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Accounting is the field of worldwide application andhaving a wide range of diversity in its application. Inpractical situations, it is many times observed that thereis different treatment of accounting for the same eventor transaction. Thus it was necessary to give uniformaccounting treatment to such transactions so as to attainthe objective of at true and fairness of books ofaccounts . It was also intended to give the best possibletreatment to such transactions. Accounting Standardscame with this basic objective.

In India, The Institute of Chartered Accountants ofIndia being the apex body in the field of Accountancyissues the Accounting Standards for various matters.On the same ground Accounting Standard (AS) 22 wasissued by the Institute of Chartered Accountants ofIndia w.e.f. 1.04.2001

Now with this background we can come across the AS22 for more discussions.

Basically one should ask himself, why is this standard?and what this standard means?

For such basic knowledge, we should get oneselfconversant with the Scope and Applicability of thisstandard. The scope of the standard as is as follows:

It is mandatory in nature for:

a. All the accounting periods commencing on orafter 1st April 2001, in respect of the following:

i. Enterprise whose equity or debt securitiesare listed on a recognized stock exchangein India and enterprises that are in the

ACCOUNTING FOR TAXES ON INCOME (AS 22)

Shrikant Jadhav & Gurunath Bhide, Pune

process of issuing equity or debt securitiesthat will be listed on a recognized stockexchange in India as evidenced by theboard of directors’ resolution in thisregard.

ii. All the enterprises of a group, if the parentpresents consolidated financial statementsand the accounting standard is mandatoryin nature in respect of any of theenterprises of that group in terms of (i)above.

b. All the accounting periods commencing on orafter 1st April 2002, in respect of companiesnot covered by (a) above.

c. All the accounting periods commencing on orafter 1st April 2006, in respect of all otherenterprises.

Thus we can now take out the extract as, first clausehas been not applicable being the next two areoverlapping the first one. Thus we can classify theapplicability broadly into two categories as before 1stApril 2006 applicable to some selective entities andafter 1st April 2006.

If the accounting period is commenced before 1st April2006, the standard is applicable to all the companies.Here "company" means a company defined undercompanies act, 1956.But for the accounting periodscommencing on or after 1st April 2006, standard isapplicable to all the Enterprises where enterpriseincludes partnership firms and sole proprietorship

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concerns also. Thus now the standard is going to covera large group of entities and job of accountants andauditors is going to be more challenging.

Objective:

Secondly it is necessary to get conversant with the basicobjective of this standard. Its objective is to prescribeaccounting treatment for taxes on income. As per theMatching concept of accounting, Taxes on income areaccrued in the same period of the revenue and expensesto which they are related. i.e. there has to be acorrelation between the revenue for the period and theexpenditure incurred for earning the revenue. But itgenerally observed that there are various counts whereaccounting income significantly defers from taxableincome. This divergence arises due to difference inthe Accounting Principles & Tax Laws. The standardhelps to explain how to tackle those differences .ForInstance we can quote an example as under.

There is a deduction available for certain assets suchas expenditure on scientific research (capital nature)under section 35 of the Income Tax Act, 1961. Thoughthe benefits of such assets are spread over the economiclife of the asset the entity is going to get weighteddeduction under the said section after compliance ofprovisions. This situation is contrary to the MatchingConcept of accounting leading towards difference intaxable income & accounting income.

We will get due knowledge about this in due coursebut its important to know basically what is the scopeof this standard. As per bare text of the AccountingStandard:

1. This Statement should be applied in accountingfor taxes on income. This includes thedetermination of the amount of the expense orsaving related to taxes on income in respect ofan accounting period and the disclosure of suchan amount in the financial statements.

2. For the purposes of this statement, taxes onincome include all domestic and foreign taxes,which are based on taxable income.

3. This statement does not specify when, or how,an enterprise should account for taxes ondistribution of dividends and other distributionsmade by the enterprise.

Thus, this standard has specific scope of application,

which includes foreign taxes also but excludes taxeson distribution of profits or funds like DividendDistribution Tax under section 115 O of the IncomeTax Act, 1961. We consider Dividend Distribution taxas an appropriation of profit & any appropriation ofprofit is not eligible for deduction under Income TaxAct. This means it gets automatically escaped fromthe net of this standard.

