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Why AS 22 is applied

ESHA AGRAWAL 
on 10 February 2014

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My aim of writing this article is to discuss with you all why AS 22 is applied, generally this happens we study the whole AS, solve the questions, but we don’t know the crux of it. So friends AS 22 is ”Accounting for taxes on income” and the reason for its application is mentioned below

There could be situations where depreciation is charged in the books over its useful life but for which the entire deduction is claimed in the first year as per tax laws. In other words, the income is charged to tax in year other than the year in which it is recorded in the books of accounts due to varied tax provisions. Thus higher book profits and less tax in the current year cannot completely justify about the profitability of the company, if the tax burden changes in the future. Thus for the purpose of making a provision for tax an income in the same year of its accrual irrespective of its actual due, is the main punch line of this Accounting Standard.

For the purpose of this standard following terms are used with the meaning below:-

1) Accounting income (loss) is the net profit or loss for a period, as reported in the statement of profit and loss, before deducting income tax expense or adding income tax saving.

2) Taxable income (tax loss) is the amount of the income (loss) for a period, determined in accordance with the tax laws, based upon which income tax payable (recoverable) is determined.

3) Tax expense (tax saving) is the aggregate of current tax and deferred tax charged or credited to the statement of profit and loss for the period.

4) Current tax is the amount of income tax determined to be payable (recoverable) in respect of the taxable income (tax loss) for a period.

5) Deferred tax is the tax effect of timing difference

6) Timing difference are the difference between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent period

7) Permanent difference are the difference between taxable income and accounting income for the period that originate in one period and do not reverses subsequently .Permanent difference do not result in deferred tax assets or deferred tax liabilities

ILLUSTRATION

A company, ABC Ltd., prepares its accounts annually on 31st March. On1st April, 2001, it purchases a machine for research purpose at a cost of Rs. 1,50,000. The machine has a useful life of three years and an expected scrap value of zero. Although it is eligible for a 100% first year depreciation allowance for tax purposes the straight-line method is considered appropriate for accounting purposes.ABC Ltd. has profits before depreciation and taxes of Rs. 2,00,000 each year and the corporate tax rate is 40 per cent each year.

The purchase of machine at a cost of Rs. 1,50,000 in 2001 gives rise to a tax saving of Rs. 60,000. If the cost of the machine is spread over three years of its life for accounting purposes, the amount of the tax saving should also be spread over the same period as shown below:

Statement Of Profit And Loss Account

(for the year ending  31st March 2001, 2002, 2003)

  (Rupees in thousands)
  2001 2002 2003
Profit before depreciation and taxes 200 200 200
Less: Depreciation for accounting purposes  50 50 50
Profit before taxes    150 150 150
Less: Tax expense      
Current tax  20 80 80
Deferred tax  40 (20) (20)
Profit after tax     90 90 90
       

Working note 1:- calculation of current tax

Profit before tax    150 150 150
Add:- Depreciation for accounting purposes   50 50 50
Less:- Depreciation for tax purpose     150 0 0
Taxable Income   50 200 200
Tax  @ 40%         20 80 80

Working note 2:- calculation of deferred tax

Timing Difference

Opening balance  0 100 50  
Add:- creation 150 0 0
Less:- reversal 50 50 50
Closing balance     100 50 0
Deferred tax liability 40    
Reversal of deferred tax liability    20 0
Less:- opening balance  0 40 (20)
Transfer to P/L account  40     (20)     (20)

In 2001, the amount of depreciation allowed for tax purposes exceeds the amount of depreciation charged for accounting purposes by Rs. 1,00,000 and, therefore, taxable income is lower than the accounting income. This gives rise to a deferred tax liability of Rs. 40,000. In 2002 and 2003,accounting income is lower than taxable income because the amount of depreciation charged for accounting purposes exceeds the amount of depreciation allowed for tax purposes by Rs. 50,000 each year. Accordingly,deferred tax liability is reduced by Rs. 20,000 each in both the years. As may be seen, tax expense is based on the accounting income of each period. In 2001, the profit and loss account is debited and deferred tax liability account is credited with the amount of tax on the originating timing difference of Rs. 1,00,000 while in each of the following two years, deferred tax liability account is debited and profit and loss account is credited with the amount of tax on the reversing timing difference of Rs. 50,000.

So from the above example we come to know we don’t get any additional depreciation as per income tax on asset in fact whatever additional depreciation we get  that get reverse in subsequent years, and we get depreciation as per the life of the machine.

So i have discussed just a part of this accounting standard, i hope you all will get some knowledge from this. If you have any queries please ask me i will try to solve it, you can mail me at agrawalesha6@gmail.com.

Thanks for reading!

Esha Agrawal


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