Deferred Tax Asset & Deferred Tax Liability: A Complete Guide

Deferred Tax Liabilities and Assets (AS 22):

• Deferred Tax Liability (DTL): Arises when taxable income is lower than accounting income due to temporary differences. These differences will reverse in future periods, leading to higher tax payments.

1. Taxable Income <Accounting Income.
2. The above difference will reverse in tax years yet to come.

• Deferred Tax Asset (DTA): Occurs when accounting income is lower than taxable income, leading to a tax benefit in the future when these differences reverse.

Executive Guidance:

1. Measurement: DTA and DTL should be measured using tax rates and laws that are enacted or substantively enacted by the balance sheet date.
2. Review: Deferred tax assets must be reviewed at each balance sheet date. Write-downs should be done if it’s no longer certain that future taxable income will be available to utilize the DTA.
3. Presentation: DTA and DTL should be presented separately from current tax liabilities.

Corporate Financial Practices:

• Infosys Limited: Deferred tax assets and liabilities are disclosed separately, with detailed notes explaining the nature of temporary differences.
• Reliance Industries Limited: The balance sheet provides a comprehensive breakdown of DTL and DTA, along with a reconciliation of the opening and closing balances.

Steps for Financial Reporting

1. Identification of Timing Differences:

• Determine temporary differences between the carrying amount of assets and liabilities in the balance sheet and their tax base.
• Examples include differences in depreciation methods, revenue recognition, provisions, and allowances.

2. Measurement

• Calculate deferred tax assets and liabilities using the applicable tax rate at the balance sheet date.
• Example of Calculation in different situations:

  Tax base of an asset is lower than it carrying amount due to accelerated tax depreciation:
  𝐷𝑇𝐿=(𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑎𝑚𝑜𝑢𝑛𝑡−𝑇𝑎𝑥 𝑏𝑎𝑠𝑒)×𝑇𝑎𝑥 𝑟𝑎𝑡𝑒

  If carrying amount of a liability is lower than its tax base due to provisions:
  𝐷𝑇𝐴=(𝑇𝑎𝑥 𝑏𝑎𝑠𝑒−𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑎𝑚𝑜𝑢𝑛𝑡)×𝑇𝑎𝑥 𝑟𝑎𝑡𝑒

3. Reporting

• Separate presentation of current tax assets/liabilities and deferred tax assets/liabilities in the financial statements.
• Disclosures should include the nature of the temporary differences, the amounts of deferred tax assets and liabilities, and the tax rates used.

Example:

• To record a DTL:
  Profit and Loss A/c           Dr.         40,000
  To Deferred Tax A/c                                        40,000
• To adjust for a reversing timing difference:
  Deferred Tax A/c              Dr.         20,000
  To Profit and Loss A/c                                    20,000

4. Disclosure of Context and Justification:

• Explain the nature of temporary differences and why deferred tax is recognized.
• Justify the recognition and measurement based on future taxable income projections and enacted tax rates.

Real-Life Example:

• For XYZ Ltd: (Assuming current and future Tax Rate @ 44%)

  Year 1: Loss of ₹100,00,000, Expected future profits allow recognition of DTA.
  Year 2: Expected Profit of ₹50,00,000, utilizing ₹20,00,000 of DTA.
  Year 3: Expected Profit of ₹60,00,000, utilizing the remaining ₹24,00,000 of DTA.

Journal Entries for Year 1:
          Deferred Tax Asset A/c                  Dr.         44,00,000

To Profit and Loss A/c                                                    44,00,000

Conclusion:

• The principles outlined in AS 22 provide a robust framework for recognizing and measuring deferred tax assets and liabilities, promoting transparency and comparability in financial reporting.
• Universal acceptance requires consistent application of these principles, clear disclosure of assumptions and estimates, and regular review of deferred tax assets to ensure their recoverability.

By adhering to these guidelines, companies can enhance the reliability and credibility of their financial statements, aiding stakeholders in making informed decisions. For Example:

Infosys Limited:

• Infosys discloses deferred tax assets and liabilities separately in its financial statements.
• Detailed notes explain the nature of temporary differences, such as provisions for employee benefits, depreciation differences, and MAT credit entitlement.

Reliance Industries Limited:

• Reliance Industries provides a comprehensive breakdown of deferred tax liabilities and assets.
• The company’s notes include a reconciliation of opening and closing balances, showing the impact of temporary differences on the deferred tax position.

These real-life examples from leading Indian companies illustrate the practical application of AS 22, emphasizing the importance of transparency and detailed disclosures in financial reporting.

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