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ACCA Financial Accounting
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Introduction
1. The context and purpose of financial reporting
2. Accounting principles, concepts and qualitative characteristics
3. Double-entry bookkeeping and accounting systems
4. Recording transactions and events
5. Reconciliations
6. Preparing trial balance
7. Preparing financial statements
7.1 Statements of profit or loss and financial position
7.1.1 An introduction
7.1.2 Extracting the statements from general ledgers
7.1.3 Income tax expense
7.1.4 The formats
7.1.5 Walkthrough question one
7.1.6 Walkthrough question two
7.2 Statement of cash flow
7.3 Incomplete records
7.4 Events after the reporting period
7.5 Disclosure-notes
8. Preparing basic consolidated financial statements
9. Interpretation of financial statements
Wrapping up
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7.1.3 Income tax expense
Achievable ACCA Financial Accounting
7. Preparing financial statements
7.1. Statements of profit or loss and financial position
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Income tax expense

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This chapter explains how to record income tax expense in financial statements. It covers:

  • The current year tax calculation
  • Prior year adjustments (under- and over-provisions)

Learning objectives

By the end of this chapter, you should be able to record income tax expense in the statement of profit or loss, including any under-/over-provision of tax from the prior year.

Definitions
Income tax expense
The tax charge for the year in the statement of profit or loss: the current year tax estimate, adjusted for any under- or over-provision from the prior year.

At this level, it helps to think of income tax expense as having two parts:

  1. Current year tax
  2. Prior year adjustment

So, total income tax expense is:

  • Current year tax
  • Plus or minus the prior year adjustment

Current year tax

Definitions
Current year tax
This is the tax the company expects to pay on the current year’s profit to the government authorities. It is calculated by applying the tax rate to the taxable profit.

For example, if a company has a taxable profit of $100,000 and the tax rate is 25%, the current year tax expense is $25,000 (25% × $100,000). Taxable profit can differ from accounting profit (profit before income taxes), because tax rules and accounting rules don’t always treat items the same way. In exam questions, the current year’s tax estimate is usually given to you directly rather than calculated, so to keep the illustrations below simple, we’ll assume taxable profit equals profit before income taxes.

In practice, the final tax payable is confirmed by the tax authorities after the year-end (often a few months later), using the audited financial statements. That means the current year tax shown in the financial statements is an estimate, not the final agreed amount.

Because it relates to the tax that will be paid later, the current year tax creates:

  • An expense in the statement of profit or loss
  • A liability (income tax payable) shown as a current liability in the statement of financial position

Prior year adjustments

Definitions
Prior year adjustments
When companies prepare their accounts, they estimate the tax they will pay. Later, when they agree on the actual amount with the tax authorities, it might be different. The difference between the estimated and actual income tax from the previous year is the prior year adjustment. The difference must be adjusted in the current year’s tax expense.

Types of prior year adjustments

Definitions
Under-provision
Arises when the tax expense is underestimated. That is, the actual income tax for the previous year is more than the estimated tax reported. This increases the tax expense. It shows as a debit balance on the tax account in the trial balance. Over-provision
Arises when the tax expense is overestimated. That is, the actual income tax for the previous year is less than the estimated tax reported. This decreases the tax expense. It shows as a credit balance on the tax account in the trial balance.

Illustration: recording tax expense

You have been given the following about a company.

  • Current year tax (20X8): $60,000
  • Prior year (20X7) estimated tax was: $50,000
  • Actual 20X7 tax agreed and paid in 20X8: $52,000

Required: Determine

  1. the total tax expense to be reported on the statement of profit or loss
  2. the tax liability to be reported on the statement of financial position

Suggested solution:

Part 1: total tax expense to be reported on the statement of profit or loss

(spoiler)

Total tax expense = Current year tax expense ± over/under provision

Over/under provision = Actual tax - Estimated tax = $52,000 - $50,000 = $2,000

Since the actual tax for the previous year is more than what was estimated, the difference is an under-provision. An under-provision increases the current year’s tax expense.

Total tax expense = $60,000 + $2,000 = $62,000.

This is reported in the statement of profit or loss as follows:

$
Profit before income taxes X
Income tax expense (62,000)
Profit for the year X

Part 2: tax liability to be reported on the statement of financial position

(spoiler)

Only the current year tax expense of $60,000 would be reported as a current liability on the statement of financial position. The 20X7 liability has already been settled at the agreed $52,000, so the $2,000 difference goes to profit or loss only; the year-end liability is the 20X8 estimate of $60,000.

Illustration 2: from trial balance to the financial statements

At 31 December 20X8, a company’s trial balance includes an income tax account with a credit balance of $3,000. This is the balance remaining after the 20X7 tax liability of $50,000 was settled for an agreed $47,000. The year-end estimate of tax on 20X8 profits is $60,000.