Before we go for working part of the standard, it willbe desirable for us to know the definitions quoted forthe purpose of this standard.

1. Accounting Income (loss): It is the net profit orloss for a period, as reported in the statementof profit and loss, before deducting income taxexpense or adding income tax saving.

i.e. it is a book profit arrived at applying theGenerally Accepted Accounting Practices.

2. Taxable Income (Tax Loss): It is the amount ofthe income (loss) for a period, determined inaccordance with the tax laws, based upon whichincome tax payable (recoverable) is determined.

3. Tax Expense (Tax Saving): It is aggregate ofcurrent tax and deferred tax charged or creditedto the statement of profit and loss for the period.

4. Current tax: It is the amount of income taxdetermined to be payable (recoverable) inrespect of the taxable income (tax loss) for theperiod.

5. Deferred tax: It is the tax effect of timingdifferences.

6. Timing Differences: These are the differencesbetween taxable income and accounting incomefor a period that originate in one period andcapable of reversal in one or more subsequentperiods.

Timing differences are temporary differencesbetween the accounting income & taxableincome, which are capable of reversal insubsequent periods. In short the impact on taxdue to the difference originated in one period getsnullified over future period

For this purpose we will consider one example:-

An asset is purchased on 1.04.2001 on whichunder Companies Act depreciation is to be

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charged at 18.91% where as Income Tax Act rateof depreciation is 25%. This leads to TimingDifference as in the initial years the depreciationallowable as per income tax in higher thanprovided in the books. But in the subsequent yearsthe situation gets reversed as the depreciationallowed as per income tax gets reduced ascompared to provided in the books.

7. Permanent Differences: These are thedifferences between taxable income andaccounting income for a period that originatein one period and do not reverse subsequently.

Permanent Difference creates a irreversibleimpact on the taxable & accounting income.

e.g. amount deducted under section 80G of theIncome Tax Act, which is allowable to the extentof 50% only though the entire amount is debitedto profit & loss A/c. once the deduction is allowedto the extent of 50%, the remaining part is notgoing to be allowed as deduction forever.

Now with this much introduction of the standard wewill concentrate towards the main part i.e. Computationof Deferred Tax Asset or Liability.

Steps involved in recognition of deferred tax asset orliability:-

1. Compute the profit as per books of accounts:-

Profit as per books of accounts is computedfollowing the Generally Accepted AccountingPractices. i.e. profit is calculated by applying allaccounting conventions & principals. E.g.Concept of Prudence, Concept of mutuality,Concept of accrual, etc.

2. Ascertain the taxable profits: -

Taxable profit is computed applying the tax lawsthat are enacted for the relevant assessment year.

3. Find out the difference in the profit as per booksof accounts & taxable income as calculated inabove two steps.

4. Analyse the causes for differences & classifythem into "Timing Differences" or "PermanentDifferences"

5. Divide the "Timing Differences" into differencesleading towards Deferred Tax Asset and DeferredTax Liability separately.

6. Net out the aforesaid timing differences resultingtowards either net deferred tax asset or netdeferred tax liability.

7. Apply the tax rates & tax law that are enacted orsubstantively enacted by the balance sheet dateon net timing difference. (When tax rates areapplied as per slabs of income, then average rateshould be used for calculation of deferred taxasset and liability)

Deferred tax = Net Timing Difference Tax Rate

8. Calculate the tax expense for the period: -

Tax expense is an aggregate of current tax &deferred tax. The tax expense is to be shown inthe financial statements as a separate disclosure.

Also, the companies act, 1956 allows slightdeviation from Schedule VI for presentation ofBalance sheet.

Therefore,

Tax expense for the period = Current tax + DeferredTax

Special points to be kept in mind while computingdeferred tax asset or liability:-

1. Concept of prudence:-

The deferred tax asset so calculated should bebased on concept of prudence i.e. there shouldbe a reasonable assurance that the future profitswill be available against which the deferred taxasset can be realized. For example if the companyhas got a contract for supply of raw material to aforeign buyer, this gives a reasonable assuranceabout the future available profit to realize thedeferred tax asset.

