Conceptual Basis for the Recognition of Deferred Taxation in Accordance with IAS 12

Deferred Tax Overview:
Deferred tax represents the estimated future tax consequences of transactions and events recognized in the financial statements of the current and previous periods due to temporary differences. These temporary differences arise when the carrying amount of an asset or liability in the financial statements differs from its tax base. Essentially, deferred tax arises because income or expenses are recognized for accounting purposes in one period, but are taxed in a different period.

Temporary Differences:
Temporary differences are the discrepancies between the carrying amount of an asset or liability in the financial statements and its value for tax purposes. Deferred tax is recognized when such differences result in future tax liabilities or assets.

Types of Temporary Differences

1. Deductible Temporary Differences:
   These occur when the tax base of an asset exceeds its carrying amount. They can give rise to a deferred tax asset. Examples include:
   • Retirement benefit costs: These are expensed in the financial statements when incurred but are only deductible by tax authorities when paid.
   • Revaluation losses: These losses are recognized in the financial statements, but tax authorities allow them only when the asset is sold.
   • Research costs: Expensed for accounting purposes but deductible by the tax authorities only when paid.
   • Unrealized intra-group profits in the consolidated accounts.
2. Taxable Temporary Differences:
   These arise when the carrying amount of an asset exceeds its tax base. They lead to the recognition of a deferred tax liability. Examples include:
   • Interest income: Recognized for accounting purposes when earned but taxed when received.
   • Revaluation gains: These are recognized in the financial statements but are taxed when realized.
   • Interest capitalized in the construction of an asset: The tax authorities allow the expense when incurred, but for accounting purposes, it is charged as the related asset is depreciated.
3. Temporary Differences that Could Be Either Taxable or Deductible:
   These differences arise in cases like accelerated capital allowances, where the carrying amount of an asset differs from its tax written-down value (WDV).
   • For example, the carrying amount of non-current assets can differ substantially from their tax WDV, which leads to either taxable or deductible temporary differences.

Measurement and Recognition Criteria for Deferred Tax under IAS 12

1. Tax Rates:
   Deferred tax assets and liabilities should be measured using tax rates expected to apply when the asset is realized or the liability is settled. These rates must be based on laws or tax rates that are enacted or substantially enacted at the end of the reporting period.
2. Recognition of Deferred Tax Assets:
   A deferred tax asset must be recognized for all deductible temporary differences, but only to the extent that taxable profit will be available to offset these differences. However, there are exceptions when:
   • The deferred tax asset arises from the initial recognition of an asset or liability in a transaction that is not a business combination, and
   • At the time of the transaction, it does not affect either accounting profit or taxable profit (tax loss).
3. Non-Discounting:
   IAS 12 does not permit deferred tax assets and liabilities to be discounted to present value.
4. Recognition of Deferred Tax Assets for Unused Tax Credits:
   A deferred tax asset should also be recognized for unused tax credits. However, it should only be recognized to the extent that it is probable that future taxable profit will be available to utilize these credits.
5. Review of Deferred Tax Assets:
   The carrying amount of deferred tax assets should be reviewed at the end of each reporting period. If it becomes probable that future taxable profit will be available to recover a previously unrecognized deferred tax asset, it should be recognized.
6. Offsetting Deferred Tax Assets and Liabilities:
   Deferred tax assets and liabilities should be offset only if:
   • The entity has a legally enforceable right to offset current tax assets against current tax liabilities.
   • The deferred tax assets and liabilities relate to income taxes levied by the same tax authority.

b. (i) Accounting for the Transactions

1. Profit Before Tax

• The total income tax charge, including deferred tax, will be deducted from the profit before tax of ₦487.5m to arrive at the accounting period’s net profit.

2. Current Tax Liability
The current tax liability is determined by applying the applicable tax rate (30%) to the taxable profit. The taxable profit for Limelight Plc for the year ended December 31, 2014 is ₦131.25m, so the current tax liability is ₦39.39m (30% of ₦131.25m).

The journal entry to recognize the current tax charge is:

3. Non-Current Assets

• A deferred tax provision must be made for the temporary difference between the accounting carrying amount of non-current assets (₦937.5m) and the tax written-down value (₦637.5m).
• The related deferred tax computation is calculated as: $$\text{Temporary Difference}=937.5m-637.5m=300m$$ Deferred Tax=300m×30%=90m

The deferred tax on the non-current asset will be recorded as follows:

4. Freehold Building Purchased in February 2014

• The freehold building, purchased for ₦750m in February 2014, is revalued to ₦985m as of December 31, 2014, resulting in a revaluation surplus of ₦235m (₦985m – ₦750m).
• The deferred tax on the revaluation surplus is calculated as: $$\text{Deferred Tax on Revaluation}=235m\times 30\%=70.5m$$

The journal entry for the purchase of the building is:

The journal entry for the revaluation surplus and deferred tax is: