(ii) The need for deferred tax arises because of the temporary differences that exist between
accounting rules for recognition of profits and the equivalent taxation rules. These differences
potentially result in profits being recognised in the financial statements in accounting periods
different from the period in which the entity is liable to pay tax on such profits, leading to a
mismatch between the tax expense in the income statement and the profit against which it is
being charged. The purpose of deferred tax is to alleviate this mismatch by recognising the tax
effect of transactions in the period in which such transactions are recognised in the accounts
rather than the period in which the tax effect actually crystallises in the tax computation.
Chapter 1 of the IASB's Conceptual Framework ('The objective of general purpose financial
reporting') states that financial performance is better reflected by accrual accounting than by
accounting on a cash basis.
Accounting for deferred tax is entirely consistent with this principle. As explained above, the
need for deferred tax arises through a mismatch between the income tax expense and the
accounting profit against which it is being charged. The principle of matching is derived from,
and is an integral part of, the accruals concept.
The Conceptual Framework also contains an underlying assumption, the going concern
concept, i.e. that financial statements are normally prepared on the assumption that an entity
will continue in operation for the foreseeable future. By recognising a deferred tax liability, the
entity is essentially making provision for a tax liability that has yet to crystallise but will
become due and payable in a future period when the temporary difference that caused it
reverses. Hence the implicit assumption is that the entity will continue in operational existence
until this reversal occurs i.e. the entity is a going concern. |
