deferred Tax Liabilities:
- A deferred tax liability must be recognized for all taxable temporary differences, except in specific cases, such as:
  - The initial recognition of goodwill.
  - The initial recognition of an asset or liability in a transaction that is not a business combination and affects neither accounting profit nor taxable profit.

Measurement of Deferred Tax:

Deferred tax assets and liabilities must be measured using the tax rates that are expected to apply to the period when the asset is realized or the liability is settled, based on tax rates (and tax laws) that have been enacted or substantively enacted by the reporting date.

The measurement of deferred tax assets and liabilities must reflect the tax consequences that would follow from the manner in which the entity expects to recover or settle the carrying amount of its assets and liabilities.

Deferred tax assets and liabilities are not discounted.

Presentation of Deferred Tax Assets and Liabilities:

Deferred tax assets and liabilities must be presented as separate line items in the statement of financial position.

Deferred tax assets and liabilities must be classified as non-current.

Disclosure Requirements under IAS 12 Standard:

IAS 12 Standard requires entities to disclose information about:

Components of tax expense(income) separately: current tax expense, adjustments for current tax of previous periods, deferred tax expense(income) related to origination and reversal of temporary differences, and more.
Reconciliation between tax expense (income) and the accounting profit multiplied by the applicable tax rate(s).
An explanation of changes in the applicable tax rate(s) compared to the previous period.
The amount (and any expiry date) of deductible temporary differences, unused tax losses, and unused tax credits for which no deferred tax asset is recognized.
The aggregate amount of temporary differences associated with investments in subsidiaries, branches, and associates and interests in joint arrangements, for which deferred tax liabilities have not been recognized.
In respect of each type of temporary difference and in respect of each type of unused tax losses and unused tax credits:
- the amount of the deferred tax assets and liabilities recognized in the statement of financial position for each period presented;
- the amount of the deferred tax income or expense recognized in profit or loss.

Importance of IAS 12 Standard for Companies:

IAS 12 Standard is one of the important IFRSs that helps companies to:

Comply with IFRS: IAS 12 Standard ensures that companies account for income taxes consistently with IFRS.
Improve the Quality of Financial Reporting: Applying IAS 12 Standard leads to improved quality, relevance, and reliability of financial information related to income taxes.
Enhance Investor Confidence: IAS 12 Standard helps build investor confidence by providing more accurate and transparent information about the impact of income taxes on the entity’s financial position and financial performance.
Better Manage Tax Liabilities: IAS 12 Standard provides a clear accounting framework for income taxes, helping companies manage their tax liabilities more effectively.

Challenges in Applying IAS 12 Standard:

Complexity of the Standard: IAS 12 Standard is a relatively complex standard, and its understanding and application may require specialized accounting expertise.
Identifying Temporary Differences: It can be challenging to identify all temporary differences, especially in companies with complex activities.
Estimating Future Tax Rates: Measuring deferred tax requires estimating the tax rates expected to apply in the future, which involves some uncertainty.
Assessing the Recoverability of Deferred Tax Assets: Companies must assess whether it is probable that sufficient future taxable profits will be available to utilize the deferred tax assets. Role of Technology in Applying IAS 12 Standard: Accounting software and Enterprise Resource Planning (ERP) systems can help in applying IAS 12 Standard more effciently and accurately by:
- Automating the calculation of current and deferred tax.
- Tracking temporary differences, and calculating deferred tax assets and liabilities.
- Generating the reports required to comply with the disclosure requirements.
- Improving the accuracy and completeness of financial information related to income taxes.

Practical Example of Applying IAS 12 Standard:

Scenario: Company “A” owns a fixed asset with a carrying amount of 100,000 Riyals and a tax base of 80,000 Riyals. The applicable tax rate is 20%.

Analysis:

There is a taxable temporary difference of 20,000 Riyals (100,000 – 80,000).
This difference will result in a deferred tax liability of 4,000 Riyals (20,000 * 20%).

Journal Entry:

Debit: Income Tax Expense (4,000 Riyals)
Credit: Deferred Tax Liability (4,000 Riyals)

Note: Income tax expense is recognized in the statement of profit or loss, while the deferred tax liability is recognized in the statement of financial position.

Review and Updates of the Standard: The International Accounting Standards Board (IASB) reviews the IFRS periodically, including the IAS 12 Standard to ensure they are still relevent and keep up with the business environment’s developments. Companies must track any updates to the standards and ensure they apply them correctly.

Conclusion:

IAS 12 Standard, “Income Taxes,” provides a comprehensive framework for accounting for income taxes, ensuring that both current and deferred taxes are treated in a way that achieves the objectives of IFRS. Companies that fall within the scope of applying IAS 12 Standard must adhere to its requirements to ensure the proper recognition, measurement, presentation, and disclosure of income taxes. Understanding IAS 12 Standard is essential for accountants, auditors, investors, and anyone seeking to understand how income taxes affect an entity’s financial position and financial performance. Applying IAS 12 Standard correctly also contributes to enhancing transparency and reliability in financial reporting and supports the efficiency of capital markets