The Quest for the Perfect Story

Have you ever heard of addiction to story? Apparently this is a real addiction, as shown below:

If you are not convinced that this addiction is real, watch this video:

See this cute little baby, so addicted to story until the point that he cried when the story has ended. Poor baby. I will buy you lots of books next time ok? 😂

As a matter of fact, I think I am addicted to stories. I crave for stories that can make me reflect on my life as well as story that managed to leave an impact in my heart.

I guess the reason why so many of us are addicted to stories is that stories allow us to experience a different life (especially a life that you can't have in the real life). All you need to do is to simply imagine yourself as one of the characters in the story.

For example, you could be flying in the sky, if you imagine yourself as Peter Pan.

Or you could go for an adventure in the Pacific Ocean, by imagining yourself as the little mermaid.

Or if you longed for the perfect love story (well in my opinion, this story is perfect enough), just imagine yourself as Cinderella.

I mean, what else can you ask for, if your love story is full of magic and a pumpkin carriage?

See my point? Life seems to be perfect, if we were to live in such a story. Story allows us to live a multiple life, if you like.

Stories are also useful tools for us to understand our life better. It trains us to be an empathy person. I believe that if you want to understand human being, you will need to read more stories and try to be empathy, i.e. try to understand the feelings of the characters in the story.

As such, I started to wonder about what makes a good story. To be exact, I want to know why certain stories stayed with us for a long period of time.

Thus, I decided to embark on a soul searching journey. Perhaps you can call it "The Quest for the Perfect Story".

To answer this question, I decided to go through three stories that have changed my life (i.e. stories that have change my world view or stories that allow me to understand our life better). I will explain why these stories have touched my heart, and I hope that we can find some common similarities between these stories.

1. Sword Art Online

Sword Art Online (SAO) is a Japanese anime which was introduced to me by one of my students (if you are reading this, thank you for introducing this anime to me because this anime had changed my life).

Basically, SAO is about VRMMORPG (virtual reality massively multiplayer online role-playing game). If you are not so familiar with this term, VRMMORPG means a virtual reality online game in which it allows a lots of player to play the game together at the same time.

I find this anime interesting because instead of facing computer screen when we play computer game, SAO allows the player to enter the gaming world via a technology called NerveGear.

All you need to do is to install the NerveGear on your head (as shown in the diagram above) and the NerveGear will reroute all your brain signal into the game server. As such, you can enter the gaming world (Aincrad) which looks like this:

SAO is a floating castle which houses 100 floors. Inside each floor, you get to see something like this:

Imagine that you can live inside such a world. How perfect life would be.

However, there is a twist.

On the first day of official launch of SAO, many enthusiastic players entered the game. However, they realised that they can't log out the game.

Yes, you did not read that wrong. The players are trapped inside the game, with no ability to log out. There is also no way for you to control your body in the real life because NerveGear has rerouted all your brain signal to the game server.

Thereafter, we learn that this was done on purpose by the developer of the game, Kayaba Akihiko.

For no specific reason, he trapped 10,000 people in the game and he mentioned that the only way they can log out is to clear the 100 floors in Aincrad. However, if any player accidentally die in the game, the player will also be killed in the real life because NerveGear will automatically emit high-powered microwaves which can fry your brain. Any attempt to disconnect NerveGear by anyone in the real life will also have similar consequences.

10,000 people were trapped in such a game with no obvious reason. For no reason, they were forced to live in the game. For no reason, they were forced to try to clear the games in order to be able to return to the real world. The worst thing is that they may die trying.

Imagine if you were the players trapped inside the game, how would you feel? How would you react? Can life still be meaningful if you were one of them?

Well if you find this story to be absurd, let me tell you that our life can be very absurd too. For no reason, we were born into this world. For no reason, we were forced to go to school, get a degree, and start working. Similarly, in our life, we may also die accidentally if we were not careful. Well eventually, we are going to die anyway. So what is the meaning of life then?

I will try to answer this question at a later part. But since we are on the topic of death, let's talk about the second story that has forever changed my life.

2. Tuesday with Morrie

Tuesday with Morrie is one of the best books that I have read in my life. It is always said that movie can make us shed tears due to the background music. However, I shed lots of tears after I read this book (even without any background music).

This is a story about an old man (Morrie), a teacher, who was diagnosed with amyotrophic lateral sclerosis (ALS) which has no known cure. And yes, death is inevitable for him.

It is funny isn't it? All these while when we were living, we never really thought of dying. It was only until the time when the doctor delivered the death sentence to us then we were hit by the reality - our days are numbered. Although we are going to die, the sun still shines brightly and other people will still continue on with their life. The world will not stop for us.

Read this quote from this book:

Perhaps it is very pessimistic for me to say this, but since we will die eventually, why should we study so hard for our exam? Why should we climb the corporate ladder in order to get a higher pay? Why should we torture ourselves so much?

