Deferred tax is a concept whereby a liability is recognized in the financial statement due to the difference between the carrying amount of an asset or liability in the financial statement and its tax base. This difference is referred to as a temporary difference.

This results in a deferred tax liability which is the amount of income tax payable in future periods. Depending on the nature of the asset or liability, it may result in a deferred tax asset or deferred tax liability.

Deferred tax assets are created when the tax base of an asset or liability is higher than its carrying amount in the financial statement, resulting in a future income tax benefit. On the other hand, deferred tax liabilities are created when the tax base of an asset or liability is lower than its carrying amount in the financial statement, resulting in a future income tax expense.

Audit procedures for deferred tax involve verifying the recognition and measurement of the deferred tax assets and liabilities, ensuring that they are based on reliable estimates, and assessing whether any changes in deferred tax assets or liabilities are appropriate. It also involves assessing the adequacy of the disclosure of deferred tax assets and liabilities in the financial statements.

Audit Deferred Tax

Assessing the timing differences between when revenue is recognized for financial reporting purposes and when it is recognized for tax purposes is essential for accurate reporting of deferred taxes. The purpose of the audit procedure is to determine the accuracy of the deferred tax reported on the financial statements.

An audit procedure should assess the reasonableness of the assumptions the company has used to calculate the amount of deferred tax liability or asset. The auditor should also assess the accounting policies of the company related to deferred taxes to ensure that they are in accordance with the applicable accounting standards.

The auditor should also obtain sufficient evidence to support the deferred tax balance. This evidence should include a review of the financial statements, tax returns, and other relevant documents. The auditor should also verify the accuracy of the deferred tax balances by utilizing analytical procedures, such as comparing the deferred tax balances to prior period balances. The auditor should also consider the appropriateness of the related disclosures in the financial statements.

Audit Assertion

Evaluating the accuracy of the deferred tax balances on the financial statements requires an audit assertion. This assertion is used to determine the existence, rights, and obligations of the organization related to the deferred tax liabilities and assets. The audit assertion should be based on the information provided in the financial statements and should be supported by tangible evidence.

1. Existence and Presentation:

• Verify that the recorded deferred tax liability accurately reflects the existence of temporary differences between accounting and taxable income arising from current and future transactions.
• Ensure proper classification of the deferred tax liability within the balance sheet framework.

2. Measurement and Valuation:

• Assess the completeness and accuracy of the calculations underlying the deferred tax liability, including identification of all temporary differences and application of the appropriate tax rate(s).
• Evaluate the reasonableness of the chosen valuation methods and assumptions used to estimate the future tax consequences of temporary differences.

3. Cut-off and Periodicity:

• Confirm that the deferred tax liability is recorded in the correct accounting period, reflecting the timing of temporary differences and their expected reversal.
• Verify that changes in deferred tax estimates are appropriately classified and accounted for in the current period.

4. Disclosure and Transparency:

• Ensure disclosures related to deferred tax liabilities are presented fairly and comprehensively, providing adequate explanations of the nature and amount of the liability, along with any critical accounting judgements employed.

Audit Risk

When auditing deferred taxes, there is a risk of inaccurate or incomplete information leading to misstatements in the financial statements. Misinterpretation of tax laws and regulations can complicate the calculation of deferred tax and lead to incorrect calculation of the amount, as can the mismatch between taxable and financial reporting.

Timing differences in recognizing taxable and financial reporting income can also result in a misstatement of deferred tax.

The following audit risks should be considered when auditing deferred taxes:

• Errors in the calculation of deferred tax
• Misstatement due to incorrect application of tax rates
• Misstatements due to incorrect recognition of timing differences
• Misstatement due to incorrect recognition of permanent differences
• Misstatement due to incorrect recognition of valuation allowance

The auditor should ensure that each of these risks is addressed to ensure that the deferred tax balance is properly reflected in the financial statements. Careful consideration should be given to the tax laws, regulations, and judgments that affect the calculation of deferred tax to allow for an accurate assessment of the deferred tax balance.

Audit Procedure

The auditor must carefully assess the accuracy of deferred tax balances by performing certain procedures. These procedures include reconciling deferred tax amounts in financial statements with tax records, performing analytical procedures to identify unusual trends, reviewing and testing the calculation of temporary differences, evaluating the company’s assumptions and methodology for estimating deferred tax amounts and performing substantive testing of deferred tax amounts through sample tests on transactions.

Additionally, the auditor should review and test any processes for monitoring deferred tax balances and review any changes or updates. Lastly, the auditor should evaluate the disclosure of deferred tax information in financial statements.

Audit procedures for deferred tax are designed to ensure that the financial statements accurately reflect the deferred tax balances and that the company complies with the relevant tax laws. Through these procedures, the auditor is able to determine if the financial statements are fairly presented following the applicable financial reporting framework. The procedures also help to assure that the company’s processes for monitoring and calculating deferred tax balances are adequate.

1. Documentation Review:

• Critically evaluate company documentation like tax returns, calculations, and internal memos, assessing accuracy and completeness in reflecting underlying transactions and temporary differences.

2. Reconciliation and Consistency:

• Reconcile deferred tax amounts reported in financial statements with corresponding entries in tax records, verifying consistency and identifying discrepancies requiring further investigation.

3. Analytical Procedures:

• Perform substantive analytical procedures on deferred tax trends and fluctuations, assessing reasonableness and identifying potential areas for misstatements.

4. Temporary Differences and Recognition Testing:

• Review and test the company’s methodology for identifying and calculating temporary differences, ensuring recognition of deferred tax assets and liabilities complies with GAAP and relevant tax regulations.

5. Process Monitoring and Updates:

• Evaluate the company’s processes for monitoring deferred tax balances, assessing controls over changes and updates to ensure timely and accurate adjustments.

6. Supporting Documentation Verification:

• Scrutinize supporting documentation for deferred tax amounts, including contracts, agreements, and regulatory guidance, confirming consistency with underlying transactions and calculations.

7. Substantive Testing:

• Conduct substantive tests on deferred tax balances, including sample testing of transactions and tax positions affecting the calculation, to validate accuracy and completeness.

Conclusion

In conclusion, deferred tax is an accounting concept that can be audited. The audit process involves assessing assertions, analyzing risk, and performing various procedures.

In order to assess the reasonableness of the deferred tax amounts, auditors must evaluate the underlying transactions, assess the appropriateness of the accounting policies, and ensure compliance with the applicable accounting standards.

Through such procedures, auditors can provide assurance that the amounts reported in the financial statements are accurate and reliable. Furthermore, effective audit planning and execution will help ensure that all significant risks are addressed and any necessary adjustments are made.

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