Question

Briefly explain the concepts of accounting profit, taxable profit, temporary difference, taxable temporary difference, deductible temporary difference, deferred tax assets and deferred tax liability

Answer 1

Accounting Profit:

• Accounting profit is also referred to as bookkeeping profit.
• It is the net income that comes after subtracting all explicit costs from the organization's total revenue as defined by accounting standards or GAAP.
• These explicit costs include raw material costs, labor costs, distribution costs, and other production costs or expenses.
• The main aim is to recognize the business profitability as a whole.

Taxable Profit:

• Taxable profit considers tax liabilities and refers to the profit that is taxable as per income tax guidelines or income tax act.
• It includes accounting profits and other costs.
• The composition of taxable profit varies by taxation authority, so it will vary depending upon the rules of the taxation authorities within which an entity is located or does business.
• The main aim is to derive the tax liability of the business enterprise.

Temporary difference:

• Temporary differences are differences between financial accounting and tax accounting rules that cause the pretax accounting income subject to tax to be higher or lower than the taxable income in current period and lower or higher by an equal amount in future periods.
• A temporary difference can be either of the following:
  • Deductible temporary difference
  • Taxable temporary difference

Taxable temporary difference:

• Taxable temporary differences are timing differences which cause taxable income in current period to be lower than pretax accounting income subject to taxes and hence income tax payable in current period to be lower than the accrual income tax expense.
• The difference between the income tax payable and the accrual income tax equals the deferred tax liability.

Deductible temporary difference:

• Deductible temporary differences are differences which cause the taxable income and hence income tax payable in current period to be higher than the accrual income tax.
• They result in deferred tax asset which is expected to be utilized in future periods to plug the difference between the lower taxable income and income tax payable in future periods.

Deferred tax Asset:

• When profits as per tax laws is more than profits as per books of accounts, Deferred tax asset is required to be created.
• Deferred tax assets are often created due to taxes paid or carried forward but not yet recognized on the income statement.
• Creation of deferred tax asset is subject to the principles of prudence.
• It is shown under the head of Non- Current Assets in the balance sheet.
• Example: Deferred tax assets can be created due to the tax authorities recognizing revenue or expenses at different times than that of an accounting standard.

Deferred Tax Liabilitiy:

• When profits as per tax laws is less than profits as per books of accounts, Deferred tax liability is required to be created.
• A deferred tax liability records the fact the company will, in the future, pay more income tax because of a transaction that took place during the current period
• creation of deferred tax liability is subject to payment of minimum Alternative Tax (MAT)
• It is shown under the head of Non- Current Liability in the balance sheet.