My point is that after we worked so hard in our life, we will still die anyway. Why not we just enjoy our life to the max since our life is so meaningless after all?

Again, I will try to answer this question at a later part. Let's look into another story that made me think a lot about our life.

3. Lord of the Rings

I guess I have watched Lord of the Rings for around 5 times. I must say that each time I watched the movie, I learnt something different.

This is a story about two hobbits, Frodo and Sam attempting to take the One Ring to a volcano (Mount Doom) in hope of destroying the ring.

Both of them were not involved in the forging of the evil ring, but somehow they were tasked to embark on the journey to Mount Doom to destroy the ring.

To put things into perspective, this is the route that Frodo and Sam had taken in the Middle Earth:

According to this website, Frodo and Sam had walked a total of 1,350 miles (roughly 2,170km+) over a period of 6 months. This is roughly equivalent to travelling from Kuching to Sabah and from Sabah back to Kuching (on foot!).

Despite Frodo and Sam had no role in forging the evil one ring, they still had to bear the burden of the ring. They may get killed in the process too. True enough, they were captured or were almost captured multiple times in their journey.

What's the point of suffering so much for other people's mistake? Were there any hope at all for two small hobbits to actually reach Mount Doom and to destroy the ring? Well, Gandalf the wizard in Lord of the Rings had said this:

Perhaps what he said is true. Sometimes in life, we need to be a fool. We need to be foolish enough to believe that there are still some hope, despite everyone telling us to give up.

Similarities in the Three Stories

By now you may have realised some recurring questions - is our life meaningless after all? Why must we suffer so much in our life? We will be dead at the end of the day anyway.

My friend, if you are still reading, I hope you realised that these stories are sharing a common plot - the characters were in a situation in which there weren't much hope. However, you should also realised that these characters never give up in these stories.

In SAO, despite knowing that they may die in real life, the players still try their very best to clear the games. The front line players (the players with high levels who were fighting very hard to clear the game) felt that they owe the other non-front line players a duty to clear the games so that everyone can be released from this nightmare.

In Tuesday with Morrie, despite knowing that he would die eventually, he still wanted to try to help as many people as possible. This including sharing the life lessons with one of his ex-student (the author) so that the author can write a book about life and death. According to Morrie,

Morrie also said this:

To fully understand the meaning of offering others what you have to give, you will have to experience it yourself by reading the book. Allow me to share with you one part of the novel that really made me shed tears:

In other words, the help by Morrie transcends life and death. He is still helping us after he is dead. Although he can't talk to us face to face, his story will always remain in the book and it will continue to inspire lots of people. He is really a true teacher to the end.

What about Lord of the Rings? I will let Sam to explain to you the significance of this story. Watch this video (a very touching speech by him).

“It's like in the great stories, Mr. Frodo. The ones that really mattered. Full of darkness and danger they were. And sometimes you didn't want to know the end. Because how could the end be happy? How could the world go back to the way it was when so much bad had happened? But in the end, it’s only a passing thing, this shadow. Even darkness must pass. A new day will come. And when the sun shines it will shine out the clearer. Those were the stories that stayed with you. That meant something, even if you were too small to understand why. But I think, Mr. Frodo, I do understand. I know now. Folk in those stories had lots of chances of turning back, only they didn’t. They kept going, because they were holding on to something. That there is some good in this world, and it's worth fighting for.”

Lessons Learnt

I think Sam has summarised the lessons learnt well. Our life is indeed meaningless (or hopeless if you want). Sometimes we were in the situation where we can't even see the light at the end of the tunnel. How could the ending be happy, when our life sucks to the max?

However, these stories appeal to me because in the end, there will be a happy ending (spoilers alert!). 

In SAO, despite the sacrifice of some players who will never come back to life, the game was finally cleared.

In Tuesday with Morrie, even though Morrie passed away eventually, he left us with an invaluable gift, i.e. life lessons in the book.

In Lord of the Rings, the ring was successfully destroyed after so much of struggles and hardship.

So is life really meaningless? I guess not. Let's be a fool to believe that there are still some hope in our life. Let's be a fool to believe that there are still something good in this world which is worth fighting for, and believe me, whatever sufferings that you and I are facing now are temporary. It will not last forever and a better tomorrow will definitely come.

It is true that we are going to die at the end of our life, but this doesn't render our life meaningless. Why not we try our best to create an interesting life? Why not we try our best to create something permanent in this temporary life? 

The Perfect Story

Coming back to the quest for the perfect story. After all the analysis above, I hope you realised that each story is unique in its own way. Perhaps we shouldn't make this quest as our number one priority in life.

Instead of hoping that you exist in a perfect story, why not we try our best to create one ourselves? After all, you are living your own life. You only live once (YOLO). Make it meaningful, and I guess that shall be our ultimate quest for the perfect story.

