KAS 12 – PROFIT TAXES

EXPLANATORY NOTE

Explanatory notes to the Kosovo Accounting Standards are intended to provide additional understanding of the standards and technical guidance as to their use and application. In case of any divergence between Explanatory Notes and Standards, the Standards prevail.

1. Income tax expense is reported on the income statement and calculated by taking into consideration both accounting income and taxable income.

2. Accounting income is a total income or loss for the reporting period calculated according to KAS. Taxable income and related taxes payable to the tax authorities are determined in compliance with the tax code.

3. In certain circumstances, tax code requirements used to calculate taxable income differ from accounting requirements according to KAS. For accounting purposes, differences between the tax code and KAS accounting requirements are classified as one of the following:

  • Permanent differences
  • Temporary differences

Income Tax - Permanent Differences

4. One reason for a difference between taxable income and accounting income is that certain items are included in one calculation but are required to be permanently excluded from the other. For example, some expenses are not an allowable deduction in determining taxable income, however ALL expenses are deducted in determining accounting income. Differences like these are described as permanent differences. Permanent differences include expenses that are included in the calculation of the enterprise’s net income but are not allowed for tax purposes. For example, the tax code limits the amount of expense that may be deducted for charitable contributions, while the income statement will report the entire amount.

Examples of Permanent Differences:

5. The following situations are the type of permanent differences that may arise between an enterprise’s net income calculated according to KAS and the enterprise’s taxable income calculated according to tax code requirements:

  • Penalties and fines are included in the income statement but are not allowed as a deduction when calculating taxable income.
  • All charitable contributions are included in the income statement but the amount that may be deducted in calculating taxable income is limited.
  • All representative costs are included in the income statement but the amount that may be deducted in calculating taxable income is limited.
  • All dividend income in included in the income statement, In contrast, the tax code does not require that dividend income from certain resident companies be included in revenue for the calculation of taxable income.

6. As the tax code changes over the years, it may introduce new permanent differences or it may remove existing permanent differences, depending on the taxation policy of the Government.

Income Tax - Temporary Differences

7. Another reason for differences between taxable income and accounting income is that certain items, considered in determining both amounts, are included in the calculation for different periods. Temporary differences are due to discrepancies in the timing of when items are reported in the financial statements and when they are used in the calculation of taxable income.

8. The total of these items included in accounting income and taxable income will ultimately be the same, but the reporting periods will differ. For example, depreciation on a fixed asset will be the same total amount when the fixed asset is totally depreciated, but the amount of depreciation may vary in different reporting periods between amount reported as depreciation expense in the income statement and the amount that is used in calculating taxable income for the same reporting period. These types of differences are described as timing differences.

Examples of Temporary Differences:

9. The circumstances in which temporary differences arise are shown in the following situations. These are the type of timing differences that may arise between an enterprise’s net income calculated according to KAS and the enterprise’s taxable income calculated according to tax code requirements. This is not meant to cover every possible temporary difference.

  • In Kosovo, the amount of anticipated bad debts related to sales and account receivable balances in a reporting period must be estimated and is included on the income statement (per KAS). However, the amount that may be deducted for bad debts (per tax code) in calculating taxable income is the amount that was actually charged off during the reporting period.
  • Also in Kosovo, all repair and maintenance expenses are included in the income statement in the period they are incurred, while the tax code includes a formula that requires the capitalization of repair and maintenance expenditures over a certain amount. When this occurs the income statement will show a lower profit than the amount of taxable income for the reporting period because the income statement will include expenses that cannot be fully deducted during the reporting period. In subsequent reporting periods, the repair and maintenance expenditures that were not allowed all at once as a tax deduction will reduce taxable profit over time as the capitalized amount is depreciated.
  • Another difference arises when the depreciation rate used in determining taxable income differs form that used in determining accounting income. In Kosovo, depreciation is calculated according to KAS and included in the income statement, while guidelines for depreciation stated in the tax code must be applied when calculating taxable income. In addition, depreciation on all fixed assets is calculated according to KAS and included in the income statement, while the tax code allows a certain amount and type of fixed asset expenditures to be deducted when calculating taxable income.

Tracking Differences

10. In order to calculate taxable income, it is necessary that enterprises establish systems that identify and track items that result in permanent and temporary differences. These are items that are treated differently when preparing the income statement according to KAS and when calculating taxable profit.

11. The majority of differences between KAS and the tax code are in the treatment of fixed assets. Since these differences extend over the life of a fixed asset, it is recommended that enterprises maintain separate fixed asset records for calculation and reporting on the financial statements according to KAS, and determination of depreciation for income tax calculations. The difference between depreciation amounts in a reporting period is a timing difference. Activity in the records should be reconciled to insure that all fixed assets are recorded and tracked for both the financial statements and for tax purposes.

