Deferred tax is a liability that arises due to the difference between the financial reporting tax base and the tax base used for tax purposes. The purpose of deferred tax is to ensure that the company’s taxable income in a future period matches its taxable income for the current period.
Deferred tax is recorded as a liability in the balance sheet and is calculated as the difference between the taxable income and the taxable expense for the current period.
Audit Risks
- Misinterpretation of tax laws and regulations – Deferred tax can be difficult to calculate due to the complexity of tax laws and regulations.
- The mismatch between taxable and financial reporting – The mismatch between taxable and financial reporting can lead to incorrect calculation of deferred tax.
- Timing differences – Timing differences between the recognition of taxable and financial reporting income can lead to incorrect calculation of deferred tax.
- Accuracy of tax rate assumptions – The accuracy of tax rate assumptions is critical in the calculation of deferred tax.
- Inconsistency in the recognition of taxable and financial reporting items – Inconsistency in the recognition of taxable and financial reporting items can lead to incorrect calculation of deferred tax.
- Misclassification of taxable items – Misclassification of taxable items can lead to incorrect calculation of deferred tax.
- Lack of documentation – Lack of documentation can make it difficult to verify the calculation of deferred tax.
- Changes in tax laws and regulations – Changes in tax laws and regulations can lead to incorrect calculation of deferred tax.
- Management bias – Management bias can lead to incorrect calculation of deferred tax.
- Materiality threshold – Deferred tax may be immaterial and may not be subject to audit procedures.
Audit Assertions
- Existence – Deferred tax exists as a liability in the balance sheet.
- Accuracy – Deferred tax is calculated accurately.
- Completeness – All taxable and financial reporting items are included in the calculation of deferred tax.
- Cut-off – Deferred tax is recorded in the correct period.
- Valuation – Deferred tax is recorded at the correct amount.
- Classification – Deferred tax is recorded in the correct account.
Walkthrough Testing
Walkthrough testing involves reviewing the documentation and procedures used to calculate the deferred tax to ensure that the calculations are accurate. The auditor should review the tax laws and regulations, tax rate assumptions, and taxable and financial reporting items used in the calculation of deferred tax.
Test of Control
Test of control involves testing the internal controls over the calculation of deferred tax to ensure that the calculations are accurate and consistent. The auditor should review the controls over the accuracy and completeness of the taxable and financial reporting items used in the calculation of deferred tax, the controls over the accuracy of the tax rate assumptions, and the controls over the completeness of the documentation used to calculate deferred tax.
Substantive Audit Procedure
Substantive audit procedures are audit procedures performed to obtain sufficient and appropriate audit evidence to support the auditor’s conclusions on the financial statements.
These procedures are performed after the auditor has completed the walkthrough testing and test of controls and are designed to test the completeness, accuracy, and validity of the financial statement information.
When auditing deferred tax, the following substantive audit procedures can be performed:
- Understanding the company’s tax position and tax laws, including any changes to tax laws and regulations.
- Reviewing the company’s documentation on deferred tax, including tax returns and tax calculations.
- Reconciling deferred tax amounts reported in the financial statements with the amounts recorded in the company’s tax records.
- Performing substantive analytical procedures to identify any unusual trends or fluctuations in deferred tax amounts.
- Reviewing and testing the company’s calculation of temporary differences and the recognition of deferred tax assets and liabilities.
- Testing the company’s processes for monitoring deferred tax balances, including reviewing any changes or updates to deferred tax amounts.
- Examining supporting documentation for deferred tax amounts, including contracts, agreements, and other relevant documentation.
- Performing substantive testing of deferred tax amounts, such as performing sample tests on transactions affecting deferred tax balances.
- Evaluating the company’s assumptions and methodology for estimating deferred tax amounts, including evaluating the reasonableness of the assumptions used.
- Reviewing the company’s disclosure of deferred tax information in the financial statements, including the disclosure of any significant deferred tax amounts and the related accounting policies.
By performing these substantive audit procedures, the auditor can obtain sufficient and appropriate evidence to support their conclusions on the deferred tax amounts and ensure the accuracy of the financial statement information.