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IAS 12 - How To Determine Tax Base (Part 3)

This is the third part of how to determine tax base. For the previous posts, you can refer to the following link:

Part 1 - https://tysonspeaks.blogspot.com/2019/08/ias-12-how-to-determine-tax-base-part-1.html

Part 2 - https://tysonspeaks.blogspot.com/2019/09/ias-12-how-to-determine-tax-base-part-2.html

For Part 3, I am going to discuss about how to determine the tax base for liability as well as tax base for some specific scenarios involving the accounting standards in the Financial Reporting (FR) paper of ACCA.

Tax Base of Liability

Before we go into the details, let's look again at the definition of tax base of liability according to IAS 12:

The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods.

In general, there are two points:

(a) Generally, the tax base of the liability will be equal to its carrying amount unless the liability represents an expense which will only be deductible in the future when it is paid. In this case, the tax base is the carrying amount minus the amount that will be deductible in the future (e.g accrued expenses in which deduction is given in the future when the liability is paid - deduction on cash basis).

(b) If the liability represents an income received in advance, then the tax base is the carrying amount minus any revenue that is not taxable in the future (e.g. an income received in advance which is taxed in this year on receipt basis. This income will not be taxable in the future).

You will understand more after going through the following illustrations:

1. Trade Payables

The entity incurs an expense of $100 on credit. The accounting double entry is:

Dr Expenses (SOPL) $100
Cr Trade payables $100

In this case, the carrying amount of the liability is $100.

Tax treatment: Assuming that the tax rule provides that such expense is deductible on an accrual basis (i.e. deduction is given even though the entity has not paid for the expense).

The imaginary tax double entry in the imaginary tax financial statements will be:

Dr Deductible expenses $100
Cr Trade payables $100

As we can see from the above, the tax base of the liability is also $100 because $100 is deductible in this year.

Since the CA and TB are the same, there will be no deferred tax because the accounting rule and tax rule are the same.

Note: Referring back to the definition, as none of the $100 liability is deductible in the future (the full $100 has already been deducted in the current year), the tax base is equal to its carrying amount of $100.

2. Accrued Expenses Which Is Deducted on Cash Basis

An entity has accrued water and electricity expenses of $100 for the month of December. Such expense has not been paid by year end. The accounting double entry is:

Dr Expenses (SOPL) $100
Cr Accrued expenses $100

In this case, the carrying amount of the liability is $100.

Tax treatment: Assuming that tax rule provides that the deduction for such expenses can only be made when the entity has paid for the expenses.

As the entity has not paid for the expenses, there will be no tax double entry. Accordingly, it follows that there is no tax base because the expense is not deductible in this year.

As such, CA = $100 and TB = $0. As CA > TB and this is a liability, this represents a DTD of $100.

Reason for DTD: The entity will pay higher tax this year because deduction is not given this year. However, the entity will pay lesser tax in the future when deduction is given (hence DTD).

Note: Referring back to the definition, as the $100 liability will only be deducted in the future, the tax base is equal to its carrying amount ($100) less the amount that will be deductible in the future ($100). This will result in tax base to be equal to zero ($100 - $100).

3. Deferred Income Which Is Taxed on Cash / Receipt Basis

An entity receives $100 advance payment for services to be rendered in the future. As the performance obligation has not been satisfied, according to IFRS 15 Revenue from Contracts with Customers, revenue cannot be recognised. Instead, a deferred revenue (liability) should be recognised as follows:

Dr Bank $100
Cr Deferred revenue (liability) $100

In this case, the carrying amount of the liability is $100.

Tax treatment: Assuming that the tax rule mentions that the income will be taxed if the entity has received the income.

As the income is subject to tax in this year (since the entity has received the income), the imaginary tax double entry in the imaginary tax financial statements will be as follows:

Dr Bank $100
Cr Taxable income $100

In other words, in the tax SOFP, there will be no liability because the income has already been taxed this year. As such, tax base is equal to zero.

As CA = $100 and TB = 0 and this is a liability, there will be a DTD of $100 since CA > TB.

Reason for DTD: The entity will pay more tax in this year because the deferred income is subject to tax in this year. However, the entity need not pay tax again in the future (hence the future tax is lesser and it is DTD).

Note: Referring back to the definition, as the $100 income received in advance has already been taxed in this year, there will be no tax to be paid in the future. As such the tax base is the carrying amount ($100) less the revenue that will not be taxable in the future ($100). This will result in the tax base to be equal to $0 ($100 - $100).

4. Deferred Income Which Is Taxed in the Future

Assuming that the scenario is the same as scenario no.3 above, except that the tax treatment is that the income will not be taxed now, but it will only be taxed in the future when services are rendered.

In this case, the imaginary tax double entry in the imaginary tax financial statements will be similar to the accounting double entry:

Dr Bank $100
Cr Deferred revenue (liability) $100

As such, tax base of the liability is equal to $100 because we have not paid the tax.

As CA = $100 and TB = $100, it follows that there is no deferred tax. This is because the accounting rule and tax rule are the same.

