Deferred Tax : All About Deferred Tax Asset and Liability

Deferred tax

Many people find deferred tax as a very difficult topic to understand, but the reality is just the opposite.Deferred tax is a simple concept, and one can master it by just understanding the concept properly. Let us understand the concept in detail.

What is deferred tax

Deferred tax is the tax which is calculated on the timing difference. Timing difference is the temporary difference between the profits which are calculated as per Companies Act, 2013 (commonly known as accounting income) and the profits calculated as per the provisions of Income Tax Act, 1961 (commonly known as taxable income).

What is timing difference

Timing differences are the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods.The differences which are not capable of reversal are known as permanent differences. Permanent difference does not result in deferred tax asset or liability. Examples of permanent difference are penalties and fines, donations, political contributions, etc.

How to categorize deferred tax into asset orliability

Deferred tax may be an asset or a liability. Understanding this concept is relatively easier than we actually think. For example:-

Depreciation as per Companies Act = 50,000

Depreciation as per Income Tax Act = 40,000

Tax Rate =30% (say) As per Income Tax Act, 10,000 has been disallowed or we can say that 10,000 has been taxed. This differential amount of 10,000 is known as timing difference. In other words, we can say that, extra tax has been paid on 10,000, as compared to the accounting income.Deferred tax comes out to be 1000030%=3000. So we will get the benefit of 3000 in the later year(s), because we have already paid it in the current year. Hence, this 3000 will be deferred tax asset. Similarly if we pay less tax due to timing difference in the current year, then we will have to pay that in the later years (i.e. when the liability arises in the later year(s)). So, in this case, the amount of tax on timing difference will be deferred tax liability.

Examples of differences giving rise to deferred tax:-

1. Disallowance of bad debts not written off in the current period, which will be allowed in any subsequent period(s).
   
2. Lower Rate of depreciation as per Income Tax Act as compared to the Companies Act and vice versa.
   
3. Certain expenses are allowed on cash basis as per section 43B of the Income Tax Act. Hence, those expenses will be disallowed until those are actually paid, thereby giving rise to deferred tax assets.

How to calculate deferred tax

Opening balance of timing differencexxx

Additions.                                                                                           xxx

Deletions.                                                                                            xxx

Closing balance of timing difference                                            xxx

Deferred tax @30% (say)on closing balance                               xxx

At what rate deferred tax will be calculated

Deferred tax will be calculated at the same rate at which the current income tax is calculated.

What is the accounting entry for deferred tax

Deferred tax asset account is created by crediting Statement of Profit& Loss. The following journal entry is required to be passed for deferred tax asset:-

Deferred Tax Asset A/c            Dr

               To Statement of Profit & Loss

Similarly, deferred tax liability is created by debiting the Statement of Profit & Loss. The following journal entry is required to be passed for deferred tax liability:-

Statement of Profit & Loss      Dr

                   To Deferred Tax Liability A/c

How should deferred tax be disclosed in the balance sheet

The break-up of deferred tax assets and deferred tax liabilities into major components of the respective balance should be disclosed in the notes to accounts.Deferred tax assets and liabilities should be distinguished from assets and liabilities representing current tax for the period. Deferred tax assets and liabilities should be disclosed under a separate heading in the balance sheet of the enterprise, separately from current assets and current liabilities. The break-up of deferred tax assets and deferred tax liabilities into major components of the respective balances should be disclosed in the notes to accounts