Key takeaways
- IAS 12 requires both current tax (tax payable for the period) and deferred tax (tax on temporary differences that will reverse in future).
- Temporary differences are differences between the carrying amount of an asset or liability and its tax base.
- Taxable temporary differences create deferred tax liabilities; deductible differences and unused tax losses create deferred tax assets, recognised only to the extent future taxable profit is probable.
- Deferred tax is measured at rates enacted or substantively enacted by the reporting date and is not discounted.
Accounting profit and taxable profit are rarely the same. Tax rules allow different depreciation rates, disallow certain expenses, tax some income later and give relief for losses. If the income statement showed only the tax actually payable this year, the effective tax rate would swing unpredictably and the balance sheet would ignore tax consequences that are already locked in. IAS 12 Income Taxes solves this through deferred tax, using a balance-sheet approach.
Deferred tax has a reputation for being difficult. In practice, the logic is consistent and can be applied with a structured working paper. This guide explains the key concepts and walks through the most common example: an asset depreciated faster for tax than for accounting.
1. Current tax
Current tax is the amount of income tax payable (or recoverable) on the taxable profit (or tax loss) for the period, measured using tax rates and laws enacted or substantively enacted by the reporting date. It is recognised as a liability to the extent unpaid, or as an asset if payments exceed the amount due. Uncertain tax treatments are measured under IFRIC 23, using the most likely amount or the expected value, depending on which better predicts the resolution.
2. Tax base and temporary differences
The tax base of an asset is the amount that will be deductible for tax purposes against future taxable economic benefits when the entity recovers the carrying amount. The tax base of a liability is its carrying amount less any amount that will be deductible in future periods.
Asset: carrying amount > tax base → taxable temporary difference → deferred tax liability
Asset: carrying amount < tax base → deductible temporary difference → deferred tax asset
| Typical item | Usual effect | Why |
|---|---|---|
| Accelerated tax depreciation on PPE | Deferred tax liability | Tax base falls faster than carrying amount |
| Provisions deductible only when paid (warranties, gratuity) | Deferred tax asset | Expense recognised before it is deductible |
| Expected credit loss allowance not yet tax-deductible | Deferred tax asset | Allowance deducted only when written off |
| Revaluation of land and buildings | Deferred tax liability | Carrying amount increased, tax base unchanged |
| Unused tax losses | Deferred tax asset | Future taxable profit can be reduced |
| Permanent differences (e.g., non-deductible fines) | No deferred tax | Never deductible, so no future tax consequence |
3. Worked example: accelerated tax depreciation
A company buys a machine for BDT 1,000,000. For accounting it is depreciated straight-line over five years (BDT 200,000 per year). For tax, allowances are claimed faster: BDT 400,000, 240,000, 144,000, 86,400 and 129,600. The tax rate is assumed to be 25% throughout for illustration.
| Year-end | Carrying amount | Tax base | Temporary difference | Deferred tax liability (25%) | Movement (P&L) |
|---|---|---|---|---|---|
| Year 1 | 800,000 | 600,000 | 200,000 | 50,000 | +50,000 |
| Year 2 | 600,000 | 360,000 | 240,000 | 60,000 | +10,000 |
| Year 3 | 400,000 | 216,000 | 184,000 | 46,000 | -14,000 |
| Year 4 | 200,000 | 129,600 | 70,400 | 17,600 | -28,400 |
| Year 5 | 0 | 0 | 0 | 0 | -17,600 |
Tax allowances and the 25% rate are illustrative only. Use the rates and allowance rules enacted in your jurisdiction; corporate tax rates in Bangladesh vary by type of company and industry.
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Deferred tax liability on a machine with faster tax depreciation (illustrative, BDT, 25% rate)
View the data behind this chart
| Category | Deferred tax liability at year-end |
|---|---|
| Year 1 | 50.0k |
| Year 2 | 60.0k |
| Year 3 | 46.0k |
| Year 4 | 17.6k |
| Year 5 | 0.0k |
In year 1, taxable profit is BDT 200,000 lower than accounting profit because of the extra allowance, so current tax is BDT 50,000 lower. The deferred tax charge of BDT 50,000 restores total tax expense to 25% of accounting profit. As the difference reverses, current tax becomes higher than “normal” and the deferred tax credit offsets it. Over the asset’s life, total tax is the same; deferred tax simply allocates it to the right periods.