Note: Referring back to the definition, as the $100 income received in advance will be taxed in the future, the tax base is the carrying amount ($100) less the revenue that will not be taxable in the future ($0). This will result in the tax base to be equal to $100 ($100 - $0).

5. Loan Payable

An entity borrowed $100 from the bank. The accounting double entry is as follows:

Dr Bank $100
Cr Loan payable $100

As such, the carrying amount of the liability is $100.

Tax treatment: When the entity receives the borrowing from the bank, there is no tax implication. When the entity makes repayment of loan to the bank, there is also no tax implication.

The imaginary tax double entry in the imaginary tax financial statements will be similar to the accounting double entry:

Dr Bank $100
Cr Loan payable $100

As the CA and TB are the same, it follows that there is no deferred tax. This is because the accounting rule and tax rule are the same.

Note: Referring back to the definition, as the $100 liability will not be deductible in the future, the tax base is equal to its carrying amount ($100) less the amount that will be deductible in the future ($0). This will result in tax base to be equal to $100 ($100 - $0).

6. Accrued Fines and Penalties

An entity accrues fines and penalties amounting to $100. The accounting double entry is as follows:

Dr Expenses (SOPL) $100
Cr Accrued fines and penalties $100

As such, the carrying amount of the liability is $100.

Tax treatment: Assuming that fines and penalties are not deductible for tax purposes.

The imaginary tax double entry in the imaginary tax financial statements will be similar to the accounting double entry:

Dr Non-deductible expenses $100
Cr Accrued fines and penalties $100

As such, the tax base of the liability is also $100.

As the CA and TB are the same, it follows that there is no deferred tax.

Note: Referring back to the definition, as the $100 liability will not be deductible in the future, the tax base is equal to its carrying amount ($100) less the amount that will be deductible in the future ($0). This will result in tax base to be equal to $100 ($100 - $0).

Alternatively, you can also argue that as fines and penalties are not deductible, the difference represents a permanent difference and deferred tax should be ignored. Both analysis will result in no deferred tax calculation.

There you go! This is the idea of how do we determine tax base for liability.

Next, I am going to cover about some specific scenarios involving the accounting standards in the Financial Reporting (FR) paper of ACCA.

Specific Scenarios

In this part, I will cover some scenarios involving the following:

1. Unutilised tax losses or unutilised tax credits
2. Leasing (IFRS 16)
3. Convertible loan note (IAS 32)

1. Unutilised Tax Losses / Unutilised Tax Credits

Unutilised tax losses (in Malaysia, this is known as unabsorbed business losses) refer to the tax losses that can be carried forward to the future so that it can be used to offset against taxable income that an entity will earn in the future. In other words, future tax can be reduced by these unutilised tax losses.

As the entity will pay lesser tax in the future, unutilised tax losses will result in deferred tax asset (DTA).

For example, if an entity is having unutilised tax losses of $100,000 and the tax rate is 25%, there will DTA of $25,000 ($100,000 x 25%).

However, do take note that paragraph 34 of IAS 12 mentions that such deferred tax asset can be recognised "to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilised."

In other words, using the same example as above, if the entity only expects that it can earn $70,000 taxable profit in the future, the entity can only recognise DTA of $21,000 ($50,000 x 25%) instead of the full $25,000 DTA.

The remaining DTA of $4,000 ($25,000 - $21,000) will not be recognised because the entity is not able to earn the extra $30,000. In other words, the entity will not be able to use the tax losses of $30,000 because the entity cannot earn the extra $30,000. As such, the DTA of $4,000 will only be disclosed in the notes to the financial statements.

2. Leasing

Under IFRS 16, a lessee (an entity who lease an asset) will recognise right-of-use asset as well as lease liability (the detailed accounting treatment under IFRS 16 is not covered in this post). Let's just say:

Right-of-use asset - $100
Lease liability - $90
Net CA of lease (asset) - $10

Tax treatment: Assuming that the tax rule provides that lease rental is treated as a deductible expense.

The imaginary tax double entry for the lease rental in the imaginary tax financial statements will be as follows:

Dr Deductible expenses $100
Cr Bank $100

As such, under the tax rule, there will be no asset because we just claim a deductible expense on lease rental. Tax base will be equal to zero.

As CA = 10 and TB = $0 and this is an asset, the difference of $10 represents TTD.

Reason for TTD: If there is a positive net asset of lease in the accounting SOFP, it means that there will be higher profit in the accounting SOPL (due to double entry). In other words, accounting profit is more than taxable profit for this year. As we only claim lease rental as deductible expenses for tax purpose, we will actually pay lesser income tax this year. In the future, our tax might be higher after we have claimed all the lease rental deduction (hence TTD).

Note: If the net CA of the lease is a liability, then the difference shall be DTD.

