How income taxes are accounted for under IAS 12 and ASC 740

Income tax accounting links taxable profit with accounting profit while recognizing temporary differences between book and tax bases. IAS 12 (Income Taxes) and US GAAP (ASC 740 – Income Taxes) both adopt the balance sheet approach, recognizing deferred tax assets (DTAs) and deferred tax liabilities (DTLs) for future tax effects of temporary differences. Though conceptually aligned, they differ in measurement, recognition thresholds, and presentation rules.

Both frameworks ensure that the tax expense reported in the income statement reflects the economic impact of current and future tax obligations.

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How current and deferred taxes are distinguished.

Current tax represents the amount payable (or receivable) for the current year based on taxable profit according to tax laws.Deferred tax arises from temporary differences between the carrying amount of assets and liabilities and their tax bases.

Example:Depreciation under accounting = 100,000Depreciation under tax = 150,000→ Temporary difference = 50,000 (tax base lower).→ Recognize DTL = 50,000 × tax rate.

Journal entry:

• Debit: Income Tax Expense – Deferred 10,000

• Credit: Deferred Tax Liability 10,000

Total tax expense = current tax ± deferred tax movements.

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Recognition and measurement under IFRS (IAS 12).

1) Deferred tax liabilities (DTLs).Recognize for all taxable temporary differences, except for:

• Initial recognition of goodwill.

• Initial recognition of an asset/liability that affects neither accounting nor taxable profit.

• Certain undistributed profits of subsidiaries if control over reversal exists.

2) Deferred tax assets (DTAs).Recognize for deductible temporary differences and loss carryforwards only if recovery is probable (more likely than not).

3) Measurement.

• Use enacted or substantively enacted tax rates expected to apply on reversal.

• Measure on an undiscounted basis.

• Reflect future tax consequences of expected asset recovery or liability settlement (e.g., capital gains vs ordinary income rates).

Example – deductible temporary difference:Provision for warranty 120,000 not yet deductible for tax. Tax rate 25%.

• Debit: Deferred Tax Asset 30,000

• Credit: Deferred Tax Income 30,000

4) Presentation.Offset DTA and DTL if the entity has a legally enforceable right to offset and both relate to the same tax authority.

5) Deferred tax on OCI items.Recognize tax effects in the same component as the underlying item (e.g., OCI for revaluation surplus, cash flow hedge reserve).

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Recognition and measurement under US GAAP (ASC 740).

1) Deferred tax liabilities.Recognize for all temporary differences, similar to IFRS. No exemption for initial recognition other than business combination goodwill.

2) Deferred tax assets.Recognize for all deductible temporary differences and loss carryforwards, but reduce by a valuation allowance if it is more likely than not (>50%) that part or all of the DTA will not be realized.

3) Measurement.

• Use enacted tax rates only (no “substantively enacted” concept).

• No discounting.

• Reflect future reversal pattern consistent with recovery expectations.

4) Valuation allowance example:DTA before allowance = 100,000.Management expects only 60% realizable → allowance 40,000.

Entry:

• Debit: Income Tax Expense 40,000

• Credit: Valuation Allowance on DTA 40,000

5) Intraperiod allocation.Allocate tax effects among continuing operations, discontinued operations, OCI, and equity (same principle as IFRS but with detailed guidance).

6) Balance sheet classification.All DTAs and DTLs presented as noncurrent (since ASU 2015-17).

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Comparative table: IAS 12 vs ASC 740.

Aspect	IFRS (IAS 12)	US GAAP (ASC 740)
Recognition threshold for DTA	Probable (>50%)	More-likely-than-not (>50%)
Valuation allowance	Not used; directly assess recoverability	Required when realization uncertain
Measurement basis	Enacted or substantively enacted rate	Enacted rate only
Discounting	Prohibited	Prohibited
Presentation	Offset if legal right & same authority	Offset within same tax jurisdiction
Classification	Split between current/noncurrent by underlying item	All deferred items noncurrent
Revaluation reserves	Recognize tax in OCI	Same principle (comprehensive income)
Intercompany profits	DTA/DTL if reversal expected	Similar but requires “outside basis” assessment
Disclosure	Major components of tax expense, DTA/DTL breakdown	Similar, plus detailed rollforward (SEC filers)

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Typical sources of temporary differences.

Item	Accounting treatment	Tax treatment	Deferred tax impact
Depreciation	Straight-line	Accelerated	DTL
Warranty provision	Accrue	Deduct on payment	DTA
Unrealized FX gains	Recognize	Tax on realization	DTL
Lease liability (IFRS 16 / ASC 842)	Present value	Deduct cash payments	DTA
Pension liability	Actuarial valuation	Tax on contributions	DTA
Revaluation of PPE (IFRS)	Recognize in OCI	No tax until realized	DTL (OCI)

Example – depreciation difference:Book value 1,000,000; tax base 800,000; tax rate 25%.→ DTL = 200,000 × 25% = 50,000.

Entry:

• Debit: Income Tax Expense 50,000

• Credit: Deferred Tax Liability 50,000

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Disclosures required.

IFRS 12 disclosure requirements:

• Major components of income tax expense.

• Reconciliation of accounting profit × statutory rate to actual tax expense.

• Breakdown of DTA/DTL by type and jurisdiction.

• Unrecognized DTAs on losses or credits.

• Expiry dates for carryforwards.

ASC 740 disclosures:

• Total DTA and DTL components.

• Valuation allowance changes.

• Effective tax rate reconciliation.

• Unrecognized tax benefits (FIN 48).

• Open tax years subject to examination.

Example reconciliation:

Description	Amount (USD)
Accounting profit before tax	5,000,000
Tax at 25%	1,250,000
Non-deductible expenses	80,000
Tax-exempt income	(30,000)
Change in DTA valuation allowance	40,000
Income tax expense	1,340,000

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Journal entries summary.

1) Current tax payable:

• Debit: Income Tax Expense 1,500,000

• Credit: Income Tax Payable 1,500,000

2) Deferred tax liability:

• Debit: Income Tax Expense – Deferred 60,000

• Credit: Deferred Tax Liability 60,000

3) Deferred tax asset:

• Debit: Deferred Tax Asset 45,000

• Credit: Income Tax Benefit 45,000

4) Valuation allowance (GAAP only):

• Debit: Income Tax Expense 20,000

• Credit: Valuation Allowance on DTA 20,000

5) Offset DTA and DTL (if permitted):

• Debit: Deferred Tax Liability 100,000

• Credit: Deferred Tax Asset 100,000

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Impact on financial performance and ratios.

Tax accounting affects both net income and equity through current and deferred elements:

• Changes in tax rates can cause revaluation of DTAs/DTLs, impacting profit.

• Deferred taxes influence effective tax rate (ETR) and book value.

• Large DTAs signal loss carryforwards or temporary timing benefits, while large DTLs imply tax deferrals from accelerated depreciation.

• Analysts adjust for one-off tax impacts (rate changes, valuation allowance movements) to assess underlying earnings.

Example: If a tax rate reduction from 30% to 25% reduces DTL by 100,000, recognize income of 5,000 × (30%–25%) = 5,000 via tax benefit.

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Operational considerations.

Implementing IAS 12 or ASC 740 requires coordination between tax reporting and financial accounting teams. Entities should:

• Reconcile taxable vs accounting profit regularly.

• Maintain detailed temporary difference schedules by jurisdiction.

• Model forecast reversals for loss recoverability testing.

• Align systems to calculate deferred taxes automatically from sub-ledgers.

• Document assumptions for tax rate changes and cross-border transfer pricing effects.

Accurate deferred tax accounting enhances transparency and ensures compliance across both local tax regulations and global financial reporting standards.

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