Income Tax Expense

12. Total income tax expense reported on the financial statements is comprised of two components. The first component is the actual current amount of taxes payable to the tax authorities for the year based on the application of the tax code. The second component is the deferred tax net result of temporary differences (taxable or deductible temporary differences).

13. The method used to account for the differences calculates the expected future payments and receipts arising out of the differences and records these as either deferred tax liabilities or deferred tax assets.

14. Temporary differences result due to discrepancies in the timing of when items are reported in the financial statements (accounting performed in accordance with KAS) and when they are used in the calculation of taxable income (accounting performed in accordance with the tax code). The sum of timing differences is multiplied by the tax rate in order to determine the balance of deferred taxes (asset or liability).

15. Deferred taxes may either be an asset or a liability, depending upon whether profit calculated according to the tax code is more or less than that determined in the income statement prepared in accordance with KAS.

16. The net amount of all differences that are related to temporary differences is multiplied by the anticipated tax rate in order to determine the balance of the deferred tax asset or liability.

Example of Calculating and Accounting for Taxes in Accordance with KAS 12

Note, the purpose of this example is to illustrate the practical application of KAS 12 (tax expense calculation methodology and financial statement presentation). It is not intended to illustrate all the differences between financial and taxable income

Facts for Example:

1.Accounting profit (net income before tax expense calculated in accordance with KAS) for Kosovo Trading Co. at 31 December 2002 was 410,000

2.Kosovo Trading Co. sold goods worth 448,000 on credit and accounted for the sale in accordance with KAS. The tax code allows that revenue will be taxed on a cash basis and the customer plans on paying Kosovo Trading Co. the full amount in March 2003

3.As at 31 December 2002, the net book value of their depreciable assets per KAS is 450,000, whereas, the tax base value per its tax records is 432,000

4.Kosovo Trading Co. estimated their potential warranty liability for goods sold in the past to be 156,000 at 31 December 2002. The tax code allows warranty expenses to be deducted when the expense is actually incurred, not when it is estimated and accrued in the accounting records.

Required Duties for Accountant of Kosovo Trading Co. to perform at 31/12/2002

1.Calculate all temporary differences as at 31 December 2002

2.Calculate taxable income as at 31 December 2002 (other than the facts given, assume no further information is required to calculate taxable income)

3.Calculate the deferred tax balances as at 31 December 2002

4.Show how the tax expense would be shown in the Income Statement and any deferred tax assets or liabilities in the Balance Sheet as at 31 December 2002.

Practical Application of KAS 12

1.Temporary Differences:

Sales Receivable
Carrying value per KAS448,000

Tax base 0

Taxable temporary difference448,000

Depreciable Assets
Carrying value per KAS450,000

Tax base 432,000

Taxable temporary difference18,000

Warranty Liability
Carrying value per KAS156,000

Tax base 0

Deductible temporary difference156,000

2.Calculation of Taxable Income at 31 December 2002

Accounting Profit per KAS410,000

Temporary Differences

  • Sales Receivable(448,000)
  • Depreciable Assets(18,000)
  • Warranty156,000
Taxable Income100,000

Tax Rate20%

Taxes Payable20,000

3.Summary of Deferred Tax Balances at 31 December 2002

Temporary Difference / Future Taxable (Deductable) Amounts / Tax Rate / Deferred Tax
(Asset)Liability
Sales Receivable / 448,000 / 20% / 89,600
Depreciable Assets / 18,000 / 20% / 3,600
Warranty / (156,000) / 20% / 31,200
31,200 / 93,200

4.Financial Statement Presentation

Income Statement

Income before tax per KAS410,000

Income tax expense:

Current20,000

Deferred (93,200 – 31,200)62,000(82,000)

Income after tax per KAS328,000

Balance Sheet

Current Liabilities

Income taxes payable20,000

Deferred tax liability (89,600 – 31,200)58,400

Long-term Liabilities

Deferred tax liability3,600

According to paragraph 37 of KAS 12, Kosovo Trading Co. is allowed to offset current tax assets and liabilities when certain conditions are met. It is assumed that the conditions have been met, therefore, the deferred tax liability amount in the Balance Sheet of 58,400 is determined by netting the deferred tax liability of 89,600 related to sales receivables with the warranty deferred tax asset. The long-term liability is appropriately classified separately.

Tax Losses

17. The tax code will in many cases allow a current period net loss to be offset against future taxable income. The loss provides tax savings in future periods.

18. The expected future tax savings resulting from a current period loss can be used in the current period tax calculation for accounting purposes if the following statements apply to the enterprise’s situation:

  • Where there is reasonable assurance that future taxable income will be large enough to offset the loss
  • Whether the unused tax losses result from identifiable causes that are unlikely to recur

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