Required: Determine

  1. the double entry needed to record the current year tax estimate
  2. the total tax expense to be reported in the statement of profit or loss
  3. the tax liability to be reported in the statement of financial position

Suggested solution:

Part 1: double entry for the current year tax estimate

(spoiler)
  • Dr income tax expense: $60,000
  • Cr income tax payable: $60,000

This records the estimate of tax on 20X8 profits as both an expense and a liability.

Part 2: total tax expense to be reported on the statement of profit or loss

(spoiler)

The $3,000 credit balance on the income tax account is the over-provision left over from 20X7 (actual tax of $47,000 was $3,000 less than the $50,000 estimated). It came from settling the 20X7 liability:

  • Dr income tax payable: $50,000
  • Cr cash: $47,000
  • Cr income tax: $3,000

A credit balance on the tax account means an over-provision, so it’s deducted from the current year’s tax expense:

Total tax expense = $60,000 - $3,000 = $57,000

Part 3: tax liability to be reported on the statement of financial position

(spoiler)

The tax liability is the 20X8 year-end estimate of $60,000. The $3,000 over-provision relates to a liability that was already settled in cash, so it doesn’t reduce the liability carried forward.

Income tax expense basics

  • Formula: Income tax expense = Current year tax ± prior year adjustment (under-/over-provision)
  • Current year tax = tax rate × taxable profit; figure given in exams, treated as an estimate until agreed with tax authorities
  • Creates an expense (statement of profit or loss) and a current liability (income tax payable) on statement of financial position

Prior year adjustments

  • Arise when prior year’s actual agreed tax differs from the prior year’s estimate
  • Under-provision: actual tax > estimated tax → increases current year’s tax expense; appears as debit balance in trial balance
  • Over-provision: actual tax < estimated tax → decreases current year’s tax expense; appears as credit balance in trial balance

Applying adjustments to statements

  • Statement of profit or loss: report total tax expense = current year estimate adjusted by prior year difference (add under-provision, subtract over-provision)
  • Statement of financial position: report only the current year’s tax estimate as the liability — prior year’s settled liability doesn’t affect this year’s closing liability
  • Example: current year tax $60,000, prior year under-provision $2,000 → total expense $62,000; liability = $60,000 (current year estimate only)

Trial balance to financial statements

  • A credit balance on the income tax account in the trial balance represents a carried-forward over-provision from settling prior year tax for less than estimated
  • Double entry for current year estimate: Dr income tax expense / Cr income tax payable
  • Total expense = current year estimate minus any over-provision (or plus under-provision) brought forward
  • Year-end liability = current year’s estimate only, regardless of prior year settlement adjustments

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Income tax expense

This chapter explains how to record income tax expense in financial statements. It covers:

  • The current year tax calculation
  • Prior year adjustments (under- and over-provisions)

Learning objectives

By the end of this chapter, you should be able to record income tax expense in the statement of profit or loss, including any under-/over-provision of tax from the prior year.

Definitions
Income tax expense
The tax charge for the year in the statement of profit or loss: the current year tax estimate, adjusted for any under- or over-provision from the prior year.

At this level, it helps to think of income tax expense as having two parts:

  1. Current year tax
  2. Prior year adjustment

So, total income tax expense is:

  • Current year tax
  • Plus or minus the prior year adjustment

Current year tax

Definitions
Current year tax
This is the tax the company expects to pay on the current year’s profit to the government authorities. It is calculated by applying the tax rate to the taxable profit.

For example, if a company has a taxable profit of $100,000 and the tax rate is 25%, the current year tax expense is $25,000 (25% × $100,000). Taxable profit can differ from accounting profit (profit before income taxes), because tax rules and accounting rules don’t always treat items the same way. In exam questions, the current year’s tax estimate is usually given to you directly rather than calculated, so to keep the illustrations below simple, we’ll assume taxable profit equals profit before income taxes.

In practice, the final tax payable is confirmed by the tax authorities after the year-end (often a few months later), using the audited financial statements. That means the current year tax shown in the financial statements is an estimate, not the final agreed amount.

Because it relates to the tax that will be paid later, the current year tax creates:

  • An expense in the statement of profit or loss
  • A liability (income tax payable) shown as a current liability in the statement of financial position

Prior year adjustments

Definitions
Prior year adjustments
When companies prepare their accounts, they estimate the tax they will pay. Later, when they agree on the actual amount with the tax authorities, it might be different. The difference between the estimated and actual income tax from the previous year is the prior year adjustment. The difference must be adjusted in the current year’s tax expense.

