Finance & Accounting

AS 22 – Accounting for Taxes on Income

AS 22 - Accounting for Taxes on Income

Accounting Standard 22’s main goal is to specify how income taxes should be treated in accounting. Taxable and accounting income may differ greatly, making it difficult to match taxes to revenue for a given time. Profits shown in your financial statements and taxable profits rarely coincide. And failing to account for the difference between these two gains would be erroneous. In detail, let us discuss the Accounting Standard 22 – Accounting for Taxes on Income.

Accounting for Taxes on Income

The ICAI has specified that Accounting Standard 22 be used when accounting for income taxes. This Accounting Standard is used to align the differences between taxable and accounting income. 

  • The net profit before taxes for a period, as shown in the profit and loss statement, is called accounting income.
  • Taxable income is the income on which income tax is payable, computed by applying provisions of the Income Tax Act, 1961 & Rules. 

Objectives

Accounting Standard 22, Accounting for Taxes on Income, aims to specify how income taxes should be treated in accounting. One of the key components of an enterprise’s profit and loss statement is taxes on income. According to the matching idea, taxes on income are incurred at the same time as the related revenue and expenses. Because taxable income in some instances may differ greatly from accounting income, matching such taxes to revenue for a period presents unique challenges. There are two basic causes for the difference between taxable income and accounting income.

The items considered revenue, costs, or deductions for tax purposes differ from those shown in the statement of profit and loss in the first place. Second, there are discrepancies between the amount related to a specific item of revenue or expense acknowledged in the statement of profit and loss and the corresponding amount acknowledged for the computation of taxable income. A company must meet the following disclosure duties in accordance with the standards of this standard: 

  • Is the entity’s disclosure of the breakdown of deferred tax assets and liabilities into their key components in the notes to accounts?
  • If an entity has a legally enforceable right to set off current tax assets, current tax liabilities, and deferred tax assets and deferred tax liabilities related to income taxes levied by the same governing taxation laws, whether an entity has offset the deferred assets and deferred liabilities in the balance sheet.
  • Whether an entity has offset current tax obligations and assets in the balance sheet where the entity has a legally enforceable right to do so and plans to settle those assets and liabilities on a future date.
  • Whether MAT credit has been presented under the heading Loans and Advances as MAT credit entitlement if it is acknowledged as an asset (subject to prudential considerations).
  • Has the Minimum Alternative Tax been stated as the current tax in the profit and loss statement?
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Scope  

  • All domestic and international taxes that are dependent on taxable income are included in income taxes.  
  • The timing and method of how an enterprise should account for taxes due on dividend distributions and other distributions made by the enterprise are not specified in this Accounting Standard.

Definitions

The following terms are used in this sentence with the definitions provided. 

  • Accounting Income: Accounting income (loss) is the net profit or loss for a period as shown in the profit and loss statement before subtracting income tax expense or including income tax savings.
  • Taxable Income: The amount of income (loss) for a period is calculated in compliance with the tax laws and used to determine whether income tax is payable or recoverable.
  • Tax Expense (Tax Saving): The total amount of current taxes charged or credits recorded on the profit and loss statement during the period. Tax payments are deducted from the income subject to the tax as an expense item.
  • Current Tax: The amount of income tax that has been judged to be payable (recoverable) about the taxable income (tax loss) for a certain period.
  • Deferred tax: Impact of timing difference
  • Timing Differences: Differences that start in one period but have the potential to reverse themselves in one or more following periods between taxable income and accounting income for that period.
  • Permanent Differences: Permanent differences are those that start in one period and do not later reverse between taxable income and accounting income for a period.

Recognition  

Calculating the period’s net profit or loss should consider the period’s tax expense, which consists of both current and deferred tax. All timing differences should be treated as deferred tax, subject to the application of caution about deferred tax assets (DTA).

Disclosure 

If a legal right to set off exists or if assets and liabilities are intended to be settled on a net basis, assets and liabilities representing current tax should be offset. Deferred tax assets and liabilities should be separated from current tax, current assets, and current liabilities and presented under a separate heading in the balance sheet if the following conditions are met, and there is a legal right to set off; – the assets and liabilities related to taxes levied by the same governing taxation laws.

Types of differences and why they appear?

There are two categories of differences:

Timing Differences 

Timing differences are those that can be corrected in one or more subsequent periods between accounting income and taxable income. For instance, depreciation is permitted when calculating taxable income using the WDV (Written Down Value Method) technique and when calculating accounting income using the SLM (Straight Line Method) method.

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Permanent Differences

They are accounting income and taxable income that cannot be reversed in a later period. For instance, a cash donation is not allowed while calculating taxable income but is permitted when calculating accounting income. The following factors can produce differences between accounting income and taxable income:

  • Expenses that were deducted from profits and losses but were not authorised by the Income Tax Act of 1961 when calculating taxable income.
  • When calculating accounting income, provision for bad or doubtful debts is permitted; however, it is not permitted when calculating taxable income.
  • Charging depreciation at various rates in accordance with the Companies Act of 2013 and the Income Tax Act of 1961.
  • Any income that was recorded in the profit and loss statement but was recorded on a receipt basis in a later period to calculate taxable income. Accounting Standard 22 must be used to consider these kinds of variances.

