Question

Question 01: When should a deferred tax asset or liability be recognized? (150 words) Question 02: What instances give rise to a deferred tax asset?(150 words) Question 03: What rate should be used?(150 words) Question 04: Should the asset or liability be disclosed separately on the face of the balance sheet?(150 words) Question 05: Are there circumstances where timing differences should not be recognized? (150 words)

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Answer 1

Answer: Answer 1: Introduction : Deferred tax: Deferred tax is the tax effect of timing differences. Type of differences: The differences between taxable income and accounting income can be classified into permanent differences and timing 1. Timing differences: Timing differences are the differences between taxable income and accounting income for a period that 2. Permanent differences : Permanent differences are the differences between taxable income and accounting income for a period that originate in one period and do not reverse subsequently Recognition : The tax effect on the timing differences is termed as deferred tax which literally means taxes which are deferred. Deferred tax is recognised on all timing difference - Temporary and Permanent. Sl.No Entity - Current Entity - Future Effect Pay less tax now Pay more tax in future Entity Profit Status Book profit higher than the Taxable profit Book profit is less than the Taxable profit Creates Deferred Tax Liability (DTL) Creates Deferred Tax Asset (DTA) Pay more tax now Pay less tax in future With respect to timing differences related to unabsorbed depreciation or carry forward losses, DTA is recognised only if there is future virtual certainty. It means DTA can be realized only when the company reliably estimates sufficient future taxable income. This test for virtual certainty has to be done every year on balance sheet date and if the condition is not fulfilled, such DTA/DTL should be written off. While computing future taxable income, only profits pertaining Business and Professional should be considered and not the income from other sources.

Answer 2 : Examples of Deferred Tax Asset : 1- Business Loss The simplest method by which these tax assets is created is when the business incurs a loss. The loss of the Company can be carried forward and set off against the profits of the subsequent years thus reducing tax liability. Hence, such a loss is an asset or deferred tax assets to be precise for the Company, 2-Differences in Depreciation Method in Accounting and Tax Purpose Due to differences in the methods used for depreciation in accounting and tax purposes, this tax asset can be created. There are two methods of depreciation - straight line method and the double depreciation method. In double depreciation method the depreciation expenses more in the initial periods and if this method is used for accounting purposes where a straight-line method is used for tax purposes, the Company will pay more tax than shown in its books. Thus, it will record deferred tax assets in the balance sheet. 3-Differences in Depreciation Rate in Accounting and Tax Purpose Not only the depreciation method but the depreciation rate could cause an occurrence of this tax assets. For example, if a Suppose taxable income is $ 5000 and thus as per this taxable income, the tax will be $ 750 on the income statement and $ 1000 paid to the tax authorities. Hence, there will be a deferred tax asset of 1000-750 = $ 250) due to the difference in depreciation rates In the above two examples i.e. deferred tax assets are arising due to depreciation and carry forward losses. This asset is recorded only if it can materialize in future incomes. The Company checks and prepares a projection of future income statement and balance sheet and if it feels it can be used, it is only then the recorded on deferred tax assets in the balance sheet. If in a certain period, the Company feels that this asset cannot materialize in the future with certainty, it will write off any such entry from deferred tax assets in the balance sheet. 4-Expenses Deferred tax assets can also form when expenses are recognized in the income statement before they are recognized in the tax statement and to tax authorities. For example, some legal expenses are not considered as the expense and thus not deducted immediately in tax statement, however, they are shown as the expense in the income statement.

5- Revenues Sometimes revenue is recognized in one period for tax purposes and in a different period for accounting purposes. If the revenue is recognized for tax purposes before it is done in accounting, the Company will pay tax on such high revenue and thus creating this tax asset. 6 - Warranties Warranties are one of the most common Deferred Tax asset example. Let us say an electrical goods Company has a revenue of $5 million and it has expenses of $3 million thus a profit of $2 million. However, the expenses are bifurcated as $2.5 million for the cost of goods sold, general expenses etc and $0.5 million for future warranties and returns. The tax authorities do not consider future warranties and returns as an expense because this expense has not been incurred but only accounted for. Therefore, the Company cannot deduct such an expense while calculating taxes and thus has to pay tax on $0.5 million as well. Therefore, this amount will be part of the deferred tax assets in the balance sheet. 7-Bad Debts Another example of Deferred tax assets is Bad Debt. Lets assume that a Company has a book profit of $10,000 for a financial year which includes a provision of $500 as bad debt. However, for the purpose of taxes, this bad debt is not considered until it has been actually written off. Thus, the Company will have to pay tax on $10,500 and hence creating this tax asset. If the tax rate is 30%, the Company will make a deferred tax asset journal entry in its book for $150. Conclusion Deferred tax assets in the balance sheet line item on the non-current assets which are recorded whenever more tax is paid by the Company. The amount under this asset is then utilized to reduce future tax liability. It can be caused due to many reasons because there are certain items allowed/disallowed in the tax income statement than in the accounting income statement. The the deferred tax assets calculation of book profits and tax profits may lead to the recording of deferred tax asset. To summarize: This is created whenever the book profit is lower than the taxable profit which causes the Company to pay a higher tax now and lesser tax in the future.

Answer 3: Measurement - what tax should be used ? 1 Current tax should be measured at the amount expected to be paid to (recovered from) the taxation authorities, using the applicable tax rates and tax laws. 2 Deferred tax assets and liabilities should be measured using the tax rates and tax laws that have been enacted or substantively enacted by the balance sheet date. 3 Deferred tax assets and liabilities are usually measured using the tax rates and tax laws that have been enacted. However, certain announcements of tax rates and tax laws by the government may have the substantive effect of actual enactment. In these circumstances, deferred tax assets and liabilities are measured using such announced tax rate and tax laws. 4 When different tax rates apply to different levels of taxable income, deferred tax assets and liabilities are measured using average rates. 5 Deferred tax assets and liabilities should not be discounted to their present value. 6 The reliable determination of deferred tax assets and liabilities on a discounted basis requires detailed scheduling of the timing of the reversal of each timing difference. In a number of cases such scheduling is impracticable or highly complex. Therefore, it is inappropriate to require discounting of deferred tax assets and liabilities. To permit, but not to require, discounting would result in deferred tax assets and liabilities which would not be comparable between enterprises. Therefore, this Standard does not require or permit the discounting of deferred tax assets and liabilities.

Answer 4: Presentation and Disclosure 1 An enterprise should offset assets and liabilities representing current tax if the enterprise: (a) has a legally enforceable right to set off the recognised amounts; and (b) intends to settle the asset and the liability on a net basis. 2 An enterprise will normally have a legally enforceable right to set off an asset and liability representing current tax when they relate to income taxes levied under the same governing taxation laws and the taxation laws permit the enterprise to make or receive a single net payment. 3 An enterprise should offset deferred tax assets and deferred tax liabilities if (a) the enterprise has a legally enforceable right to set off assets against liabilities representing current tax; and (b) the deferred tax assets and the deferred tax liabilities relate to taxes on income levied by the same governing taxation laws. Answer 5: Circumstances where timing differences should not be recoginzed: The carrying amount of deferred tax assets should be reviewed at each balance sheet date. An enterprise should write down the carrying amount of a deferred tax asset to the extent that it is no longer reasonably certain or virtually certain, as the case may be, that sufficient future taxable income will be available against which deferred tax asset can be realised. If sufficient le income will not be available in that case timing differnece should not be recognized