Financial Accounting · Statement of profit or loss and other comprehensive income

Income Tax, Finance Costs and Dividends in the Statement of Profit or Loss

Updated 11 October 2026 · Fact-checked

The income tax charge is the current year's estimate plus any under provision or minus any over provision from last year. Finance costs are loan interest charged on an accruals basis. Dividends are distributions of profit, so they appear in the statement of changes in equity, not in profit or loss.

Understand Income Tax, Finance Costs and Dividends in the Statement

A company pays tax on its profit. At the year end the exact tax bill is not yet known, so the company estimates it. The estimate is charged as an expense in profit or loss and a liability is recorded in the statement of financial position.

The estimate is rarely exact. When the tax authority settles the bill later, the amount paid differs from the earlier estimate. The difference is not restated in the old year. It is corrected in the current year's tax charge. If last year's estimate was too low, you have an under provision and the current charge goes up. If it was too high, you have an over provision and the current charge goes down.

Finance costs are the interest a company pays on loans, such as loan notes. Interest is an expense of the period it relates to, whether or not cash has been paid. So you calculate the full year's interest (loan × rate × time) and accrue any unpaid part. It is shown after operating profit and before profit before tax.

Dividends are different. They are a distribution of profit to owners, not an expense of earning it. They never reduce profit for the year. They are shown in the statement of changes in equity as a deduction from retained earnings. Preference share dividends are the exception: if the shares are classified as liabilities, the dividend is treated as a finance cost.

Key formulas to remember

Income tax charge: Tax charge = current year estimate + under provision − over provision; Shown in profit or loss between profit before tax and profit for the year.
Under provision: Under provision = tax actually settled − prior year estimate (when settled is higher); Increases the charge in the current year.
Over provision: Over provision = prior year estimate − tax actually settled (when estimate is higher); Reduces the charge in the current year.
Finance cost: Finance cost = loan × interest rate × fraction of year outstanding; Charge the full amount for the year. Accrue the unpaid part as a current liability.
Profit for the year: Profit before tax − income tax charge; Dividends are not deducted here.
Closing retained earnings: Opening retained earnings + profit for the year − dividends recognised in the year; Done in the statement of changes in equity. Deduct a dividend only if it was paid in the year, or declared on or before the reporting date. A final dividend declared after the year end is not a liability at the year end, so it is disclosed only and not deducted.

How to solve Income Tax, Finance Costs and Dividends in the Statement questions

Use this order for any question mixing tax, interest and dividends.

1Read the trial balance. Note the tax liability balance, any tax estimate for the year, the loan and its rate, and any dividends.
2Work out the prior year adjustment. Compare the opening tax liability balance with the amount paid or settled. Decide if it is an under or over provision.
3Calculate the tax charge: current estimate plus under provision or minus over provision.
4Calculate the finance cost for the full year. Check the date of issue or repayment if the loan changed during the year.
5Identify the accrual: finance cost minus interest already paid. Add it to current liabilities.
6Place items correctly: finance cost above profit before tax, tax below it.
7Keep dividends out of profit or loss. Deduct them in the statement of changes in equity.
8Calculate the closing tax liability (current year estimate only) for the statement of financial position.

Quickest way: Charge and liability shortcut

When to use it: Use in number entry or multiple choice questions with limited time.

Closing tax liability in the statement of financial position = this year's estimate only.
Tax charge in profit or loss = estimate ± the prior year difference in the tax liability account.
Under provision: after the opening liability is settled, a debit balance is left in the tax account. Transfer it to the income tax expense, so it is added to the charge.
Over provision: after the opening liability is settled, a credit balance is left in the tax account. Transfer it to the income tax expense, so it is deducted from the charge. Once the balance is cleared, only the current year estimate remains as the closing liability.
Finance cost = full year interest. Ignore cash paid for the charge.
If the option says dividends reduce profit, it is wrong.

