Accounting income and Taxable income FRA

Accounting Standard 22 has been prescribed by ICAI to be applied in accounting for taxes on income. This AS is applied to match the differences between accounting income and taxable income.

1. Accounting income is the net profit before tax for a period, as reported in the profit and loss statement.

2. Taxable income is the income on which income tax is payable, computed by applying provisions of the Income Tax Act, 1961 & Rules.

DIFFERENCE BETWEEN THE TWO

The differences can be of two types:

a. Timing difference

Timing differences are those differences between accounting income and taxable income which can be reversed in one or more subsequent periods. For example, Depreciation allowed as per WDV method for computing taxable income and as per SLM method for computing accounting income.

b. Permanent difference

Permanent differences are those differences between accounting income and taxable income which cannot be reversed any subsequent period. For example, Donation paid in cash is disallowed in computing taxable income whereas it is allowed as expenditure while computing accounting income.

There can be differences between accounting income and taxable income because of the following reasons :
1. Expenses debited in profit and loss statement, but disallowed as per Income Tax Act 1961, while computing taxable income

2. Provision for Bad/doubtful debts allowed while computing accounting income, but disallowed while computing taxable income

3. Charging depreciation using different rates as per Companies Act 2013 and Income Tax Act 1961

4. Any income recognized on an accrual basis in profit and loss statement but recognized on receipt basis in subsequent period for computing taxable income.
In order to account for these kinds of differences, AS 22 needs to be applied.

APPLICATION OF AS 22

AS 22 needs to be applied when there are differences between taxable income and accounting income. If taxable income is greater than accounting income, then it will result in deferred tax asset. And if accounting income is greater than taxable income, then it will result in deferred tax liability.

When the difference is resulting in deferred tax asset, then it should be recognized only when there is a reasonable certainty of its realization. The recognition of deferred tax asset should be to the extent of the reasonable certainty of the expected realization. The reasonable certainty can be determined by making the realistic estimates of future profits based on the examination of profits and loss statement of earlier periods.

Say, an entity has unabsorbed depreciation or carry forward of losses. In such a case, deferred tax asset should be recognized to the extent there is a virtual certainty supported by convincing evidence. Virtual certainty is a matter of judgment of convincing evidence, which should be available in a concrete form at a particular date.

Comparison between AS 22 and IND AS 12

Basis	AS 22 Accounting for Taxes on Income	IND AS 12 (Income taxes)
Recognition	AS 22 recognized tax effect of differences between taxable income and accounting income.	IND AS 12 recognized tax effect of differences between assets and/or liabilities and their tax base.
Approach	AS 22 is based on profit or loss statement approach.	IND AS 12 is based on balance sheet approach.
Differences	The types of differences on which AS 22 is applied are timing differences and permanent differences.	The types of differences on which IND AS 12 is applied are taxable temporary differences and deductible temporary differences. Permanent differences are not dealt in by this standard.
Recognition of Deferred tax asset/deductible temporary differences	DTA is recognized only when and to the extent there is a reasonable certainty of its realization	Deductible temporary differences are recognized to the extent of the probability of taxable profits in future periods.
Disclosure	AS 22 deals with the disclosure of DTA/DTL in the balance sheet.	IND AS 12 deals with the recognition of current or deferred tax as income or expense in profit and loss statement. It also deals with the disclosure of out of profit and loss transaction in the balance sheet as current or non-current assets/liability.
Revaluation of assets	AS 22 does not cover the difference arising between taxable income and accounting income due to the revaluation of assets.	IND AS 12 deals with the difference between carrying the amount of revalued asset and its tax base.
Goodwill	AS 22 does not cover the difference arising due to goodwill arising a business combination.	As per IND AS 12, the difference between carrying the amount of goodwill and its tax base (which will be NIL) is the taxable temporary difference. It does not allow the recognition of such difference because goodwill is measured as a residual and its recognition would increase the carrying amount of goodwill.
The concept of virtual certainty	When an entity has unabsorbed depreciation or carry forward of losses then in such a case deferred tax asset should be to the extent there is a virtual certainty supported by convincing evidence.	There is no concept of virtual certainty in IND AS 12. Deductible temporary differences are recognized to the extent of the probability of taxable profits in future periods.
Tax holiday	AS 22 specifically provides guidance regarding recognition of deferred tax in the situations of Tax Holiday under Sections 80-IA, 80-IB, 10A and 10B of Income-tax Act.	IND AS 12 does not specifically deal with the situations of the tax holiday.
Capital Loss	AS 22 provides guidance regarding recognition of DTA in case of loss under the head of ‘capital gains’.	IND AS 12 does not specifically provide for the same.

SIMPLIFIED ANALYSIS OF AS 22

Deferred Tax is the tax effects of Timing Difference. The whole concept of deferred tax is depend on timing difference. Before proceeding further we need to understand the meaning of Accounting Income and Taxable Income.

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.

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.

As per AS-22 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.

In Simple words, Timing Difference is those items of Expense/Income which creates difference between Accounting Income and taxable Income of a period and subsequent period.

Items creating the difference between Accounting Income and Taxable Income can be categorized into Permanent difference and Timing difference.

