Income Taxes and Fair Value Measurement
Deferred tax and fair value measurement
This domain tests temporary differences, DTA recognition, tax bases, expected reversal rates and the IFRS 13 hierarchy. Deferred tax arises on temporary differences between carrying amount and tax base. Recognise a deferred tax liability for taxable temporary differences; recognise a deferred tax asset only if probable taxable profit will be available. Do not discount deferred tax. The initial recognition exception applies to certain assets or liabilities that do not affect accounting or taxable profit and are not part of a business combination.
- Measure at tax rates expected to apply when the asset is realised or the liability settled, based on enacted or substantively enacted rates.
- Fair value is the exit price in the principal market between market participants.
- Hierarchy: Level 1 quoted prices; Level 2 observable inputs; Level 3 unobservable inputs.
- Highest and best use applies to non-financial assets; liability fair value includes own credit risk.
Worked example
A warranty provision of 100,000 is deductible for tax when paid. Carrying amount is 100,000; tax base is 0; the deductible temporary difference is 100,000. At a 25% tax rate, recognise a deferred tax asset of 25,000 only if future taxable profit is probable. If no probable profit exists, the DTA is not recognised.
Traps
- Discounting deferred tax.
- Recognising a DTA on all tax losses without assessing probable profit.
- Using transaction price instead of fair value on day one.
- Ignoring highest and best use for land.