Reason for DTD: If there is a net liability of lease in the accounting SOFP, it means that there will be higher expenses (thus lower profit) in the accounting SOPL (due to double entry). In other words, accounting profit is lower than taxable profit for this year. We will pay more income tax in this year. In the future, our tax might be lower (hence DTD).

3. Convertible Loan Note (IAS 32)

Under IAS 32, convertible loan note needs to be split into loan component and equity component (the detailed accounting treatment under IAS 32 is not covered in this post). Let's just say we have a convertible loan note of $100 and upon initial recognition, the entity has determined that

Loan element - $90
Equity element - $10

The double entry upon initial recognition is

Dr Bank $100
Cr Convertible loan note $90
Cr Equity component $10

As such, the CA of the convertible loan note (liability) is $90.

Tax treatment: Assuming that we do not split the loan into loan and equity component as per tax rule.

As such, TB will be $100.

As CA = $90 and TB = $100 and this is a liability, the difference of $10 represents TTD.

Notes:

1. The deferred tax liability arising on initial recognition (as explained above) is not charged to SOPL. Instead, it is charged directly to the equity component. Remember, the deferred tax treatment should follow the accounting treatment. Since in accounting we credit equity component $10, we have to charge the deferred tax to the equity component too.

2. On subsequent accounting, when we apply amortised cost method to the carrying amount of convertible loan note, the carrying amount of convertible loan note will be increased by finance cost and reduced by actual interest paid. The subsequent changes in deferred tax liability as a result of this will be charged to SOPL because the finance cost on convertible loan note is charged to SOPL.

Congratulations! You have reached the end of this post!

In my next post on IAS 12, I will talk about some specific scenarios relevant for SBR students. So stay tuned!

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IAS 12 - How To Determine Tax Base (Part 2)

This post is a continuation from Part 1. If you have not read Part 1, you can access it via the following link:

https://tysonspeaks.blogspot.com/2019/08/ias-12-how-to-determine-tax-base-part-1.html

In Part 1, we have covered the basic of deferred tax. In this post, we will cover the following:

1. Techniques that I use in determining tax base
2. Determining whether the temporary difference is taxable temporary difference (TTD) or deductible temporary difference (DTD).

For item no.1 above, the way that I use in determining tax base is by imagining the amount that would appear in the tax Statement of Financial Position (tax SOFP) if we prepare financial statements using tax rule.

To fully understand tax base, you will need to use some imagination. Normally, we adopt IAS/IFRS in preparing financial statements (we will call this accounting rule). However, let's just imagine, if we were to use income tax rule to prepare financial statements, the financial statements will become something like this:

Tax Statement of Profit or Loss (Tax SOPL)

For tax purpose, we are concerned with taxable income and deductible expenses as these two items will determine taxable profit as well as the tax expenses. Thereafter, we also have the non-taxable income as well as non-deductible expenses in our tax SOPL. The final figure is the profit for the year.

Note: In practice we don't prepare SOPL using this manner. This is just my imagination.

Tax Statement of Financial Position (Tax SOFP)

If we prepare the SOPL using tax rule, the amount recognised in SOFP will also be different (due to different double entry).

The general idea is that tax base is the amount of asset or liability that is recognised in the tax SOFP if we prepare financial statements using tax rule.

Consider the definition of tax base in IAS 12 below:

The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.

We can thus interpret tax base as the amount that is recognised in tax SOFP.

In a tax SOFP, we also have asset, liability and equity. As we know the basic accounting equation is:

Asset - Liability = Equity

In any case, I came across the following in Facebook:

17 Equations that changed the World..
Posted by Electronic Engineering on Thursday, August 1, 2019

I was wondering why accounting equation is not included.

Allow me to add on the #18:
Accounting Equation: Asset - Liability = Equity
Luca Pacioli, 1494 😂😂😂

Luca Pacioli, a.k.a. Thanos 😂😂😂

Anyway back to deferred tax. About the accounting equation, the idea when we calculate deferred tax is that we are going to compare all the assets and liabilities in both our accounting SOFP as well as tax SOFP (i.e. comparing carrying amount and tax base). We can ignore equity when we calculate deferred tax (since we already considered all the assets and liabilities).

Note: For this post, I will refer to the financial statements prepared using tax rule as "imaginary tax financial statements" because really, it is just my imagination ok 😂😂😂

You will understand more once you look into the different scenarios that I will illustrate below. But before we go into that, we will look into how do we determine whether a temporary difference is a taxable temporary difference or deductible temporary difference.

Taxable Temporary Difference (TTD) or Deductible Temporary Difference (DTD)?

In general, TTD means we are going to pay more tax in the future and DTD means we are going to pay lesser tax in the future. TTD will result in deferred tax liability whereas DTD will result in deferred tax asset. For the detailed explanation of what are these items, you can refer to Part 1.

There is a quick way to determine whether a temporary difference is TTD or DTD. You can use the following table in exam:

Note: CA represents carrying amount (value in accounting SOFP) whereas TB represents tax base (value in tax SOFP).

