Measurement of Current and Deferred Tax Items

Current taxes payable or recoverable are determined using the relevant tax rates at the balance sheet date. Deferred taxes, however, are measured at the tax rate that is expected to be applicable when the asset is realized or the liability is settled.

Income tax for a current or previous period, that is not yet paid, is recognized as a tax liability until it is paid. Any amount paid in excess of a tax obligation will be recognized as an asset.

Recognition and Measurement of Current and Deferred Tax Items

• Deferred taxes and income taxes should always be recognized on the income statement unless they relate to: (i) taxes or deferred taxes that are charged directly to equity; or (ii) a possible provision for deferred taxes that is related to a business combination.
• The carrying amount of deferred tax assets and liabilities should be assessed at each balance sheet date. All unrecognized deferred tax assets and liabilities should also be reassessed at the balance sheet date and measured against the criteria of probable future economic benefits.
• If there is uncertainty over the future recovery of the deferral, the carrying amount should be reduced to the expected recoverable amount. The reduction may, however, be reversed in the event that circumstances subsequently change and project the possibility of recovery of the deferral in future. Under US GAAP, deferred tax assets are reduced by creating a valuation allowance.
• If an item which gives rise to a deferred tax liability is taken directly to equity, the same should apply to the resulting deferred tax.
• A suitable adjustment should be made once it is determined that a deferred tax liability will not be reversed. In this event, the deferred tax liability will be reduced by an amount that is taken directly to equity. Deferred taxes related to a business combination must also be recognized in equity.

Question 1

Which of the following statements is the most accurate?

1. Under IFRS and US GAAP, the recognition of deferred tax liabilities and current income tax is treated differently from the asset or liability that gave rise to the deferred tax liability or income tax.
2. Under IFRS, and not US GAAP, the recognition of deferred tax liabilities and current income tax is accorded the same treatment as the asset or liability that gave rise to the deferred tax liability or income tax.
3. Under IFRS and US GAAP, the recognition of deferred tax liabilities and current income tax is accorded the same treatment as the asset or liability that gave rise to the deferred tax liability or income tax.

Solution

The correct answer is C.

Under both IFRS and US GAAP, the recognition of deferred tax liabilities and current income tax is accorded the same treatment as the asset or liability that gave rise to the deferred tax liability or income tax.

Question 2

Chargers Co. reported a tax liability of $50,000 in its 2016 annual financial reports release. During the year of the report, the applicable tax rate was 20%. Suppose the tax rate was expected to change to 30% before the end of the year 2017, how would that affect the company’s tax liability?

1. The change would increase the company’s liability.
2. The change would decrease the company’s liability.
3. The change would have no effect on the company’s liability.

Solution

The correct answer is A.

The value of a company’s deferred tax assets or liabilities is positively related to the applicable tax rates. An increase in tax rates would increase the value of the deferred tax assets or liabilities.  Conversely, a decrease of tax rates would decrease the value of the deferred tax assets or liabilities.