Background-
There are differences in profit calculated by a business entity in its books and income calculated as per income tax act. We pay tax as per income calculated as per income tax act.
There are 2 types of differences-
1) Permanent differences
These are differences between our accounting income and taxable income that originate in one period but do not reverse subsequently. For eg.-Personal expenses debited to profit and loss account. In books we can debit these expenses in profit and loss account but it is added back while computing income as per income tax act. This expense will never be allowed to us in future also. Thus it is a permanent difference.
2) Timing differences –
These are differences between our accounting income and taxable income that originate in one period and are capable of reversal in subsequent years. For eg- Interest to nationalized banks. Now we can debit it in our books on accrual basis but as per Income tax act it will be allowed only when it is actually paid. Thus suppose in financial year ending 31/03/18 interest is due but not paid we will debit it in our profit and loss account but as per Income tax act it will be added back. Now if we pay this interest in financial year 31/03/19, it will be allowed to us under income tax act in that year. Thus now we will be allowed this expense in IT act but we will not debit it in our books. Thus this is what we call a reversal.
√ Deferred tax asset and deferred tax will arise due to timing differences only.
√ Deferred tax asset / Liability arise in books only when there is difference between income calculated as per Income tax act (taxable income) and income in our books (accounting income) due to timing differences
√ Calculation of DTA/DTL is done as per Accounting standard 22
√ One important thing to remember is that these adjustments which we are going to discuss now are only for books only. Purpose of AS 22 is to record tax expense in books as per income in our books. Tax payment will simply be done as per income calculated as per income tax rules only.
Thus now we shall look into both these terms in detail
Deferred Tax Asset (DTA)
♦ When does DTA arises-
DTA arise when my taxable income is more than my accounting income due to timing difference.
♦ How to calculate DTA
We will understand the calculation through the example discussed below.
Suppose net profit as per books is Rs.100000 for F.Y 17-18 It is arrived at after deducted interest payable to bank of Rs.20000.
Now as discussed profit as per IT act would be 120000 as interest due but not paid will be added back.
Now if presume tax rate to be 30% flat for the purpose of simplicity. Our tax payable will be 120000 * 30% i.e. 36000
Due to timing difference excess tax paid by me is 20000*30% i.e. 6000 This 6000 is my deferred tax asset.
I call it excess because this expense will be allowed to us in subsequent years when we pay the interest.
Now in next year i.e. F.Y 18-19 suppose income in my books is 100000 again and I have paid interest in this year but as I have already debited interest in my books in previous year I will not be debiting same interest again in my profit and loss account.
Now my taxable income would be 100000-20000 interest paid in current year. Taxable income is 80000. Now tax is 24000 i.e. 80000*30%. Now according to books my tax is 100000*30% which is 30000. Thus I pay tax less by 6000. Thus DTA created in previous year is now reversed.
Crux: I have paid excess tax of 6000 which will be adjusted in future, thus this 6000 is my deferred tax asset.
♦ Accounting treatment –
Now we will understand how deferred tax asset is dealt in books of accounts. For this first we should know the journal entry to be passes when DTA is created and when it is reversed.
Journal Entries
When DTA arises
Deferred tax asset a/c dr.
To Profit and loss account
On reversal of DTA
Profit and loss account A/C dr.
To Deferred tax asset A/C
If we take above case in F.Y 17-18 tax paid by us was Rs.36000 Thus if I credit DTA of 6000 to profit and loss account my tax expense for books would be 30000 only. Then in FY18-19 tax paid by us was Rs 24000. Thus if I debit DTA created to profit and loss account my tax expense would be 30000 only for the purpose of recording in books.
♦ Classification of DTA in schedule III Balance sheet
When the DTA is created we will classify it under the head noncurrent assets
Deferred Tax Liability (DTL)
♦ When does DTL arise-
DTL arise when my taxable income is less than accounting income due to timing differences.
♦ How to calculate DTL
We will understand the calculation through the example discussed below.
Profit before depreciation as per books for F.Y 17-18 -100000
For simplicity we will assume Straight line method of depreciation and cost of asset is taken at 30000.
Deprecation as per books- 15000
Thus profit before tax – 85000
Now suppose deprecation calculated as per IT act is- 30000
Income as per IT act would be 85000 +15000-30000 = 70000
Tax rate -30%
Income tax payable = 70000* 30%= 21000
Now tax expense as per books is 85000*30% = 25500.
Thus this difference of 4500 in tax is my deferred tax liability.
Now in F.Y 18-19
Profit before deprecation -100000
Deprecation – 15000
Profit after deprecation – 85000
Now as per IT act 30000 deprecation is already allowed in previous year, income would be 100000 only and tax on it will be 30000.
Tax expense on income as per books – 85000*30%=25500
Thus now excess tax of 4500 is paid. Thus DTL is reversed.
CRUX-Thus this 4500 which I paid less in previous year was my deferred tax liability.
♦ Accounting treatment –
Now we will understand how deferred tax liability is dealt in books of accounts. For this first we should know the journal entry to be passes when DTL is created and when it is reversed.
Journal Entries
When DTL arises
Profit and loss account a/c dr.
To Deferred tax Liabilities a/c
On reversal of DTL
Deferred tax Liabilities a/c dr.
To Profit and loss account a/c
If we take above case in F.Y 17-18 tax paid by us was Rs.21000 Thus if I debit DTL of 4500 to profit and loss account my tax expense for books would be 25500 only. Then in FY18-19 tax paid by us was Rs 30000. Thus if I credit DTL created to profit and loss account my tax expense would be 25500 only for the purpose of recording in books.
♦ Classification of DTL in schedule III Balance sheet
When the DTL is created we will classify it under the head noncurrent liabilities
Author Bio
Very well explained.