Taxation

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Current Taxation and Deferred Tax Audit Case Example: ABC Manufacturing Company

Context

ABC Manufacturing Company is subject to income tax laws in the jurisdictions it operates in. The company recognizes current tax liabilities for taxes payable on taxable profits and deferred tax assets or liabilities for temporary differences between the carrying amounts of assets and liabilities in the financial statements and their tax bases.

Audit Objective

To obtain reasonable assurance that current tax liabilities and deferred tax assets and liabilities are accurately calculated, appropriately recognized, and sufficiently disclosed in accordance with the applicable financial reporting framework.

Types of Audit Evidence and Documentation for Taxation Assertions

1. Existence and Rights and Obligations (Current Tax Liabilities and Deferred Tax Liabilities)

• Case: Verify the existence of current tax liabilities and deferred tax liabilities, and the company’s obligation to settle these liabilities.

• Documentation: Document the verification process, including reconciliation of the tax expense in the income statement to tax returns and the assessment of legal agreements and correspondence with tax authorities.

2. Completeness

• Case: Ensure all current tax liabilities and potential deferred tax assets and liabilities have been identified and recorded.

• Documentation: Outline procedures for testing completeness, such as reviewing temporary differences not recorded as deferred tax assets or liabilities and tracing amounts from tax returns to the financial statements.

3. Valuation and Allocation (Deferred Tax Assets and Liabilities)

• Case: Assess the valuation of deferred tax assets, including the likelihood of realization, and the correct measurement of deferred tax liabilities based on applicable tax rates.

• Documentation: Summarize the assessment of valuation allowances for deferred tax assets and the application of appropriate tax rates for measuring deferred tax liabilities.

4. Accuracy and Occurrence

• Case: Verify the accuracy of the tax amounts recorded, including the tax base of assets and liabilities, temporary differences, and the tax expense for the period.

• Documentation: Document the testing of tax calculations, including the reconciliation of the starting and ending balances of temporary differences and the tax expense per the financial statements to the company’s tax returns.

5. Presentation and Disclosure

• Case: Review the financial statements to ensure that current tax liabilities, deferred tax assets, and deferred tax liabilities are correctly presented and disclosed in accordance with the financial reporting framework.

• Documentation: Note the evaluation of tax-related disclosures, including the nature of temporary differences, the basis for recognition of deferred tax assets, and the movement in deferred tax balances.

6. Assessment of Internal Controls over Taxation

• Case: Evaluate the design and operating effectiveness of internal controls over the taxation process, including the calculation of current and deferred taxes and compliance with tax laws.

• Documentation: Document the review of controls related to taxation, identifying any control weaknesses and their implications for the audit approach.

7. Inquiries of Tax Advisors and Management

• Case: Make inquiries of management and, if applicable, external tax advisors regarding the approach to calculating current and deferred taxes, including any significant estimates or judgments.

• Documentation: Summarize the inquiries made and the responses received, focusing on areas involving significant judgment, such as the recognition of deferred tax assets.

8. Communication with Those Charged with Governance

• Case: Discuss significant findings related to taxation with those charged with governance, including any issues regarding the recognition, measurement, or disclosure of tax balances.

• Documentation: Prepare a summary of communications with those charged with governance about taxation matters, including any significant risks identified and how they have been addressed.

Conclusion

The audit of current taxation and deferred tax requires a thorough examination of tax balances and transactions to ensure they are accurately reflected in the financial statements according to the applicable financial reporting framework. Documenting the audit procedures and findings related to taxation assertions supports the auditor’s opinion on the financial statements and ensures stakeholders have reliable information regarding the company’s tax positions. This comprehensive approach helps in assessing the company’s compliance with tax laws and the financial reporting of tax-related items.