Deferred tax arises due to differences between how income and expenses are recognized for accounting purposes versus how they are calculated for tax purposes. These differences create either a deferred tax asset (DTA) or a deferred tax liability (DTL).
When deferred tax is receivable from the income tax department, it is considered outstanding income and will be shown as an asset on the company's balance sheet.
On the other hand, when deferred tax is payable to the income tax department, it is treated as an outstanding expense and will be recorded as a liability in the balance sheet.
Remember
- We either calculate the net income as per accounting purpose more than net income for tax purpose. So, if we paid tax on the basis of net income of accounting purpose, this tax may be less or more than tax on the basis of net income for tax purpose.
1. Deferred Tax Liability (DTL)
A DTL occurs when income is reported in the financial statements before it is taxable, or when expenses are tax-deductible before being recognized in financial reporting.
Now, we learn to pass its journal entries with following 2 examples.
Example Scenario 1: Depreciation Allow for Tax purpose.
For example, we show our expense of depreciation Rs. 10000 as per 10% of our fixed asset but Income tax department has allowed only 5%. So, depreciation allow for tax purpose is Rs. 5000. So, it increases our deferred tax liability. and this difference is Rs. 5000, we have to pay tax on Rs 5000 net income due to decrease allowable depreciation. If tax rate on net income is 10%. Our deferred tax liability is Rs. 500
Income Tax Expenses Outstanding Account Debit 500
Deferred Tax Liability 500
Income tax is expense of our business, so we have to debit it. and and it will transfer to profit and loss account
Profit and loss account Debit 500
Income tax Expenses account Credit 500
We will show in balance sheet's Liability side
Deferred tax Tax Liability 500
Example Scenario 2: Depreciation Allow for Tax purpose.
For example, we show our expense of depreciation Rs. 10000 as per 10% of our fixed asset 100,000 but Income tax department has allowed only 20%. So, depreciation allow for tax purpose is Rs. 20000. So, it increases our deferred tax asset. and this difference is Rs. 10000, we have to receive tax on Rs 10000 net income due to increase allowable depreciation. If tax rate on net income is 10%. Our deferred tax asset is Rs. 1000
Deferred Tax Asset Account Debit 1000
Income tax Receivable Account Credit 1000
Income tax is expense of our business, but it is receivable because we have paid excess. so, it is our income. so we have to credit it. and it will transfer to profit and loss account
Income tax Receivable Account Credit 1000
Profit and loss account Credit 1000
We will show in balance sheet's asset side
Deferred Tax asset 1000
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