Definition of Deferred Income Tax
Deferred Income Tax are the taxes applicable on the taxable income of the entity which is payable in the future years as they are not due for payment in the current financial year which arises because of the difference in the tax amount reported in the accounting framework opted by the company and the tax amount reported in the taxation regime of the local tax authorities.
Sometimes due to different regulations and rules followed in tax regime and accounting framework; some taxable proportion is reported and tax liability on the same is reported in the financials of company but tax is not due in that reporting period as per the regulations of the tax authorities and the same will be payable in other financial periods or reporting period. Although tax is not to be paid in the current reporting period but the liability of the same is need to be created because the tax is to be paid in the future period. This is known as deferred income tax and need to be reported in the financial statement of the company for true and fair view of the financials.
Example of Deferred Income Tax
Let’s take an example for more clarity.
Suppose a company has a fixed asset costing $ 50000.00 and as per International accounting standard in the accounting framework the depreciation is to be charged at the rate of 10% per annum as per straight line method which amounts to $ 5000.00 per annum and the same will be reported in the financials of the company. But as per the income tax regime, the company is only allowed to charge depreciation through weighted average method which comes to rate of 10% per annum amounting to $ 7500.00. Hence the profit of the company undervalued by $ 2500.00 and the company has to pay less tax because of that in comparison to the tax calculated in the financial statement. However, the tax on the amount of $ 2500.00 will need to be paid in the future time period and hence liability for the same should be recognized in the financial statements of the company.
Deferred Income Tax in balance sheet
As it has been explained in the above example, the deferred income tax is needed to be presented in the financial statements of the entity. It should be noted that the main reason for creation of deferred tax asset or liability is due to the difference arising due to temporary timing difference, as the same would be reversed in the future. In case the scenario occurs where due to temporary time difference the assesse has to pay low taxes at the current time but may have to pay high taxes later in the future, deferred tax liability should be created in the year by appropriating the profit & loss of that year of the company. The deferred tax liability will be presented in the Non-current liability schedule of the balance sheet. But in case, the scenario indicates that the current taxable profit is more than that of book profit then in that cases deferred tax asset should be created and the same should be presented in the non-current asset schedule of the balance sheet.
Deferred Income Tax Journal Entry
Following are the Journal entries to be booked in case of deferred tax cases-
- In Case of Deferred Tax Liability
When book profit is more than the taxable profit, deferred tax liability needs to be created in the financials of the company. The following journal entries should be booked-
- In Case of Deferred Tax Assets
When book profit is less than the taxable profit , deferred tax asset needs to be created in the financials of the company. Following journal entries should be booked-
Deferred Income Tax vs Deferred Tax Liability
Following are the key differences between the deferred tax assets & deferred tax liabilities:
- When book profit of the assesse is more than the taxable profit as per income tax rules than the deferred tax liability is created whereas when the book profit of the assesse is less than the taxable profit as per income tax rules than the deferred tax assets is created.
- The deferred tax liability indicates that the tax liability of the current year is more than as compare to the financials of the assesse which means the assesse has to pay more taxes in the future which results into creation of liability or provisions whereas deferred tax assets indicate that the tax liability of the current year is less than as compare to the financials of the assesse which means the assesse has to pay more in the current year and less in the later years.
Following are the benefits of the deferred income tax:
- Deferred income tax provides the true & fair view of the financials by accommodating the certain future liabilities or the benefits that is going to arise for the company.
- The deferred income tax procedures helps in validating the tax liability of the financials of the company as per the companies acts and accounting frameworks with the tax liability arising as per the income tax rules.
Following are the disadvantages of the deferred income tax:
- Mostly the users of the financial statements are common people for whom the deferred tax rules are complicated and they may not understand the purpose and the reason for the same.
- In case of deferred tax asset, the company may have to bear a substantial increase in actual tax liabilities and may have a substantial effect on the financial output of the company for the fiscal year.
The deferred income tax provides the methods for the assesse to deal with the differences arising in the tax liability of the assesse as per the accounting frameworks and the local income tax rules due to the temporary time differences. The temporary time differences results into deferred income tax as the situation are reversed in the future but permanent time differences will not result into deferred income tax.
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