what is the rationale for recognising a deferred tax asset or deferred tax liability?

Expert Solution

Ans: The rationale for recognizing Deferred Tax Asset or Deferred Tax Liability is TIMING DIFFERENCE.

Company derives its book profits from the financial statements prepared in accordance with the rules of companies act and it calculates its taxable profit based on provision & rules of Tax Act.

There is a difference between the book profit and taxable profit because of certain items which are specifically allowed and disallowed for tax purpose. This difference between the book and the taxable income or expense is known as timing difference and it can be either:

1. Temporary Difference – Differences between book income and tax income which are capable of reversing in subsequent period. Expenses allowable in future, eg. – Sales tax Payable.

2. Permanent Difference – Differences between book income and tax income which are not capable of reversing in subsequent period. Expenses that are disallowed permanently, eg – Fines & penalties.

Temporary differences are defined as being differences between the carrying amount of an asset (or liability) within the Statement of Financial Position and its tax base ie the amount at which the asset (or liability) is valued for tax purposes by the relevant tax authority.

Taxable temporary differences are those on which tax will be charged in the future when the asset (or liability) is recovered (or settled).

The tax effect on the timing differences is termed as deferred tax which literally means taxes which are deferred. Deferred tax is recognized on all timing difference – Temporary and Permanent.

These deferred taxes are given effect to in the financial statements through Deferred Tax Asset and Liability as under:

S.no	Entity Profit Status	Current Year	Future Year	Creation of
1	Book Profits > Tax Profits(Tax authorities provided excess allowance of Expenditure as compared to Book Profits)	Pay Less Tax now	Pay More Tax in Future	Deferred Tax Liability
2	Tax Profits > Book Profits (Tax authorities disallowed allowance of Expenditure as compared to Book Profits)	Pay More Tax now	Pay Less Tax in Future	Deferred Tax Liability

There is no DTA or DTL provisions made for permanent differences.

ekkarill92 answered 8 months ago

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