As part of the transition to the Australian International Financial Reporting Standards (AIFRS or A-IFRS), the reporting of income tax has moved from the income statement method (AASB 1020 (1989)) to a balance based method under Accounting Standard AASB 112 – Income Taxes (the Australian equivalent of IAS 12).
The balance sheet method requires a totally new approach to the computation of income tax expense and can result in some very different tax figures being disclosed in the financial statements from the old method. The balance sheet approach also makes reported earnings more sensitive to swings in tax expense resulting from large fluctuations in book and tax balances.
Many CFO’s and Tax Managers have also expressed concern that under IFRS it is not easy to identify the reasons for material impacts on tax expense relating to deferred tax movements in fixed assets and other assets and liabilities that generate large temporary differences.
In Australia, the transition to IFRS was greatly complicated by its interaction with the new tax consolidation regime. Unlike other countries with tax consolidation rules, such as the USA, in Australia the head entity of the consolidated group assumes the entire group’s income tax liability and tax losses. However, recognition of the entire group’s current and deferred tax liabilities in the head entity could have made the head company technically insolvent and contravened core IFRS principles.
Consequently, the Urgent Issues Group (UIG) of the Australian Accounting Standards Board (AASB) issued Interpretation 1052 – Tax Consolidation Accounting (UIG 1052) to provide guidance on the recognition of current and deferred tax balances in a consolidated group, and the relevance of Tax Funding Agreements (TFA) and Tax Sharing Agreements (TSA).
For groups with overseas entities and non-100% owned subsidiaries or associated companies, tax systems need to handle foreign exchange differences and minority interests upon consolidation.
Tax systems used to prepare year-end tax provision calculations need to integrate with tax compliance systems that prepare annual income tax returns, to generate journals for “unders and overs” between these two calculations. In particular, as a key internal control, these systems need to be able to reconcile book and tax balances and temporary differences between these two calculations in order to generate the true-up in deferred tax expense.
From an auditor‘s or reviewer’s perspective, tax-effect accounting systems should provide a full reconciliation of the difference between expected tax expense, using the standard company or entity tax rate on profit, and the actual tax expense, being the movement in current and deferred tax expense. This reconciliation and audit trail should adequately explain the nature of movements in material temporary differences such as fixed assets and capital allowances.