Deferred Tax Adjustments

Welcome back. In our previous lesson, we navigated the complex classification rules for financial assets under IFRS 9. We saw how the accounting treatment is driven by the company's business model and the asset's cash flow characteristics. This focus on aligning accounting with economic reality is a core theme in advanced financial reporting.

Today, we address another critical and often challenging topic that sits at the intersection of accounting standards and tax law: Deferred Tax. This concept, governed by IAS 12, is essential for accurately preparing year-end financial statements.

Your learning objective for this lesson is to calculate and record year-end adjustments for deferred tax assets and liabilities. We will demystify this topic by first understanding why deferred tax exists, then learning the mechanics of how to calculate it, and finally applying it through practical examples relevant to the Moroccan context.

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1. The Core Problem: Two Sets of Rules

At the heart of deferred tax is a simple fact: companies keep two sets of books, not for any dubious reason, but because they must follow two different sets of rules.

• Accounting Profit is calculated according to accounting standards (like IFRS or Moroccan GAAP). The goal is to provide a fair representation of the company's performance over a period (the accrual basis).
• Taxable Profit is calculated according to the rules set by the tax authorities (in our case, the Moroccan Code Général des Impôts). The goal is to determine the amount of tax payable for a period.

These two profit figures are often different because the rules for recognizing income and expenses can vary significantly. To begin, let's clarify this fundamental distinction.

These differences between accounting and tax rules can be of two types: permanent or temporary.

Permanent Differences

These are differences that will never reverse. They arise when an income or expense item is recognized for accounting purposes but is never recognized for tax purposes, or vice-versa.

Common examples in Morocco include:

• Fines and penalties (amendes et pénalités), which are an accounting expense but are not tax-deductible.
• The portion of Corporate Income Tax (Impôt sur les Sociétés - IS) itself, which is an expense but obviously not deductible for its own calculation.

Permanent differences do not create deferred tax. They are simply adjusted in the current year's tax calculation to move from accounting profit to taxable profit.

Temporary Differences

These are the differences that give rise to deferred tax. A temporary difference is a difference between the accounting and tax treatment of an item that will reverse in a future period. For example, an expense may be recognized in 2024 for accounting but only become tax-deductible in 2025. The difference originates in 2024 and reverses in 2025.

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2. The Balance Sheet Method: Identifying Temporary Differences

IAS 12 requires us to use the "balance sheet method" to identify and measure temporary differences. The logic is to compare the value of assets and liabilities in the accounting records with their value for tax purposes.

The formula is:
$\text{Temporary Difference}=\text{Carrying Amount (CA)}-\text{Tax Base (TB)}$

• Carrying Amount (CA): This is the value of an asset or liability as recorded on the balance sheet according to accounting rules. You are already familiar with this concept.
• Tax Base (TB): This is the value attributed to an asset or liability for tax purposes. This is the new, crucial concept to master.

Let's watch a video that defines these terms and then provides clear examples of how to determine the tax base for both assets and liabilities.

As the video explains, a simple way to think about the Tax Base is:

• For an Asset: What is the amount that will be deductible for tax purposes in the future?
• For a Liability: What is the portion of the liability that will not be deductible in the future?

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3. Deferred Tax Liabilities vs. Deferred Tax Assets

Once you have the temporary difference, you multiply it by the applicable future tax rate to get the deferred tax amount. This amount will be either a liability or an asset.

Deferred Tax Liability (DTL)

A DTL arises from a taxable temporary difference. This occurs when a difference will result in more tax being paid in the future. It's essentially a pre-payment of an accounting expense relative to tax, or a delay in tax payment relative to accounting income.

The most common cause is when the Carrying Amount of an asset is greater than its Tax Base (CA > TB).

• Classic Example: A company uses straight-line depreciation over 5 years for accounting, but the tax law allows for accelerated depreciation over 3 years. In the early years, tax depreciation is higher than accounting depreciation, leading to lower taxable profit now. This creates a temporary difference that will reverse later (when tax depreciation ends but accounting depreciation continues), resulting in higher tax payments later. This future obligation is the DTL.

Deferred Tax Asset (DTA)

A DTA arises from a deductible temporary difference. This occurs when a difference will result in less tax being paid in the future. It's a "tax saving" stored up for a future period.

