Question

What is lease accounting and reporting for lessees?

Lease accounting is going into effect soon. Why is there a change to lease accounting from capital leases to operating leases? What is the difference?

What is the difference between defined benefit plans and defined contribution plans?

What are pension accounting impacts on the balance sheet and income statement?

What is the difference between temporary differences and permanent differences?

How do timing differences create a deferred tax liability and deferred tax asset?

Answer 1

A lease is an arrangement under which a lessor agrees to allow a lessee to control the use of identified property, plant, and equipment for a stated period of time in exchange for one or more payments. There are several types of lease designations, which differ if an entity is the lessee or the lessor.

lease accounting from capital leases to operating leases because of better presentation and preparation accounting and true and fair view of accounting

Difference between capital leases and operating leases

Basis	Operating Lease	Capital Lease
OWNERSHIP	The ownership of the asset remains with the lessor for the entire lease period.	Ownership transfer option at the end of the lease period is there with the lessee.
ACCOUNTING EFFECT	Operating lease is treated generally like renting. That means, the lease payments are treated as operating expenses and the asset does not show on the balance sheet.	A financial lease is treated like loan generally. Here, the asset ownership is considered by the lessee and so asset appears on the balance sheet.

Difference between defined benefit plans and defined contribution plans

Defined benefit plans	Defined contribution plans
Employers guarantee a specific retirement benefit amount for each participant of a defined benefit plan, which can be based on the employee's salary, years of service or a number of other factors. Employees have little control over the funds until they are received in retirement.	Defined contribution plans are funded primarily by the employee, called the participant, with the employer matching contributions to a certain amount.

Difference between temporary differences and permanent differences

temporary differences	permanent differences
Temporary differences are differences between pretax book income and taxable income that will eventually reverse itself or be eliminated. To put this another way, transactions that create temporary differences are recognized by both financial accounting and accounting for tax purposes, but are recognized at different times.	A permanent difference is a difference between the tax expense and tax payable caused by an item that does not reverse over time. In other words, it is a difference between financial accounting and tax accounting that is never eliminated.

Timing differences create a deferred tax liability and deferred tax asset

In some cases there is a difference between the amount of expenses or incomes that are considered in books of accounts and the expenses or incomes that are allowed/disallowed as per Income Tax.

A very common example of this is depreciation. For companies, depreciation rates to be considered in books of accounts are defined in companies act but while calculating Income Tax the depreciation will be allowed only as per rates given in Income Tax Act. Therefore, there is difference between income as per books and taxable income as per IT Act.

In accordance with the matching concept of accounting, taxes on income are accrued in the same period as the revenue and expenses to which they relate. Because there is a difference between income as per books and taxable income as per IT Act, this matching concept is not followed. So, only income tax related to income as per books is shown as expense in books of account and the rest amount is shown as DTA or DTL.

It should also be noted that DTA and DTL are to be considered only when it is a temporary difference. Temporary difference is a difference which is going to be settled in subsequent years. For example – In case of depreciation, if depreciation rate is 20% as per books and 15% as per income tax then depreciation on Rs. 1,00,000 is allowed in following manner.

Year	Depreciation @ 20%	Depreciation @ 15%
1	20,000	15,000
2	16,000	12,750
3	12,800	10,837.5
4	1,0240	9,211.88
5	8,192	7,830.09
6	6,553.6	6,655.58
7	5,242.88	5,657.24
8	4,194.3	4,808.66
9	3,355.44	4,087.36
10	2,684.36	3,474.25
11	2,147.48	2,953.12
12	1,717.99	2,510.15
13	1,374.39	2,133.63

As you can see in above example the depreciation as per books is more for first 5 years but this difference in then reversing from the 6th year. A DTA or DTL is to be made only for such temporary difference which are to be reversed in future.