IAS 12 Deferred Tax: A Practical Guide for Accountants

Deferred tax, governed by IAS 12 Income Taxes, is one of the trickier areas of financial reporting — but the core idea is more intuitive than it first appears. It exists because the way profit is measured for accounting differs from the way it's measured for tax. This practical guide explains what deferred tax is, the key concept of temporary differences, how deferred tax assets and liabilities arise, how it's measured, and why it matters — in plain language. It's a core financial-reporting topic, relevant to ACCA study. (Always refer to the standard for authoritative requirements.)

What is deferred tax?

IAS 12 deals with both current tax (the tax payable on this period's taxable profit) and deferred tax. Deferred tax is an accounting adjustment that arises because accounting profit and taxable profit are calculated differently. Some income and expenses are recognised in the accounts in one period but taxed in another. Deferred tax is the mechanism that accounts for the future tax consequences of these timing differences — ensuring the tax charge in the accounts reflects the transactions recognised, not just the tax currently payable.

The key concept: temporary differences

The heart of IAS 12 is the temporary difference — the difference between the carrying amount of an asset or liability in the balance sheet and its tax base (its value for tax purposes). There are two kinds:

• Taxable temporary differences — these will result in more tax being payable in the future, and so give rise to a deferred tax liability.
• Deductible temporary differences — these will result in less tax being payable in the future, and so give rise to a deferred tax asset.

A common example

The classic source of deferred tax is the difference between accounting depreciation and tax depreciation (capital allowances). Suppose a business buys an asset for £100,000. For accounting, it depreciates it over its useful life; for tax, the authorities may allow capital allowances at a faster rate. In the early years, the asset's carrying amount in the accounts is higher than its tax base — a taxable temporary difference. Tax has effectively been deferred to later years, so the business recognises a deferred tax liability now, reflecting the extra tax it will pay later as the difference reverses.

Recognising deferred tax assets and liabilities

IAS 12 requires a deferred tax liability to be recognised for (almost) all taxable temporary differences. A deferred tax asset, by contrast, is recognised for deductible temporary differences and for unused tax losses only to the extent that it is probable that future taxable profit will be available against which they can be used — a prudent restriction, since the asset is only worth something if the business will actually have profits to set it against.

How deferred tax is measured

Deferred tax is measured at the tax rates expected to apply when the asset is realised or the liability settled, based on rates that have been enacted or substantively enacted by the reporting date. Importantly, deferred tax balances are not discounted, even though they may unwind over many years. The resulting deferred tax movement is usually recognised in profit or loss, unless it relates to an item recognised in other comprehensive income or equity, in which case the deferred tax follows it.

Why deferred tax matters

Deferred tax matters because it makes the tax charge in the accounts reflect the economic reality of the transactions recognised, rather than just the tax currently payable. Without it, profits could look distorted simply because of timing differences between accounting and tax rules. It also gives users insight into future tax consequences already built into the balance sheet. Although the mechanics can be fiddly, the principle — matching the tax effect to the accounting — is a core part of fair financial reporting, and a heavily-examined topic.

Frequently asked questions

What is deferred tax?

An accounting adjustment under IAS 12 that accounts for the future tax consequences of differences between how profit is measured for accounting and for tax — so the tax charge reflects the transactions recognised.

What is a temporary difference?

The difference between the carrying amount of an asset or liability and its tax base. Taxable temporary differences create deferred tax liabilities; deductible ones create deferred tax assets.

When is a deferred tax asset recognised?

For deductible temporary differences and unused tax losses, but only to the extent that it is probable future taxable profit will be available to use them against.

How is deferred tax measured?

At the tax rates expected to apply when the difference reverses (based on rates enacted or substantively enacted by the reporting date), and it is not discounted.

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