This typically occurs when the Carrying Amount of an asset is less than its Tax Base (CA < TB) or when the Carrying Amount of a liability is greater than its Tax Base (CA > TB).

• Classic Example: A company creates a provision for future warranty repairs of 100,000 DH. This is an expense in the accounting books now (CA of the liability is 100,000). However, tax law only allows a deduction when the repairs are actually paid for (TB of the liability is 0). This creates a deductible temporary difference. The company has paid more tax now than it would have if the expense were deductible. The right to deduct this 100,000 DH in the future is a DTA.
• DTAs also arise from unused tax losses that can be carried forward to offset future profits.

The image below, in French, provides an excellent summary of these concepts.

Test your understanding!

A Moroccan SME, "IndustriePlast SARL," buys a machine.

• Accounting depreciation is linear over 10 years.
• Fiscal (tax) depreciation is degressive over 5 years.

In Year 1, will this situation create a deferred tax asset or a deferred tax liability? Why?

Show answer

It will create a deferred tax liability.

Reasoning:

1. In Year 1, the degressive tax depreciation will be much larger than the linear accounting depreciation.
2. This means the Tax Base of the machine will decrease faster than its Carrying Amount.
3. Therefore, the Carrying Amount will be greater than the Tax Base (CA > TB).
4. A situation where CA > TB for an asset creates a taxable temporary difference, which results in a deferred tax liability. The company is saving tax now but will have to "pay it back" in later years when tax depreciation is zero but accounting depreciation continues.

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4. Calculation and Journal Entries

The deferred tax expense or income for the period is the movement in the deferred tax asset or liability balance from the beginning to the end of the year.

Journal Entry for a Deferred Tax Liability:
When a DTL is created or increases:

• Debit: Deferred Tax Expense (in Profit or Loss)
• Credit: Deferred Tax Liability (on the Balance Sheet)

Journal Entry for a Deferred Tax Asset:
When a DTA is created or increases:

• Debit: Deferred Tax Asset (on the Balance Sheet)
• Credit: Deferred Tax Income (a negative expense in Profit or Loss)

Let's watch a practical, numerical example that walks through the calculation and journal entries for both a DTL and a DTA.

A Moroccan Context Example

Now let's look at a comprehensive example from a Moroccan perspective. This image illustrates the accounting and tax treatment over three years for a low-value asset, referencing the Moroccan tax code.

Take a moment to study this image carefully. Notice:

1. The Table: It shows the reconciliation from the accounting result (Résultat comptable) to the fiscal result (Résultat fiscal) by reintegrating the accounting amortization and deducting the fiscal amortization.
2. The Journal Entries:
   • 6193 (DEA des immobilisations...) records the accounting amortization.
   • 6701 (Impôts sur les bénéfices) records the total tax charge, which is composed of the current tax and the deferred tax.
   • 1431 (Impôts différés passif) is the deferred tax liability account.
3. The T-Accounts: They clearly show how the Amortissement and Impôts différés accounts evolve over the three-year reversal period.

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Conclusion

You have now learned the complete process for dealing with deferred taxes, from the conceptual "why" to the practical "how." This is a key skill for any confirmed accountant, as it is a mandatory and often complex part of year-end closing.

Key Takeaways:

• Deferred tax arises from temporary differences between accounting rules and tax rules. Permanent differences do not create deferred tax.
• The calculation is based on the balance sheet method: Temporary Difference = Carrying Amount - Tax Base.
• A Deferred Tax Liability (DTL) arises from a taxable temporary difference (e.g., when CA > TB for an asset), representing tax to be paid in the future.
• A Deferred Tax Asset (DTA) arises from a deductible temporary difference (e.g., when CA < TB for an asset), representing a tax saving to be realized in the future.
• The amount recorded in the income statement is the movement in the deferred tax asset/liability balance during the period.

Preview of the Next Lesson:
Our work on deferred tax is a perfect lead-in to our final lesson in this module. We will learn how to assemble the main components of the final Moroccan tax and accounting package ('Liasse Fiscale'). You will see how the reconciliation from accounting profit to taxable profit, including the calculation of deferred taxes, forms a critical schedule within this official submission.