Working out deferred tax from temporary differences
A working method for identifying temporary differences and calculating deferred tax for a small company's statements under IAS 12, from working to note.
By Achekam · · 4 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
Deferred tax is the note many small-company preparers dread, and some quietly skip. The client pays tax on its return; why should the statements show tax nobody owes yet? The answer is that the statements and the tax return measure the same assets and liabilities differently, and those differences turn into tax as they unwind.
This article sets out a working method a preparer can use for an ordinary small company.
Carrying amount, tax base and the gap between them
IAS 12 defines temporary differences as differences between the tax base of an asset or liability and its carrying amount in the statement of financial position. It describes the tax base as the amount attributed to that asset or liability for tax purposes.
So the method starts with two columns for each balance:
- Carrying amount. What the statements show.
- Tax base. What the tax law attributes to the same item. For a vehicle, that is cost less the tax allowances already claimed. For a provision that is deductible only when paid, it is nil.
The temporary difference is the gap between the two.
Which differences create liabilities and which create assets
IAS 12 states that a deferred tax liability arises if an entity will pay tax when it recovers the carrying amount of an asset or liability, and that a deferred tax asset arises if it will pay less tax, or if it has unused tax losses or unused tax credits. It requires a deferred tax liability, or, subject to specified conditions, a deferred tax asset, to be recognised for all temporary differences, with some exceptions.
A rule of thumb that covers most small-company items:
| Situation | Result |
|---|---|
| Asset carried above its tax base | Deferred tax liability |
| Asset carried below its tax base | Deferred tax asset |
| Liability in the books, deductible only when paid | Deferred tax asset |
| Income received in advance and taxed on receipt | Deferred tax asset |
Common sources in small companies
- Property, plant and equipment. Tax allowances often run faster than accounting depreciation, so the tax base falls below the carrying amount and a liability builds up. SARS, the NRS and KRA each set their own allowances, so the tax base must come from the client's tax asset register, not its accounting register.
- Provisions and accruals. Leave pay, bonuses and legal provisions are often deductible only when paid. The provision has a tax base of nil, which creates a deferred tax asset.
- Prepayments. Where the tax law allows a deduction when the amount is paid, the prepayment's tax base is lower than its carrying amount, which creates a liability.
- Allowances for doubtful debts. Where tax relief follows different rules from the accounting allowance, a difference arises.
- Tax losses. Not a temporary difference, but a source of a deferred tax asset in their own right, discussed in deferred tax assets on unused tax losses.
Setting out the working
A one-page working a reviewer can follow:
- List every asset and liability with a difference: carrying amount, tax base, difference.
- Classify each difference as taxable, giving a liability, or deductible, giving an asset.
- Apply the tax rate. IAS 12 measures current tax at rates and laws enacted or substantively enacted by the end of the reporting period; check the standard for the matching rule on deferred tax, and use a rate that is in law, not merely announced.
- Test any net deferred tax asset against IAS 12's conditions for recognition.
- Compare the closing balance with the opening balance. The movement is the deferred tax charge or credit for the year.
- Agree the closing balance to the trial balance after the adjustment is posted.
Posting the adjusting entry
Most small clients never post deferred tax themselves. In Achekam's Financials Studio, staff can post a year-end adjusting entry for the movement, between the deferred tax line in profit or loss and the deferred tax asset or liability. A wrong entry is reversed with who and why rather than deleted, so a reworked calculation leaves a clear trail.
The carrying amount of property, plant and equipment comes from the client's own figures, because Achekam does not calculate depreciation; it presents the trial balance charge. If the depreciation is corrected by an adjusting entry, rework the deferred tax on those assets afterwards, since their carrying amount has changed.
The deferred tax note
The Studio's notes take their figures from the mapped trial balance, and its standard policy wording is based on IFRS for SMEs and labelled for review before issue; staff can write their own policies. Once the adjusting entry is posted, the deferred tax balance and the charge reach the statements from the trial balance.
Facts the trial balance does not hold are left as "[to be completed]". For deferred tax, the analysis of the balance by source of difference, and any unrecognised asset, will come from the working rather than the ledger.
Country specifics on rates and the tax note are in the guides for South Africa, Nigeria and Kenya. Rates change, so check them with the tax authority at the time of writing before finalising the working.
The IFRS Foundation's summary of IAS 12 explains the accounting treatment for income taxes, including current and deferred tax.
Keep the working with the tax computation for the same year, and file both where the reviewer will find them together. Once the two-column working exists for one year, the next year is mostly an update. That is the real argument for doing it properly once: deferred tax is only hard the first time.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
