Question

In the recognition of depreciation of assets there is a difference with the recognition of taxation, how do companies handle it?

Answer 1

Assets are depreciated in books of accounts at different rates (or using different depreciation method) as against what is allowed as per taxes. Thus, the same is handled in following manner:

• For the purpose of records, there are two set of Fixed Asset register (FAR Schedule) maintained. One as per Income taxes and other as per Accounting standards
• To align the differences in books, the concept of deferred taxes is recognised in books of accounts. The concept of deferred taxes in case of fixed asset and depreciation accounting is explained as followed:

Deferred Taxes on Depreciation

When a company depreciates its assets at a lower rate than the tax department, its gross profit inflates in its books in comparison to what is derived in its tax reports in a particular year (and vice versa).

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 with difference arising due to multiple factors such as difference in depreciation booked as expense in accounts as against depreciation allowed in taxes. Thus, by adjusting by way of deferred tax asset or liability, income taxes rates are aligned.

By the end of an assets’ lifetime, its total depreciation shall agree in both reports, as the difference between those two figures would eventually narrow over the following years.