Permanent difference: Permanent differences are those items of Expense/income that make difference between Accounting Income and Taxable Income of a period but does not make any difference between Accounting Income and Taxable Income of subsequent period (s). Eg:- Donation made (F.Y. 2014-15) to a person (not permissible u/s 80G of Income tax Act) is allowed as expense while computing accounting income but does not allowed as expense while computing taxable income (because not permissible u/s 80G) for that period and hence it makes difference between Accounting Income and Taxable Income of that period. This donation is permanently disallowed by Revenue authority, hence it shall not make any difference between Accounting Income and Taxable Income of subsequent period.

Timing Difference: Timing Difference is those items of Expense/Income which creates difference between Accounting Income and taxable Income of a period and subsequent period.

Eg:- A asset is purchased of rs. 1,00,000 having useful life of 5 year and allowed 100% depreciation under Income Tax Act. Profit before depreciation is rs. 2,00000.

Rs. 20,000 (100,000/5) is allowed as depreciation while computing the accounting income and rs. 1,00,000 is allowed as full depreciation in year of purchase while computing the taxable income. Hence,

Accounting Income is rs. 1,80,000 (2,00,000-20,000)

Taxable Income is rs. 1,00,000 (2,00,000-1,00,000)

Therefore, difference between Accounting Income and Taxable Income is created in this year and shall be created in subsequent 4 year (by the balance depreciation of rs. 80,000=1,00,000-20,000) because in subsequent years, while computing the accounting income entity shall deduct the depreciation of rs. 20,000 but nil depreciation shall be allowed while computing the taxable income. This is called timing difference.

Some example of timing difference with explanation:

1. Provision for Bed/Doubtful debts (because this is deducted 100% when computing the accounting income but disallowed while computing taxable income.)

2. Expense on payment basis, like expense u/s 43B of Income tax Act (expenses are allowed on accrual basis while computing the accounting income but some expense are allowed on payment basis while computing the taxable income.)

3. Allowance of Excessive depreciation (at the time of computing the taxable income excess depreciation is allowed u/s 32 and 32AC of income tax act but for the purpose of accounting income no such excessive depreciation is allowed)

4. While computing the income for accounting purpose some income is recognised in the given period but same income is recognised in subsequent period for computing the taxable income.

5. Preliminary expenses are fully deductible as expense in first year for computing the accounting income but same expense is allowed in the five installment u/s 35D of income tax act while computing the taxable income.

6. Unabsorbed depreciation and carried forward loss is also an example of deferred tax.

7. Charging depreciation under different methods for the purpose of accounting income and taxable income.

In one line, we can describe the timing difference as

Timing Difference is those items of Expense/Income which creates difference between Accounting Income and taxable Income of a period and subsequent period.

Current Tax: Current Tax is the income tax payable (recoverable) for current year.

Tax Expense (Saving): Tax Expense is aggregate of current tax and deferred tax charged or credited to the statement of profit and loss for the period.

3. Categorization of Deferred Tax: Deferred tax is of two type i.e. Deferred tax Asset and Deferred Tax Liability. When there is a timing difference that shall result in tax saving in future period then it shall be recognised as Deferred tax Asset (DTA).

Eg. Disallowance of provision for gratuity while computing the taxable income. This disallowance shall result in DTA, since we know that once amount of gratuity is paid on subsequent year same shall be allowed as deduction for computing the taxable income.

Eg. Excess/fully depreciation allowed for tax purpose but SLM method of depreciation has adopted for accounting purpose. In such case, we have to make provision for tax {i.e. Deferred Tax Liability (DTL)} because less/nil depreciation shall be allowed for tax purpose in subsequent years this shall result in excess income tax liability. So keeping in mind the concept of prudence one shall make the provision of this excess tax liability in subsequent year.

4. Recognition: Deferred tax should be recognised for all the timing differences, subject to the consideration of prudence in respect of deferred tax assets as set out in paragraphs 15-18 of AS-22.

As per para 15, deferred tax assets should be recognised and carried forward only to the extent that there is a reasonable certainty that sufficient future taxable income will be available against which such deferred tax assets can be realised.

As per para 16, While recognizing the tax effect of timing differences, consideration of prudence cannot be ignored. Therefore, deferred tax assets are recognised and carried forward only to the extent that there is a reasonable certainty of their realisation. This reasonable level of certainty would normally be achieved by examining the past record of the enterprise and by making realistic estimates of profits for the future.

As per para 17, Where an enterprise has unabsorbed depreciation or carry forward of losses under tax laws, deferred tax assets should be recognised only to the extent that there is virtual certainty supported by convincing evidence that sufficient future taxable income will be available against which such deferred tax assets can be realised.