To illustrate:

1. For an asset, if the CA is larger than the TB, the difference is a TTD.
2. For an asset, if the CA is smaller than the TB, the difference is a DTD.
3. For a liability, if the CA is larger than the TB, the difference is a DTD.
4. For a liability, if the CA is smaller than the TB, the difference is a TTD.

All you need to do is to memorise the one that I highlighted in yellow (i.e. the first point above). For the rest, all you need to do is just to fill in the table by following the arrows as shown below:

Notice the arrow above? Yes, there is an animation. It is a gif. You can trust your eyes

When you fill in the table, all you need to do is to insert a reverse entry. In other words, for the column CA > TB, when you move down the arrow from TTD, you will fill in DTD. Then when you move to the right, you are going to fill in TTD. Then finally, when you move up, you will fill in DTD.

With this, we can now look into the different scenarios for deferred tax.

Tax Base of Assets

Before we go into the details, let's look at the definition of the tax base of an asset according to IAS 12:

The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount.

In short, there are two main points:

(a) If an amount is deductible in the future (e.g. asset in which we can claim capital allowance), then that amount is the tax base for an asset.

(b) If we have an asset (e.g. receivable) in which we need not pay additional tax in the future when we receive the money, then tax base is equal to its carrying amount.

The various examples below would illustrate the two main points above.

1. Property, Plant and Equipment (PPE) which qualifies for capital allowance (tax depreciation)

This is the scenario that I have covered in Part 1. In this case, if we have a PPE in which we can claim capital allowance or tax depreciation, then we will have a tax base for that PPE.

Scenario: An entity purchased a machine for $100. The useful life is 5 years. For tax purpose, the entity can claim 50% tax depreciation. As such, for the first year,

CA = $100 - $100/5 = $80
TB = $100 - $100 x 50% = $50

If we were to apply tax rule in preparing financial statements, our tax SOFP will have an asset of $50 (after we charge 50% tax depreciation in our tax financial statements). As such, $50 is the tax base, indicating that we can claim $50 capital allowance in the future (an amount which is deductible in the future).

As we can see above, the CA is larger than TB. Referring to the table, as this is an asset, this represents a TTD which is equal to $30 ($80-$50).

Reason for TTD: The tax depreciation is faster than the accounting depreciation. In other words, the entity will pay lesser tax this year. In the future, the entity will have lesser or no tax depreciation if compared to accounting depreciation. This will result in higher tax payable in the future (hence TTD).

2. PPE which does not qualify for capital allowance (tax depreciation)

I have also covered this scenario in Part 1.

Scenario: An entity purchased a piece of land for $100 which does not qualify for capital allowance or tax depreciation.

If we were to prepare financial statements using tax rule, our imaginary tax double entry will be as follows (Note: this is not the real double entry. This is just my imagination of the double entry in the imaginary tax financial statements):

Dr Non-deductible expenses (Tax SOPL) $100
Cr Bank $100

In other words, since the land does not qualify for capital allowance, there is no asset in the tax SOFP. Therefore, the tax base of this land is zero because there is no amount of asset that will be deductible in the future.

As such, CA of the land is $100 and the TB is zero. This is the case when CA > TB. As this is an asset, the difference should be a TTD of $100 (but this is not true, read below).

In Part 1, I mentioned that no deferred tax is recognised for permanent difference. In this case, the difference is a permanent difference because the land will never be deductible for tax purposes (i.e. the accounting treatment will be forever different from the tax treatment). As such, we DO NOT calculate deferred tax for this scenario.

3. PPE under Revaluation Model (IAS 16)

Scenario: An entity purchased a piece of land for $100 which does not qualify for capital allowance or tax depreciation. The land is not depreciated for accounting purpose. However, the entity adopts revaluation model for land under IAS 16. As at year end, the fair value of the land has increased to $120.

Tax treatment: Assume that the land does not qualify for capital allowance. As such, the TB is zero. However, if the entity sell off the land in the future, the gain on disposal is taxable under capital gain tax (in Malaysia this is known as Real Property Gains Tax).

In this case, as explained above, the difference between CA and TB is permanent difference because the land does not qualify for capital allowance. As such, deferred tax calculation is not required.

However, deferred tax calculation will be required on the gain on revaluation as the entity will need to pay capital gain tax in the future. As the entity may need to pay extra tax in the future, this represents TTD and the TTD will be equal to the revaluation gain of $20 ($120-$100).

The accounting double entry for gain on revaluation is as follows:

Dr Land $20
Cr Other Comprehensive Income (OCI) / Revaluation Surplus $20

Notice that the gain is recognised in OCI under revaluation model. As such, it should be noted that the deferred tax on the gain on revaluation should also be recognised in the OCI (the deferred tax treatment should follow the accounting treatment of the asset).