Common mistakes in Income Tax, Finance Costs and Dividends in the Statement

Showing under or over provision as a restatement of last year's profit.
It feels natural to correct the year the error came from.
Fix: It is a change in estimate. Adjust the current year's tax charge only.
Subtracting an under provision from the tax charge.
Students mix up the direction of the adjustment.
Fix: Under means too little was charged before, so you charge more now: add it. Over provision is deducted.
Including the prior year adjustment in the closing tax liability.
The adjustment sits in the same ledger account.
Fix: The liability at year end is only the current year's estimate. The adjustment is cleared through the charge.
Using cash interest paid as the finance cost.
Students forget the accruals concept.
Fix: Calculate loan × rate × time. Accrue any unpaid interest.
Deducting ordinary dividends in profit or loss.
Dividends look like a payment out of profit.
Fix: Ordinary dividends go in the statement of changes in equity. Only liability-classified preference dividends are finance costs.
Ignoring part-year loans.
Students skim the dates.
Fix: Multiply by the months outstanding ÷ 12 for loans issued or repaid mid-year.

Worked examples

Example 1

At 1 January the tax liability was $18,000. During the year the company settled it by paying $20,500. The estimated tax for the current year is $26,000. Calculate the tax charge in profit or loss and the closing tax liability.

Show the solution

Compare the settlement with the opening provision: $20,500 − $18,000 = $2,500 under provision.
Tax charge = $26,000 + $2,500 = $28,500.
Closing liability = current year estimate only = $26,000.

Answer: Tax charge $28,500; closing tax liability $26,000.

Example 2

A company issued $400,000 of 6% loan notes on 1 April. The year end is 31 December. Interest is paid annually on 31 March, and none has been paid yet in this period. Profit before finance costs is $150,000. Tax is estimated at $27,000 and there is an over provision of $1,500 from last year. An ordinary dividend of $20,000 was paid during the year. Calculate profit for the year and state where the dividend appears.

Show the solution

Finance cost = $400,000 × 6% × 9 ÷ 12 = $18,000.
Accrued interest = $18,000, as nothing has been paid and the first payment is not due until 31 March of next year.
Profit before tax = $150,000 − $18,000 = $132,000.
Tax charge = $27,000 − $1,500 = $25,500.
Profit for the year = $132,000 − $25,500 = $106,500.
The dividend is not deducted in profit or loss. It was paid in the year, so it is deducted from retained earnings in the statement of changes in equity.

Answer: Profit for the year is $106,500. The $20,000 dividend paid in the year appears in the statement of changes in equity as a deduction from retained earnings.

Exam tips

Draw a quick tax liability T-account in number entry questions. It makes under and over provision obvious.
Read multiple response options carefully: statements like dividends are an expense are a typical trap.
Check dates on loans. A part-year loan changes the finance cost.
Remember the order: finance cost before profit before tax, tax after it.
Keep the closing tax liability separate from the tax charge. Questions often ask for one and offer the other as a distractor.

Practice questions from Statement of profit or loss and other comprehensive income

Income Tax, Finance Costs and Dividends in the Statement in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

NISM CertificationsTaxation of Dividend, Interest and Other Income

Income Tax, Finance Costs and Dividends in the Statement: frequently asked questions

Are dividends in the statement of profit or loss?

No. Dividends are a distribution of profit to owners. They appear in the statement of changes in equity. The exception is a dividend on preference shares classified as liabilities, which is a finance cost.

When is a dividend deducted in the statement of changes in equity?

Deduct a dividend in the year it is paid, or in the year it is declared if that is on or before the reporting date. A final dividend declared after the year end is not a liability at the year end. It is disclosed in the notes only and is not deducted in that year.

How do I treat tax under provision in profit or loss?

Add the under provision to the current year's estimated tax charge. Do not change last year's figures. The total is the income tax expense shown.

What is the difference between under and over provision?

Under provision means the earlier estimate was lower than the final bill. Over provision means it was higher. Under increases the current charge and over decreases it.

How do I calculate loan interest when no interest has been paid?

Calculate the full interest for the period as loan × rate × time. Charge it to profit or loss and show the unpaid amount as an accrual in current liabilities.