2. No discounting of deferred tax asset or liability:-Deferred tax asset or liability should not bediscounted to their present value due to thepractical difficulty of keeping the timely recordof reversals of the timing differences.

3. Provisions of Fringe benefit tax under section115WJ of the Income Tax Act,1961:-

The Amount of Fringe Benefit Tax is not at alldeductible expenditure for computation ofTaxable Profits. Hence it leads to PermanentDifference. Hence it should be excluded from the

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ambit of this standard.

4. Provisions of Minimum Alternate Tax undersection 115JB of the Income Tax Act, 1961: -

In the event of Taxable losses for a corporateassessees Minimum Alternate Tax might bepayable as per the provisions of aforesaid section.

From the Assessment Year 2006-07, credit forMinimum Alternate Tax can be carried forwardto next five assessment years. Thus now it leadsto timing Difference. Hence credit available forMinimum Alternate Tax should be considered forthis standard.

Now we will concentrate on issue of determination of timing difference leading to Deferred Tax Asset or Liability.

How to decide the deferred tax asset or deferred tax liability:-

Situation Tax impact Def. Tax Asset /Liability

1. When accounting income is Tax on taxable income is lesser Deferred tax liabilitygreater than taxable income than tax on accounting income

2. When accounting income is Tax on taxable income is greater Deferred tax Assetlesser than taxable income than tax on accounting income

3. When accounting loss is The opportunity to carry forward Deferred tax Liabilitygreater than taxable loss & set off of losses against future

profit gets restricted to the taxableloss and that results in future morepayment of taxes.

4. When accounting loss is Enterprise is in a position to carry Deferred Tax Asset.lesser than taxable loss. forward & set off more loss against

the future profit and that leads tolowering the future payments oftaxes

5. When there is loss as per books Enterprise will have to pay tax on Deferred tax assetbut taxable income is computed. taxable income though its books

of accounts are showing loss

6. When there is profit as per Enterprise will not have to pay tax Deferred tax liabilitybooks but taxable loss though there is profit in books

Some examples of Timing Differences:-

1. Depreciation provided in books & allowed bythe Income tax act

2. Disallowance under section 43B of the incometax act

3. Amortization of preliminary expenses undersection 35D

4. Provision for doubtful debts

5. Municipal tax paid are allowed as deduction onlywhen payment is made during the pervious year

Some examples of permanent differences:-

1. Donations given under section 80G

2. Tax Holiday benefits

3. Taxable income on presumptive basis undersection 44AD, 44AE, 44AC

4. Standard deduction under section 24(a)

5. Capital gain indexation

6. Weighted deduction under section 35

7. Income exempt from tax & expenses relatingthere to under section 10

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We will now go for one example to get ourselves moreclarified with the above issues.

Illustration:

ABC Co. Ltd. started business on 1/04/2001. Followinginformation is available from records of the ABC Co.Ltd.

Profit before depreciation, amortization of preliminaryexpenses & taxes: -

Year Rs.

2001-02 100000

2002-03 150000

2003-04 250000

2004-05 300000

The co. has purchased following Plant & Machinery:-

Date of purchase Purpose Amount (Rs.)

1/04/2001 General 30000

1/04/2002 Research 25000

1/11/2004 Research 36000

Company charges depreciation on plant & machinery@ 15% on Straight Line Method where as the rates ofdepreciation as per Income Tax Act for generalmachinery @ 25% on Written Down Value Method &for research purpose @ 100%

The tax rates for relevant years were 45%, 40%, 35%& 35.875% respectively.

During the year 2001-02 Company has written offRs. 30000/- preliminary expenses to Profit & LossA/c. Under Income Tax Act the qualifying sum foramortization for 5 years is Rs. 25000.

During 2003-2004 payment of Rs. 140000/- made by bearer cheque, which will be disallowed @ 20 % undersection 40A(3).

Prepare Profit and Loss Statement using AS 22.

