How to calculate deferred tax asset and deferred tax liabilities

Accounting profit as shown in company’s financial statements differs with the IT profit for many reasons. One of such reason is timing difference. Timing difference arises due to difference in rate of depreciation, method of depreciation and expenses allowed in calculation of accounting profit but now allowed in calculating IT profit.

Based on the impact of timing difference company has to calculate deferred tax asset and liability.

As depreciation is one of the main reasons for having difference in accounting profits and IT profit. In this article we will be discussing how to calculate deferred tax asset and liability that arises due to depreciation.

deferred tax asset and liability

If depreciation charged for the year as per companies act is Rs. 250000 and depreciation charged as per IT act is Rs. 450000 then accounting profit will differ from IT profit. In our case we have charged Rs. 200000 more to IT profits. This means profit as per IT act must have been reduced.

As higher depreciation is charged to IT profit, the company has deferred a liability which will be paid in future years i.e. deferred tax liability of Rs. 61800 (30.9% of 200000).

In coming years, depreciation charged by IT act will be lesser as compare to companies act, as already the value of asset has been reduced drastically in IT act because of charging of higher depreciation.

This means in future years when depreciation as per companies act will be more compare to IT act, we have to create deferred tax asset for the difference amount based on the tax rates applicable at that time.

Example – Calculation and impact of deferred tax liability and asset

Year Companies act IT Act Difference Tax @ 30.9% Deferred tax asset (DTA) or deferred tax liability (DTL)
Value of computer Depreciation @40% Value of computer Depreciation @ 60%
1 60000 24000 60000 36000 12000 3708 DTL
2 60000-24000= 36000 14400 60000 -36000 = 24000 14400 0 0 NA
3 36000-14400= 21600 8640 24000 -14400 = 9600 5760 -2880 -890 DTA
4 21600-8640 = 12960 5184 9600 -5760 = 3840 2304 -2880 -890 DTA
5 12960-5184 = 7776 3110 3840 -2304 = 1536 921.6 -2188 -676 DTA

In the first year we have deferred our tax liability of Rs 3708 by charging higher depreciation in IT act compare to companies act. This liability will come back in future years.

In year two, depreciation charged as per companies act and Income Tax Act are same by which there is no deferred tax asset or liability.

However in third, fourth and fifth year, our book depreciation charged as per companies act is higher compare to Income Tax Act by which instead of creating liability we have to create deferred tax assets.

At the end of the year when you charge complete depreciation in both books of account as per IT act and companies act, you will find that deferred tax asset and liability has been cleared out and the balance is NIL for a particular asset.

Table showing when to consider deferred tax asset and liability

Why Deferred tax asset or liability Deferred tax asset (DTA) / deferred tax liability (DTL) Accounting entry
Accounting income is more than taxable income Tax to be paid for the year is less compare to tax as per accounting year. This means we are creating a liability which will be paid in future. DTL Profit and Loss A/c DrTo Deferred Tax A/c
Accounting income is less than taxable income Tax to be paid for the year is more compare to tax on accounting income. This means we are creating an asset. DTA Deferred tax  A/c DrTo Profit and loss A/c

Disclosure requirements of deferred tax asset and liability

Deferred tax asset should be disclosed on the face of the balance sheet under the head ‘Non current assets’ after the head Non current investment.

Deferred tax liability should be disclosed under the head ‘Non current liabilities’ after the sub head ‘Long term borrowing’.

Deferred tax asset or liability should be disclosed separately from current asset or liability and also to be distinguished from current year tax liability.

8 thoughts on “How to calculate deferred tax asset and deferred tax liabilities

  1. CA VIJAY CHOPRA

    Dear Sir

    I have incorporated Three new companies I want to know the deferred tax or liability of the co There are no assets in all the three co But yes last yeas we have debited Preliminary Expenses in three co as 21000,21000 and 45000 I have not calculated Deferred Tax liability Now this year Though I have filed my ITR but I want to change at least P&L and B/s after adjusting this Deferred Tax Liability pls advice also write how we have to pass entries in books pls I am waiting for your reply

    CA VIJAY CHOPRA

    9268469900
    9868469900

    Reply
  2. Samad Shaikh

    Dear ilyas

    Deferred tax liability always shows liability side of balance sheet , in tally group will be taferred tax liability under head liability and ledger will be same as group deferred tax liability under group deferred tax liability

    Reply
  3. Nikesh

    Jus wanted to know rate at the which DTA/DTL is calculated, the date on which it is actually calculated or the rate for relevant assessment.

    Reply
  4. Shobhit Sareen

    What about the amount of depreciation difference on which DTL is created? Is it unabsorbed depreciation and to be set off in the following year?
    Kindly advice suitably.

    Reply
  5. sriganesh

    In obsense of Asset/depreciation bookings, only on business loss can consider and treat the defered tax in the books? please explain suitably..

    Reply

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