Determination of virtual certainty that sufficient future taxable income will be available is a matter of judgment based on convincing evidence and will have to be evaluated on a case to case basis. Virtual certainty refers to the extent of certainty, which, for all practical purposes, can be considered certain. Virtual certainty cannot be based merely on forecasts of performance such as business plans. Virtual certainty is not a matter of perception and is to be supported by convincing evidence. Evidence is a matter of fact. To be convincing, the evidence should be available at the reporting date in a concrete form, for example, a profitable binding export order, cancellation of which will result in payment of heavy damages by the defaulting party. On the other hand, a projection of the future profits made by an enterprise based on the future capital expenditures or future restructuring etc., submitted even to an outside agency, e.g., to a credit agency for obtaining loans and accepted by that agency cannot, in isolation, be considered as convincing evidence.

5. Re-assessment of Unrecognised Deferred Tax Assets: At each balance sheet date,  an enterprise re-assesses unrecognized deferred tax  assets. The enterprise recognises previously unrecognized deferred tax assets to the extent that it has become reasonably certain or virtually certain, as the case may be (see paragraphs 15 to 18), that sufficient future taxable income will be available against which such deferred tax assets can be realised. For example, an improvement in trading conditions may make it reasonably certain that the enterprise will be able to generate sufficient taxable income in the future.

6. Treatment in Balance sheet & Statement of P&L:

a). DTA (in the nature of tax saving) is to be added to Net profit and DTL (in nature of provision) is to be deducted from Net profit.

b). If net of DTA and DTL is DTL then same shall be shown under “Non-Current Liabilities” on Liabilities side of balance sheet.

c). If net of DTA and DTL is DTA then same shall be shown under Non-Current Assets after non-current investment on Assets side of Balance Sheet.

7. Whether MAT is a DTA: The definition of asset is “anything which is expected to be provided future economic benefit”. MAT is income tax paid on book profit (a type of taxable income). MAT does not create any difference between accounting income and taxable income since it comes in the scene after computation of accounting income & taxable income. Therefore MAT is not a deferred tax asset.

8. Accounting entries for deferred tax: followings are the accounting entries for deferred tax:-

a). For creating DTA:

DTA a/c                      Dr.

          To P&L a/c

b). For creating DTL:

P&L a/c                   Dr.

          DTL a/c

c). For reversal of DTA in subsequent years:

P&L a/c                      Dr.

          DTA a/c

d). For reversal of DTL in subsequent years:

DTL a/c                   Dr.

          P&L a/c

9. Practical example of Deferred Tax:

Facts: A company has a profit before depreciation & tax Rs. 2,00,000 in each of five year. Company bought a machinery of rs. 60,000 having useful life of 3 year for accounting purpose but for tax purpose 100% depreciation is allowed in first year. There is also a disallowance of rs. 80,000 in 4th year, out of which rs. 40,000 is allowed in 5th year.

Statement of Profit & Loss
Particulars	year-1	Year-2	year-3	year-4	year-5
Profit Before Depreciation & Tax	200,000	200,000	200,000	200,000	200,000
Less: Depreciation	-20,000	-20,000	-20,000	–	–
Accounting Profit (PBT)   (A)	180,000	180,000	180,000	200,000	200,000
Tax Expense:-
Current Tax	-42,000	-60,000	-70,000	-98,000	-56,000
Deferred Tax	-12,000	6,000	6,000	28,000	-14,000
(B)	-54,000	-54,000	-64,000	-70,000	-70,000
Profit After Tax (A-B)	126,000	126,000	116,000	130,000	130,000

–

Computation of Taxable Income
Particulars	year-1	Year-2	year-3	year-4	year-5
Accounting Profit (PBT)   (A)	180,000	180,000	180,000	200,000	200,000
Add: Depreciation as per books	20,000	20,000	20,000	–	–
Less: Depreciation as per income tax Act	-60,000	–	–	–	–
Add: Disallowance	–	–	–	80,000
Less: Allowance	–	–	–	–	-40,000
Taxable Profit	140,000	200,000	200,000	280,000	160,000
Tax rate	30%	30%	35%	35%	35%
Current tax	42,000	60,000	70,000	98,000	56,000

–

Deferred Tax Computation
Particulars	year-1	Year-2	year-3	year-4	year-5
Opening balance of timing difference	–	-40,000	-20,000	–	80,000
Addition	-40,000	–	–	80,000	–
Deletion	–	20,000	20,000	–	-40,000
Closing Balance	-40,000	-20,000	–	80,000	40,000
Tax rate	30%	30%	35%	35%	35%
Deferred Tax	-12,000	-6,000	–	28,000	14,000
DTA/DTL to be shown in Balance Sheet	DTL	DTL	NIL	DTA	DTA
Amount for P&L	-12,000	6,000	6,000	28,000	-14,000
To be Debited/Credited to P&L	Debited	Credited	Credited	Credited	Debited
Reason for Debit/Credit	Creation of DTL	Reversal of DTL	Reversal of DTL	Creation of DTA	Reversal of DTA

–

Entry for Deferred Tax in year-1:
	P&L a/c	Dr.	12,000
	TO DTL a/c			12,000
Entry for Deferred Tax in year-2&3:
	DTL a/c	Dr.	6,000
	To P&L a/c			6,000
Entry for Deferred Tax in year-4:
	DTA a/c	Dr.	28,000
	To P&L a/c			28,000
Entry for Deferred Tax in year-5:
	P&L a/c	Dr.	14000
	TO DTA a/c			14000