Recognising Deferred Tax Assets Accounting Standard 22 stricter conditions, such as virtual certainty if tax losses and/or unabsorbed depreciation are involved (Indian Accounting Standard 12), for the recognition of deferred tax assets When a recovery is likely, deferred tax assets should be recognised. Though at a lesser level of likelihood than “virtual certainty,” the phrase “probable” is regarded to be akin to the term “reasonable certainty.” In comparison to Indian Accounting Standard 12, fewer deferred tax assets would be recognised under Accounting Standard 22.

On the consolidated financial statements, deferred tax expense IAS 12 Temporary differences emerging from the removal of unrealised profits and losses from intra-group transactions should be considered when calculating consolidated financial statements’ tax expenditures. Accounting Standard 22 No specific instructions. According to ASI 26, the total of the tax expenses that appear in the parent company’s and its subsidiaries’ separate financial statements shall be included in the consolidated financial accounts.

Profits shown in your financial statements and taxable profits rarely coincide. And failing to account for the difference between these two gains would be erroneous. To control the accounting for such differences, we examine the following themes in this article w.r.t. Accounting Standard Accounting Standard 22: 

Deferred Tax Asset

When the income reported under the Income Tax Act exceeds the income reported under the Profit and loss account, a Deferred Tax Asset (DTA) is created. Therefore, even if real income, as reported by the Profit & Loss statement, is lower, tax payable is higher due to higher income under the Income Tax Act.

Additionally, since a portion of the tax is paid in advance for which a benefit will be received in the future, DTA is an asset that is established in the books of accounts.

Deferred Tax Liability

When the income reported under the Income Tax Act is less than the income reported under the Profit and loss account, a Deferred Tax Liability (DTL) is established. As a result, tax payable is lower because income is lower under the Income Tax Act, but actual income is higher under the Profit & Loss account.

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Additionally, DTL is a provision that was added to the books since the tax that has been paid is less than what the books show is owed and must be paid in the coming years.

When to apply AS 22 Accounting for Taxes on Income

When there are differences between taxable income and accounting income, Accounting Standard 22 must be used. A deferred tax asset will be created if taxable income is higher than accounting income. Additionally, deferred tax liability will ensue if accounting income exceeds taxable income.

 When a difference generates a deferred tax asset, it should only be acknowledged when there is a reasonable certainty that it will be realised. Deferred tax assets should be recognised to the extent that they are reasonably certain to be realised. Making realistic predictions of future profits based on an analysis of past periods’ profit and loss statements will help you evaluate the level of reasonable certainty.

 Let’s say that an entity has carryover losses or unabsorbed depreciation. Deferred tax assets should be recognised in this situation to the degree that a virtual certainty is supported by strong evidence. Virtual certainty is based on evaluating compelling evidence, which should be accessible in a tangible form at a certain time.

Conclusion

For every time discrepancy, Accounting Standard 22 stipulates that deferred tax must be recognised. This is based on the matching principle, which states that all current or deferred transactions should be included in the financial statements for a period. Therefore, when there are differences between taxable income and accounting income, Accounting Standard 22 applies. A deferred tax asset will be created if taxable income exceeds accounting income. Additionally, deferred tax liability will ensue if accounting income exceeds taxable income.

FAQs: –

  1. What is the entry for income tax paid?

    Income tax paid must be debited from the owner’s drawing account because it is a personal expense.

  2. What is the accounting entry for tax?

    The total amount of the invoice or cash received is debited from the accounts receivable or cash account, and the amount of sales taxes billed is credited to the sales account and the sales tax due account.

  3. Is income tax paid an expense or income?

    Income tax is a sort of responsibility that either a business or an individual may have. It is a tax that the government imposes on both corporate and personal income. Because paying taxes results in a cash outflow, income tax is considered an expense for businesses and individuals.

  4. Is income tax debited or credited?

    Taxes are both a payment and an expense. Costs are consistently debited. As a result, the trial balance debit column includes income tax.

  5. What are the Indian Accounting Standard (IAS) 12 income taxes?

    The accounting treatment for income taxes is outlined in Indian Accounting Standard 12. All domestic and international taxes that are based on taxable profits are included in income taxes. To the extent that it is unpaid, current tax is identified as a liability for both the current and past periods.

  6. What does tax reconciliation entail? 

    The tax reconciliation is one of many disclosures mandated by the Indian Accounting Standard 12 Income Tax standard. It explains the connection between your accounting profit and your tax expense (income).

  7. What is the basic principle for accounting for income taxes under IAS 12?

    The “comprehensive balance sheet method” of accounting for income taxes, as it is known in IAS 12 Income Taxes, takes into account both the present-day tax ramifications of events and transactions as well as the future-day tax ramifications of future recoveries or settlements of the carrying amounts of an entity's assets and liabilities.

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