AS 22 is considered a tricky accounting standard and rightly so. This article is an honest effort to explain the same it in simple words.
Deferred tax means providing for the differences between accounting income and taxable income which could arise due to:
- Permanent difference and
- Timing difference
Timing differences mean allowances or disallowances by tax authorities which are capable of reversal in future; and
Permanent differences mean allowances or disallowances which are not capable of reversal.
Let’s take up a few examples for better understanding of timing differences:
As we are aware that depreciation rates of the Companies act and the Income Tax act differ.
Take an asset A with cost Rs 10000.
Depreciation rate (Companies Act) – 15 %
Depreciation rate (Income tax Act) – 25 %
So, the company would have expensed Rs 15000 in P/L account. The tax authorities would allow expense of Rs 25000.
This creates a timing difference of Rs 10000 and in turn deferred tax liability (DTL). Liability because this would be reversed out and is a payable in hands of company.
The company treats bonus not yet paid as expense in current year. This won’t be allowed by tax authorities until it is actually paid. So, this creates a timing difference in the hands of company that an expense is disallowed at present but will be allowed subsequently.
This would lead to creation of deferred tax asset (DTA) in books of company. Asset because it’s a kind of recoverable in hands of company due from tax authorities.
As Praveen Sharma sir explains it “Today it’s a loss, will give benefit in future”
Before creation of DTA, following paragraphs need should be considered.
Whenever any entity does not have c/f of losses or unabsorbed depreciation, then DTA can be created if there is a reasonable certainty that there will be sufficient future taxable income against which DTA could be realised.
Whenever any entity has c/f of losses or unabsorbed depreciation, then DTA can be created only if there is a virtual certainty with convincing evidence (VCCE) that there will be sufficient future taxable income against which DTA could be realised.
These paragraphs are of vital importance considering the prudence assumption as per AS 1.
This is kept in place to avoid cases where entity is a loss making company and keeps on adding lumps of DTA, which would disrupt the motive behind the standard.
- At each year, DTA/DTL should be re-viewed through P/L account
- DTA/DTL should be created using rates for which law have been enacted by law on balance sheet date.
So, these were few basics for AS 22. It would be wonderful to have your views or questions.
Thanks for reading