Types of prior year adjustments

Definitions
Under-provision
Arises when the tax expense is underestimated. That is, the actual income tax for the previous year is more than the estimated tax reported. This increases the tax expense. It shows as a debit balance on the tax account in the trial balance. Over-provision
Arises when the tax expense is overestimated. That is, the actual income tax for the previous year is less than the estimated tax reported. This decreases the tax expense. It shows as a credit balance on the tax account in the trial balance.

Illustration: recording tax expense

You have been given the following about a company.

  • Current year tax (20X8): $60,000
  • Prior year (20X7) estimated tax was: $50,000
  • Actual 20X7 tax agreed and paid in 20X8: $52,000

Required: Determine

  1. the total tax expense to be reported on the statement of profit or loss
  2. the tax liability to be reported on the statement of financial position

Suggested solution:

Part 1: total tax expense to be reported on the statement of profit or loss

(spoiler)

Total tax expense = Current year tax expense ± over/under provision

Over/under provision = Actual tax - Estimated tax = $52,000 - $50,000 = $2,000

Since the actual tax for the previous year is more than what was estimated, the difference is an under-provision. An under-provision increases the current year’s tax expense.

Total tax expense = $60,000 + $2,000 = $62,000.

This is reported in the statement of profit or loss as follows:

$
Profit before income taxes X
Income tax expense (62,000)
Profit for the year X

Part 2: tax liability to be reported on the statement of financial position

(spoiler)

Only the current year tax expense of $60,000 would be reported as a current liability on the statement of financial position. The 20X7 liability has already been settled at the agreed $52,000, so the $2,000 difference goes to profit or loss only; the year-end liability is the 20X8 estimate of $60,000.

Illustration 2: from trial balance to the financial statements

At 31 December 20X8, a company’s trial balance includes an income tax account with a credit balance of $3,000. This is the balance remaining after the 20X7 tax liability of $50,000 was settled for an agreed $47,000. The year-end estimate of tax on 20X8 profits is $60,000.

Required: Determine

  1. the double entry needed to record the current year tax estimate
  2. the total tax expense to be reported in the statement of profit or loss
  3. the tax liability to be reported in the statement of financial position

Suggested solution:

Part 1: double entry for the current year tax estimate

(spoiler)
  • Dr income tax expense: $60,000
  • Cr income tax payable: $60,000

This records the estimate of tax on 20X8 profits as both an expense and a liability.

Part 2: total tax expense to be reported on the statement of profit or loss

(spoiler)

The $3,000 credit balance on the income tax account is the over-provision left over from 20X7 (actual tax of $47,000 was $3,000 less than the $50,000 estimated). It came from settling the 20X7 liability:

  • Dr income tax payable: $50,000
  • Cr cash: $47,000
  • Cr income tax: $3,000

A credit balance on the tax account means an over-provision, so it’s deducted from the current year’s tax expense:

Total tax expense = $60,000 - $3,000 = $57,000

Part 3: tax liability to be reported on the statement of financial position

(spoiler)

The tax liability is the 20X8 year-end estimate of $60,000. The $3,000 over-provision relates to a liability that was already settled in cash, so it doesn’t reduce the liability carried forward.

Key points

Income tax expense basics

  • Formula: Income tax expense = Current year tax ± prior year adjustment (under-/over-provision)
  • Current year tax = tax rate × taxable profit; figure given in exams, treated as an estimate until agreed with tax authorities
  • Creates an expense (statement of profit or loss) and a current liability (income tax payable) on statement of financial position

Prior year adjustments

  • Arise when prior year’s actual agreed tax differs from the prior year’s estimate
  • Under-provision: actual tax > estimated tax → increases current year’s tax expense; appears as debit balance in trial balance
  • Over-provision: actual tax < estimated tax → decreases current year’s tax expense; appears as credit balance in trial balance

Applying adjustments to statements

  • Statement of profit or loss: report total tax expense = current year estimate adjusted by prior year difference (add under-provision, subtract over-provision)
  • Statement of financial position: report only the current year’s tax estimate as the liability — prior year’s settled liability doesn’t affect this year’s closing liability
  • Example: current year tax $60,000, prior year under-provision $2,000 → total expense $62,000; liability = $60,000 (current year estimate only)

Trial balance to financial statements

  • A credit balance on the income tax account in the trial balance represents a carried-forward over-provision from settling prior year tax for less than estimated
  • Double entry for current year estimate: Dr income tax expense / Cr income tax payable
  • Total expense = current year estimate minus any over-provision (or plus under-provision) brought forward
  • Year-end liability = current year’s estimate only, regardless of prior year settlement adjustments

More from Statements of profit or loss and financial position

  • An introduction
  • Extracting the statements from general ledgers
  • The formats
  • Walkthrough question one
  • Walkthrough question two