4. Deferred tax assets and recoverability
A deferred tax asset is recognised for deductible temporary differences, unused tax losses and unused tax credits only to the extent that it is probable that taxable profit will be available against which they can be used. Sources include reversing taxable temporary differences, forecast taxable profits and tax planning opportunities. A history of recent losses is strong evidence against recognition unless there is convincing other evidence. Recoverability must be reassessed at every reporting date — a frequent audit focus area, and one that should be consistent with the forecasts used in impairment testing.
5. Key exceptions
- Initial recognition of goodwill: no deferred tax liability is recognised.
- Initial recognition exemption: no deferred tax on the initial recognition of an asset or liability in a transaction that is not a business combination and affects neither accounting nor taxable profit — but, following the 2021 amendment (effective 2023), the exemption does not apply where equal taxable and deductible temporary differences arise, such as leases and decommissioning obligations.
- Investments in subsidiaries, branches, associates and joint arrangements: deferred tax liabilities are not recognised where the parent controls the timing of reversal and reversal is not probable in the foreseeable future.
- Pillar Two: a temporary mandatory exception (2023 amendment) prohibits recognising and disclosing deferred taxes related to OECD Pillar Two global minimum top-up taxes.
6. Measurement, presentation and the tax reconciliation
Deferred tax is measured at the rates expected to apply when the asset is realised or the liability settled, based on rates enacted or substantively enacted at the reporting date, reflecting the manner of recovery. It is not discounted. Deferred tax follows the underlying item: in profit or loss, in other comprehensive income (for example on revaluation surpluses) or in equity. Deferred tax assets and liabilities are offset only when there is a legal right of set-off and they relate to the same tax authority.
The disclosure most read by analysts is the tax rate reconciliation, explaining the difference between tax expense and accounting profit multiplied by the applicable rate. Preparing it each quarter is also an excellent control: unexplained reconciling items usually reveal missing deferred tax entries.
7. A practical deferred tax working paper
- List every balance-sheet line with its carrying amount from the trial balance.
- Determine the tax base of each item from the fixed asset tax register and tax computations.
- Calculate temporary differences, identify exemptions and apply the enacted rate.
- Assess recoverability of deferred tax assets against forecasts.
- Split the movement between profit or loss, OCI and equity, and prepare the rate reconciliation.
Standards referenced in this article
IAS and IFRS are one body of standards — IFRS Accounting Standards, issued by the IASB. Standards issued before 2001 keep their IAS numbers and remain fully in force unless replaced. See the full IFRS & IAS standards list for every number and replacement.
| Standard | Title | Status | IFRS # & IAS # link |
|---|---|---|---|
| IAS 12 | Income Taxes | In force | No IFRS number — IAS 12 is the IFRS standard |
| IFRIC 23 | Uncertainty over Income Tax Treatments | In force (Interpretation of IAS 12) | — |
Frequently asked questions
What is the difference between a temporary and a permanent difference?
A temporary difference is a difference between the carrying amount of an asset or liability and its tax base that will reverse in future periods, creating deferred tax. A permanent difference — such as a non-deductible expense — never reverses and does not give rise to deferred tax.
When can a deferred tax asset be recognised?
To the extent that it is probable that future taxable profit will be available against which the deductible temporary differences, unused tax losses or unused tax credits can be utilised. Recoverability must be reassessed at each reporting date.
Is deferred tax discounted under IAS 12?
No. IAS 12 prohibits discounting deferred tax assets and liabilities. They are measured at the tax rates expected to apply when they reverse, based on rates enacted or substantively enacted by the reporting date.
Conclusion
Deferred tax makes reported tax expense reflect the tax consequences of everything recognised in the financial statements. Identify carrying amounts and tax bases, calculate temporary differences, apply enacted rates, test deferred tax assets for recoverability and reconcile the effective tax rate. A structured working paper turns one of the most feared areas of IFRS into a routine quarter-end task.
Written by Liakat Hossain
Finance and accounts professional with experience in FP&A, SAP FICO, Power BI, internal control, reporting, audit, tax, VAT and export-oriented business operations.
This article is original educational content based on professional finance practice. Real-project examples are anonymized, and scenario figures are identified as model outputs rather than guaranteed results.