Assuming a tax rate of 25%, the deferred tax liability will be equal to $5 ($20 x 25%). The accounting double entry for this deferred tax liability is:

Dr OCI / Revaluation Surplus $5
Cr Deferred tax liability $5

Take note of the highlighted debit entry, it is to OCI, not to Profit or Loss.

Refer to the following for the extract of the SOPL:

As you can see from the above, the debit entry of the deferred tax is recognised is recognised in OCI (not profit or loss). You can choose to show the deferred tax as a separate line in the OCI or to show the gain on revaluation net of tax (as shown in the extract above).

Note: If the land is an investment property under IAS 40 and it is held under fair value model (i.e. the change in fair value is recognised in SOPL), then the deferred tax will also be recognised in the SOPL. Again, the deferred tax treatment should follow the accounting treatment of the asset.

4. Development Cost (IAS 38)

An entity incurs development cost of $100 and the entire $100 meets the criteria for capitalisation under IAS 38 Intangible Asset.

Tax treatment: Assume that development cost is deductible when it is incurred.

In this case, because the entity has incurred the development cost, the entity will be able to claim a tax deduction this year. The imaginary tax double entry for the imaginary tax financial statements shall be as follows:

Dr Deductible expenses $100
Cr Bank $100

In other words, since the entity has already claimed a deduction for development cost in the current year, there will be no asset in the tax SOFP (because there is no more deduction available in the future). Hence, the tax base is zero.

Therefore, CA = 100 and TB = 0 and as this is an asset, the difference of $100 will be TTD.

Reason for TTD: As the entity has already claimed deduction in this year, the entity will pay lesser tax this year. However, as the entity will have no more deduction in the future. the entity is going to pay more tax in the future. Hence, this is a TTD.

5. Inventory Written Down to Net Realisable Value (NRV)

Purchases of Inventory

When an entity purchases inventory for $100, they will include the inventory in their current asset by

Dr Inventory $100
Cr Bank $100

As such, the carrying amount of inventory is $100.

When the inventory is sold in the future, the entity will:

Dr Cost of sales $100
Cr Inventory $100

Tax treatment: Assuming that when the entity makes a purchase of inventory, a deduction cannot be given now. However, a deduction can be given when the inventory is sold in the future.

As such, the imaginary tax double entry that we have when we prepare the imaginary tax financial statements when we purchase inventory are as follows:

Dr Inventory $100
Cr Bank $100

In this case, we have a tax base of $100 because we can claim a deduction in the future when the inventory is sold.

When the inventory is sold in the future, the imaginary tax double entry will be:

Dr Deductible expenses $100
Cr Bank $100

As the CA = $100 and TB = $100 when the entity purchases the inventory, there will be no temporary difference and no deferred tax. This is because the accounting rule and tax rule are the same (as we can see, the accounting double entry and tax double entry is similar).

Write Down of Inventory

Damaged goods

An entity purchased inventory for $100. The tax rule on purchase of inventory is similar to the previous illustration (i.e. deductible when inventory is sold in the future).

According to IAS 2, if the NRV of the inventory drop to $80 (e.g. due to damaged goods), by applying the lower of cost and NRV rule, the entity will write down the inventory to its NRV by:

Dr Cost of sales (SOPL) $20
Cr Inventory $20

As such, the carrying amount of the inventory is $80 ($100 - $20).

Tax treatment: Assuming that the write down of inventory is a non-allowable expense. However, such write down will only be permitted when the inventory is sold in future.

Because of the write down of inventory is not allowable in the current year, accordingly there is no tax double entry in the imaginary tax financial statements. The tax base of the inventory will remain at $100 as there is no adjustment for tax purpose.

In this case, the CA = $80 and TB = $100. As this is an asset and CA < TB, there will be a DTD of $20.

Reason for DTD: The entity cannot claim deduction for write down of NRV now. As such, the tax will be higher this year. In the future, when the inventory is sold, the entity can pay lesser tax as deduction will be given by then (hence DTD).

6. Impairment of Trade Receivables 

Recognise Credit Sales

When an entity makes a credit sales of $100, the accounting double entry is:

Dr Trade receivables $100
Cr Revenue $100

The carrying amount of the asset (trade receivables) is $100.

Tax treatment: Assuming that credit sales is taxable even though the entity has not received the money from customer.

As such, the tax double entry in the imaginary tax financial statements will be similar to accounting double entry:

Dr Trade receivables $100
Cr Taxable income $100

The tax base of the asset (trade receivables) is $100.

In this case, as the CA = $100 and TB = $100, there will be no temporary difference and no deferred tax. This is because the accounting rule and tax rule are the same.

Impairment of Trade Receivables

Impairment of trade receivables is covered under IFRS 9 Financial Instrument. For example, if we have trade receivables of $100 and we have determined that the trade receivables has been impaired by $20, the accounting double entry is:

Dr Impairment of Trade Receivables (SOPL) $20
Cr Allowance for Impairment of Trade Receivables $20

The carrying amount of the trade receivables is $80 ($100 - $80).

