Auditing current and deferred tax balances
How to audit a client's current and deferred tax balances under IAS 12: the computation, payments, temporary differences and deferred tax assets.
By Achekam · · 5 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
On many smaller audits the tax note is the last thing finished and the first thing that changes. The client's tax practitioner sends the computation late, the auditor ticks it to the profit figure, and the deferred tax line is rolled forward from last year with a small adjustment nobody quite understands. Then a reviewer asks why the deferred tax asset has grown in a loss-making year, and nobody has a good answer.
Tax balances deserve proper audit work, because they are a mix of arithmetic, law and judgement, and errors in them affect both profit and the balance sheet. This article covers how to test current and deferred tax under IAS 12 for clients in South Africa, Nigeria and Kenya.
Current tax at enacted or substantively enacted rates
Under IAS 12, as the IFRS Foundation summarises it, current tax for current and prior periods is recognised as a liability to the extent it is unpaid, and any overpayment is recognised as an asset. Current tax liabilities and assets are measured at the amount expected to be paid to or recovered from the tax authorities, using the rates and laws enacted or substantively enacted by the end of the reporting period.
Two audit points follow:
- The rate is the one in force or announced with legal effect at year end, not a rate that applies after a change announced later, and not a rate the client hopes for.
- The amount is what will actually be paid, so prior-period under- or over-provisions, assessments received and disputes all matter.
Agreeing the computation and payments
Start with the tax computation, whoever prepared it:
- Agree accounting profit in the computation to the audited profit before tax, after all audit adjustments.
- Test the adjustments. Non-deductible expenses, exempt income, capital allowances or wear-and-tear in place of depreciation, and assessed losses brought forward. Agree each significant item to its source and check it against the tax law of the country concerned.
- Agree the rate applied to taxable income.
- Agree payments made during the year, such as provisional tax in South Africa, instalment tax in Kenya or any tax paid to the NRS in Nigeria, to bank statements and to the tax authority's statement of account.
- Reconcile the balance: opening liability, plus current year charge, plus or minus prior-year adjustments, less payments, equals closing liability.
- Read correspondence with SARS, NRS or KRA for assessments, audits, objections and penalties that may need provision or disclosure.
Where the firm also prepares the computation, independence and self-review threats need managing. A different person from the preparer should audit it.
Temporary differences and tax bases
IAS 12 requires a deferred tax liability, or subject to conditions a deferred tax asset, for all temporary differences, with some exceptions. It defines temporary differences as differences between the tax base of an asset or liability and its carrying amount in the statement of financial position, and describes the tax base as the amount attributed to the item for tax purposes.
The audit of deferred tax is really an audit of a schedule of those differences. For each line:
- Carrying amount: agree to the audited statement of financial position.
- Tax base: agree to the tax computation or the client's tax asset register. For property, plant and equipment, the tax base is cost less allowances claimed, not cost less depreciation.
- Difference and rate: recompute.
Common temporary differences include property, plant and equipment, provisions not yet deductible, leave pay accruals, prepayments, and lease balances. Check the schedule against the balance sheet to see whether any significant item has been left out.
Deferred tax assets and recoverability
IAS 12 explains that a deferred tax asset arises if the entity will pay less tax when it recovers the carrying amount of another asset or liability, or if it has unused tax losses or credits. A deferred tax liability arises if it will pay tax when it recovers another asset's carrying amount.
Deferred tax assets need special care, because IAS 12 allows them only subject to specified conditions. In practice, that turns on whether the client will have future taxable profits to use them against. Challenge:
- forecasts of taxable profit used to support the asset, against budgets and recent results;
- losses that are old, or that the law limits in use;
- a history of losses, which makes forecasts of future profit harder to accept.
Treat the recoverability judgement as an accounting estimate; see auditing accounting estimates for the approach.
Workbooks and adjustments in Achekam
In Achekam, a working paper can carry a spreadsheet workbook whose figures refresh from the engagement's trial balance, with any figure it could not read listed. For tax, that suits the deferred tax schedule: carrying amounts pull from the trial balance, the team enters tax bases from the computation, and the differences recalculate if the trial balance changes after an audit adjustment. Refreshing is refused on a locked file or a paper under review.
The tax lines in the lead schedules trace back to the trial balance lines behind them. Where the team finds an error, such as a prior-year under-provision not booked, staff record an audit adjustment on the line with a reason and raise a finding from the working paper, closed or withdrawn later. Our article on year-end adjusting entries covers making sure the correction reaches the client's books.
Checking the rate with the tax authority
Tax rates and rules change, sometimes during the year. Do not rely on last year's file or on memory. Confirm the rate that applied at year end, at the time of writing the file, from the tax authority itself: SARS in South Africa, the Nigeria Revenue Service (formerly FIRS) in Nigeria, or KRA in Kenya. Note the source and the date checked on the working paper.
The IFRS Foundation's summary of IAS 12 Income Taxes sets out the recognition and measurement rules for current and deferred tax, and is the reference for the accounting side of the work.
Next time the computation arrives late, ask instead for the deferred tax schedule early, built from the draft trial balance. It is usually where the larger surprises are, and it can be tested before the computation is final.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
