Question
Brambleton Tool Works began operations in 2026. Its enacted tax rate is 25% for all years.
- Pretax financial income for 2026 was $320,000.
- Warranty expense of $80,000 was accrued for the books. None of it was paid in 2026; it is deductible for tax only when paid. There are no other differences, so 2026 taxable income is $400,000.
- At December 31, 2026 management concludes it is more likely than not that $6,000 of the deferred tax asset will not be realized.
- At December 31, 2027, after two profitable quarters and a signed long-term contract, management concludes the whole deferred tax asset will be realized.
Required:
- Record 2026 income taxes on December 31, 2026 as one entry using Income Tax Expense, Deferred Tax Asset and Income Taxes Payable.
- Record the valuation allowance on December 31, 2026 using Valuation Allowance for Deferred Tax Asset.
- Record the change in the valuation allowance on December 31, 2027 (ignore all other 2027 tax entries).
Scoring
- 40% Account naming / line matching
- 40% Amount correctness
- 20% Structure / section placement
IAS 12 — Income Taxes
Current tax is the amount payable on the period's taxable profit; deferred tax arises from temporary differences between the carrying amount of an asset or liability and its tax base. Identify the temporary difference first, then apply the rate expected when it reverses.
Common mistakes
- Treating a permanent difference as though it created deferred tax — only temporary differences do.
- Using the current year's tax rate when an enacted future rate applies to the reversal.
- Presenting a deferred tax balance as current — under IAS 1 it is always non-current.
IFRS vs US GAAP: Deferred tax assets under US GAAP use a valuation allowance; IFRS instead recognises only to the extent recovery is probable.
Further readingIAS 12: deferred tax explained