Tax treatment: Similar to the previous illustration, credit sales of $100 is taxable. However, assume that impairment of trade receivables is not an allowable expense. Deduction can only be given in the future if the entity confirms that the trade receivables has already gone bankrupt.

Because of the impairment of trade receivables is not allowable in the current year, accordingly there is no tax double entry in the imaginary tax financial statements. The tax base of the trade receivables will remain at $100 as there is no adjustment for tax purpose.

In this case, the CA = $80 and TB = $100. As this is an asset and CA < TB, there will be a DTD of $20.

Reason for DTD: The entity cannot claim deduction for impairment of trade receivables now. As such, the tax will be higher this year. If the trade receivables really become bankrupt in the future, the entity will be able pay lesser tax in the future (hence DTD) when deduction for impairment of trade receivables is given.

7. Prepaid Expenses

An entity made an advance payment for electricity expenses for the next financial year (prepaid expenses) amounting to $100. The double entry will be:

Dr Prepaid expenses $100
Cr Bank $100

As such, carrying amount of the asset (prepaid expenses) is $100.

Tax treatment: Assuming that the tax law mentions that an entity can only make a deduction for an expense if the expense is paid (i.e. deduction is on cash basis)

In this case, as the entity has already made the payment of $100, the entity will be able to claim a deduction. The imaginary tax double entry in the imaginary tax financial statements will be as follows:

Dr Deductible expenses $100
Cr Bank $100

In other words, since the entity has already claimed a deduction for electricity expenses in this year,  there will no asset in the tax SOFP because there is no more deduction available in the future. As such, the tax base is zero.

Therefore, CA = 100 and TB = 0 and as this is an asset, the difference of $100 will be TTD.

Reason for TTD: As the entity has already claimed deduction in this year, the entity will pay lesser tax this year. However, the entity will have no more deduction in the future. This will result in the entity to pay more tax (in relation to its accounting profit) in the future. Hence, this is a TTD.

Exam shortcut: This scenario is similar to development cost as explained above (the fourth scenario). Just remember that if the tax treatment provides that deduction is on a cash basis, then tax base will be equal to zero.

8. Income Receivable Which Is Taxed on Cash / Receipt Basis

An entity recognises interest income of $100 on accrual basis even though the entity has not received the interest income. The accounting double entry is:

Dr Interest receivable $100
Cr Interest income (SOPL) $100

As such, the carrying amount of interest receivable (asset) is $100.

Tax treatment: Assuming that the tax law mentions that interest income is only taxed when the entity receives the income (i.e. taxed on receipt or cash basis).

As the entity have not receive the income this year, the entity need not pay any tax on the interest income. Accordingly, the entity will not have any imaginary tax double entry.

In other words, because the interest income is not taxable this year, there will be no asset in the tax SOFP. The tax base of the asset will be zero.

Therefore, CA = $100 and TB = $0. As interest receivable is an asset, this represents TTD of $100.

Reason for TTD: The entity will not pay tax this year. However, the entity will pay more tax in the future when they receive the interest income. As such, it is a TTD.

Exam shortcut: As the tax treatment provides that the income will be taxed on receipt or cash basis, the tax base will be equal to zero.

9. Receivables for Non-Taxable Income

An entity has a dividend receivables of $100. The accounting double entry is

Dr Dividend receivables $100
Cr Dividend income $100

As such, carrying amount of the asset is $100.

Tax treatment: Assuming that dividend income is a non-taxable income.

The imaginary tax double entry in the imaginary tax financial statement is

Dr Dividend receivables $100
Cr Non-taxable income $100

Tax base is also equal to $100.

As the CA and TB are the same, there will be no deferred tax.

Note: As mentioned previously in the definition of tax base for asset, "if those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount."As dividend income is not taxable, the TB shall be equal to its CA.

Alternatively, you can also argue that as the income is not taxable, the difference represents a permanent difference and deferred tax should be ignored. Both analysis will result in no deferred tax calculation.

10. Loan Receivable

A loan receivable has a carrying amount of $100. The accounting double entry is:

Dr Loan Receivable $100
Cr Bank $100

As such, carrying amount of the asset is $100.

Tax treatment: When loan is given out, there is no tax consequence. When the loan is being repaid back to the entity, there is also no tax consequence.

In this case, the imaginary tax double entry in the imaginary tax financial statement is the same as the accounting double entry, i.e.

Dr Loan Receivable $100
Cr Bank $100

Tax base is also equal to $100.

As the CA and TB are the same, there will be no deferred tax.

Note: As mentioned previously in the definition of tax base for asset, "if those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount." As the repayment of loan has no tax implication (i.e.not taxable), the TB shall be equal to the CA.

That's all for this post! I believe you will have a lot to digest for now.

In my next post, I will discuss about how do we determine tax base for liability. Stay tuned!

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