SOLUTION:

PARTICULARS YEAR ENDING

31.03.2002 31.03.2003 31.03.2004 31.03.2005

Profit before depreciation and 100000 150000 250000 300000amortisation of expenses

Less :

1. depreciation 4500 8250 8250 10500

2. preliminary expenses 30000 - - -

Profit before Tax 65500 141750 241750 289500

Less : Tax Expense

Current Tax (note 1) 39375 45750 94073 91781

Deferred Tax (note 2) (7650) 10950 339 12077

Sub total 31725 56700 94412 103858

Profit Carried to Balance Sheet 33775 85050 147338 185642

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Note 1: Computation of current tax.

PARTICULARS YEAR

2001-02 2002-03 2003-04 2004-05

Profit before tax 65500 141750 241750 289500

Add back/add:

1. Depreciation. as per books 4500 8250 8250 10500

2. Preliminary Expenses 30000 - - -

3. Disallowed u/s 40A(3) - - 28000 -

(A) 100000 150000 278000 300000

Less:

Depre. As per IT Act 7500 5625 4219 3164

R&D Expenditure u/s 35 - 25000 - 36000-

Amount of Preliminary. Expenses 5000 5000 5000 5000

Sub total (B) 12500 35625 9219 44164

Taxable Profit (A-B) 87500 114375 268781 255836

Tax Rates 45% 40% 35% 35.875%

Current Tax 39375 45750 94073 91781

Calculation of depreciation as per Companies Act, 1956:-

Method:- Straight line Method

Rate of Depreciation: - 15%

Year Cost at the Depreciation Acquisition Cost of Depreciation Total(1) beginning on opening during the Acquisition on addition Rs. (3+6) =

(2) balance (3) year (date) (4) (5) (6) (7)

2001-02 -- -- 1/04/2001 30000 4500 4500

2002-03 30000 4500 1/04/2002 25000 3750 8250

2003-04 55000 8250 --- --- --- 8250

2004-05 55000 8250 1/11/2004 36000 2250 10500

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Calculation of depreciation as per Income Tax, 1961:-

Method:- Reducing Balance method

Rate of Depreciation:- 25% for general purpose machinery on W.D.V..

Year Opening Additions during Deduction Depreciation Closingbalance the year during for the year Balance

the year

2001-02 -- 30000 (1/04/2001) Nil 7500 22500

2002-03 22500 Nil 5625 16875

2003-04 16875 Nil Nil 4219 12656

2004-05 12656 Nil 3164 9492

Note II: Computation of Deferred Tax Asset or Liability:-

Particulars 2001-02 2002-03 2003-04 2004-05

Profit as per books 65500 141750 241750 289500

Taxable Profit 87500 114375 268781 255836

Difference (absolute terms) 22000 (27375) 27031 (33664)

Segregation in

1. Permanent Difference.

a. Disallowance u/s 40A(3) - - 28000 -

b. Non qualifying amount of 5000*Preliminary Expenses

2. Net Timing Difference 17000 (27375) (969) (33664)

Prima-facie Classification of Timing Differences :-

Year Timing Rate of Tax Deferred Tax Whether Deferred Tax Asset orDifference Liability should be created

2001-02 17000 45% 7650 Deferred Tax Asset

2002-03 27375 40% 10950 Deferred Tax Liability

2003-04 969 35% 339 Deferred Tax Liability

2004-05 33664 35.875% 12077 Deferred Tax Liability

*Rs.30000 Written off to Profit & Loss A/c -- Amortization Allowed Under Income Tax Rs.25000 = Non-qualifying Amount Rs.5000

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it should give the separate identification.

2. The major components in the Deferred Tax Assetsor Liabilities should be disclosed separately. Thismeans that the items contributing towardrecognition of Deferred Tax Asset or Liabilityshould be clearly spelt out in the notes toaccounts.

3. The nature of evidence supporting the recognitionof Deferred Tax Asset or Liability should be speltout in the Notes to accounts.

Presentation and Disclosure Requirements:-

1. Deferred Tax Asset or Liability should bedistinguished from assets & liabilitiesrepresenting current tax for the period. It shouldbe separately in the balance so as a distinguishingfrom current assets & liabilities.

Though the standard requires separate disclosurefor the Deferred Tax Asset or Liability, it doesnot specify the place in the Balance Sheet. It isat the discretion of the Management but provided

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