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Deferred Tax Asset and Liability

Deferred Tax Asset and Liability

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Published by: eaglewatch99 on Nov 12, 2009
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11/12/2012

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DEFERRED TAX
Deferred tax is anaccountingconcept, meaning a future taxliabilityor asset, resulting fromtemporary differencesbetween book (accounting) value of assets and liabilities and their tax value, or timing differencesbetween therecognition of gains and losses in financial statements and their recognitionin a tax computation.
DEFERRED TAX ASSET
Anassetthat is used to reduce theamountof taxthat acompanywill have to  payin a later tax period. It is often associated with aloss carryover , and is used as a futurewrite-off if the next tax period is expected to produce   positiveearnings. The asset is kept on the balance sheet. For example, a deferred taxasset of $100,000 from the previous year could be applied to before-tax incomeof $250,000 this year, resulting intaxable incomeof  $150,000 ($250,000 - $100,000).What Does
 Deferred Tax Asset 
Mean?An asset on a company's balance sheet that may be used to reduce anysubsequent period's income tax expense. Deferred tax assets can arise due tonet loss carryovers, which are only recorded as assets if it is deemed morelikely than not that the asset will be used in future fiscal periods.It must be determined that there is more than a 50% probability that thecompany will have positive accounting income in the next fiscal period before the deferred tax asset can be applied.If, for example, a company has a deferred tax asset of $25,000 on its balancesheet, and then the company earns $75,000 in before-tax accounting income,accounting tax expense will be applied to $50,000 ($75,000 - $25,000),instead of $75,000.
 
DEFERRED TAX LIABILITY
What Does
 Deferred Tax Liability
Mean?An account on a company's balance sheet that is a result of temporarydifferences between the company's accounting and tax carrying values,the anticipated and enacted income tax rate, and estimated taxes payable for the current year. This liability may or may not be realized during any givenyear, which makes the deferred status appropriate.Because there are differences between what a company can deduct for taxand accounting purposes, there will be a difference between a company'staxable income and income before tax. A deferred tax liability records thefact that the company will, in the future, pay more income tax because of atransaction that took place during the current period, such as an installmentsale receivable.In simple words:Deffered tax liability means currently you are paying lessamount of tax as per IT but in future you have to pay moreso for this timing difference we have to create a defferedtax liability in our books of accounts accoding to thevirtual certainty that in future company will earnsufficient proft to recover it.for deffererd tax liability the entry will beProfit & loss a\c dr To Deffered tax liability
 
ILLUSTRATED EXAMPLE
The basic principle of accounting for deferred tax under a temporarydifference approach can be illustrated using a common example in which acompany has fixed assets which qualify for tax depreciation.The following example assumes that a company purchases an asset for $1,000 which is depreciated for accounting purposes on a straight-line basisof five years. The company claims tax depreciation of 25% per year on adeclining balancebasis. The applicable rate of corporate income taxis assumed to be 35%.
PurchaseYear 1Year 2Year 3Year 4Accounting value$1,000$800$600$400$200Tax value$1,000$750$563$422$316Taxable/(deductible) temporarydifference$0$50$37$(22)$(116)Deferred tax liability/(asset) at 35%$0$18$13$(8)$(41)
As the tax value (tax base) is lower than the accounting value (net book  value) in years 1 and 2, the company should recognise a deferred taxliability. This also reflects the fact that the company has claimed taxdepreciation in excess of the expense for accounting depreciation recordedin its accounts, whereas in the future the company should claim less taxdepreciation in total than accounting depreciation in its accounts.In years 3 and 4, the tax value exceeds the accounting value, therefore thecompany should recognise a deferred tax asset (subject to it having sufficientforecast profits so that it is able to utilise future tax deductions). This reflectsthe fact that the company expects to be able to claim tax depreciation in thefuture in excess of accounting depreciation.

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Deepesh Jaseja added this note
Please shown the treatment of deferred tax assets in books of co in following financial year in which it showed already opening balance as on carry forward of losses and co earn sufficient profits....
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