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 with suitable example.

Answer 1

1.Accounting profit

Accounting profit is the profit earned by an organization found out by reducing the expenses incurred from the revenue earned for the accounting period. The revenue earned and the expense incurred for the year are calculated under the generally accepted accounting principles.

For example- Revenue earned during the year - $ 200; Expenses for the period - $ 100 (including accounting depreciation of $20), the accounting profit for the year is $ 100.

2.Taxable profit

Taxable profit is accounting profit adjusted to accommodate some changes in the items of income and expense with respect to the local taxation laws. This is the profit based on which a business pays income tax for a period.

Continuing the above example - The entire revenue is taxable and the entire expense is allowable under Income tax laws except for the accounting depreciation of $20 for which different method is prescribed under the income tax law leading to depreciation of $25.

In that case the taxable profit will be

Accounting profit	$100
Add-Accounting depreciation (i.e. not allowed as deduction)	$20
Less-Depreciation under tax laws (i.e. allowable as deduction)	$25
Taxable profit	$95

3.Temporary differences

Temporary differences are those differences arising between accounting and taxable profit that will reverse its impact in the future by itself.This arise as a result of difference in timing.

Continuing the above example - Depreciation is a temporary difference provided that the accumulated depreciation under tax laws would equal to the accumulated depreciation under accounting books at some point of time in the future. (i.e. the difference of one year gets reversed in the next year)

4.Taxable temporary difference

Taxable temporary differences are timing differences that cause taxable profit in current period to be lower than accounting profit as a result the income tax payable in current period will be lower than the income tax expense.

Continuing the above example - The taxable profit is lower to the accounting profit by $5 as a result of depreciation this is a taxable temporary difference because in future periods tax depreciation will be lower resulting in higher income tax payable.

5.Deductible temporary difference

Deductible temporary differences are differences that cause the taxable profit to be more than the accounting profit for the current period as a result the income tax payable in current period will be higher than the income tax.

Example - Rental income received in advance are kept as liability in the books whereas is to be considered for taxation purposes, this leads to taxable profit being more than the accounting profit , this is a deductible temporary difference resulting in higher income tax for the current period and lower income tax for future periods.

6.Deferred tax asset

When the taxable profit is more than the accounting profit as a result of deductible temporary differences there arises Deferred tax asset.

For example - Difference being rent received in advance of $20

Particulars	Profit	Tax at 20%
Accounting profit	$100	$20
Taxable profit	$120	$24

The tax payable for the period is $ 24 which would be bifurcated as tax expense of $20 and deferred tax asset of $4.This deferred tax asset created would be reversed when the rental income of $20 is accounted for in the books at which time the taxable profit will be lower than the accounting profit.

7. Deferred tax liability

When taxable profit is lesser than the accounting profit as a result of taxable temporary difference there arises Deferred tax liability

Continuing the depreciation example -

Particulars	Profit	Tax at 20%
Accounting profit	$100	$20
Taxable profit	$95	$19

In this case the tax payable is $19 but the tax expense to be accounted is $20 and the difference of $1 is accounted as deferred tax liability to provide for when the depreciation under accounting would be more than that of under taxation requiring more tax to be paid in the future.