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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 depreciation and taxes
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 gets reverse in subsequent years, and we get depreciation as per the life of the machine.

Note: This Article Does Not Belong To Us. For Sharing Knowledgeable Information We Have Taken This Article From Other Site.
Author: Esha Agrawal

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