Income Tax Accounting Definition Examples Step By Step

Accounting for Income Tax

Key Terms in Accounting for Income Tax

Understanding the income tax accounting, first, we need to understand the meaning of the below components:-

You are free to use this image on you website, templates, etc., Please provide us with an attribution linkHow to Provide Attribution?Article Link to be HyperlinkedFor eg:Source: Income Tax Accounting (wallstreetmojo.com)

Accounting Profit – Accounting profit means profit, shown in the profit & loss statement after considering all the income and expenses but before tax.Taxable Profit – Taxable profit means profit, which is arrived at as per tax laws and on which tax needs to be paid as per tax law.Current Tax – The current tax is the tax payable or paid on taxable profit as per the applicable tax rate of the current year.Deferred Tax – Deferred taxDeferred TaxDeferred Tax is the effect that occurs in a firm as a result of timing differences between the date when taxes are actually paid to tax authorities by the company and the date when such tax is accrued. Simply put, it is the difference in taxes that arises when taxes due in one of the accounting period are either not paid or overpaid.read more is a tax that arises due to timing differences. Temporary / Timing differences are the differences between the carrying amountsCarrying AmountsThe carrying amount or book value of asset is the cost of tangible, intangible assets or liability recorded in the financial statements, net of accumulated depreciation or any impairments or repayments. Accordingly, the carrying amount may differ from the market value of assets.read more of assets and liabilities in the financial statement and the number of Assets and liabilities attributed to the tax base.Tax Base.Tax base refers to the total value of the income or assets of an individual or firm which is taxable by the government or the relevant taxing authority. This taxable amount is used to evaluate the tax liability of the individual or company.read more

To understand the above terms, let us take an example –

If we purchase one asset worth $1000 at the beginning of the year and the Depreciation rate as per financial reporting purpose is 10% and as per tax law is 20%, and profit before depreciation and tax is $ 500.

Accounting profit will be ($500 – Depreciation as per accounting ($100010% = $100) i.e. $400.Taxable Profit will be ($500 – Depreciation as per tax ($100020% = $200)) i.e. $300Current Tax will be payable on $300 *Tax Rate.Deferred Tax will arise on temporary difference, i.e., the difference between depreciation as per accounting and depreciation as per tax. In the above example, the deferred tax will arise at $100.

Journal Entry of Income Tax Accounting

Provision of Income-tax – Provision of income tax recorded in books of account by debiting Profit & Loss a/c, which will show under liability in the Balance Sheet.
Advance Income tax payment – Advance income tax will show under Assets in the Balance Sheet.

Deferred Tax Assets and Deferred Tax Liabilities

Deferred tax is of two types – Deferred tax AssetsDeferred Tax AssetsA deferred tax asset is an asset to the Company that usually arises when either the Company has overpaid taxes or paid advance tax. Such taxes are recorded as an asset on the balance sheet and are eventually paid back to the Company or deducted from future taxes.read more and Deferred tax liabilitiesDeferred Tax LiabilitiesDeferred tax liabilities arise to the company due to the timing difference between the accrual of the tax and the date when the company pays the taxes to the tax authorities. This is because taxes get due in one accounting period but are not paid in that period.read more.

#1 – Deferred Tax Assets (DTA) – DTA arises when book profit is lesser than the profit calculated per tax. We understand this with the below example. E.g., X Ltd. Has a profit as per the Profit & Loss statement is $5000 before giving the effect of depreciationEffect Of DepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. read more and the depreciation rate is 20% per financial reporting purpose and 10% per income tax purpose.

Profit as per Financial StatementFinancial StatementFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more – $5000 – ($5000 *20%) =$ 4,000Profit as per Tax Purpose – $5000 – ($5000 *10%) = $4,500

Since Tax profit is more than the book profit; therefore, we have to pay more tax now, and less tax in future and due to this DTA will arise, and DTA will be ($4,500 – $4,000) *Tax Rate

#2 – Deferred Tax Liabilities (DTL) – DTL arises when book profit is more than profit calculated as per tax. We understand this with the below example.

E.g., X Ltd. has a profit of $5,000 after considering the interest receivable of $500, but as per income tax, interest is taxable when it is received.

Profit as per Financial StatementFinancial StatementFinancial statements are written reports prepared by a company’s management to present the company’s financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels.read more – $5000Profit as per Tax Purpose – $5000 – $500 = 4,500

Since the Tax profit is lesser than the book profit, we have to pay less tax now and more tax in the future, and due to this, DTL will arise, and DTL will be ($5000 – $4000) * Tax Rate.

Recognition of Deferred Tax

Deferred tax assets will recognize in books of account by crediting the profit & loss a/c, and deferred tax liabilities will recognize by debiting the profit & loss a/c

Journal Entries are as follows:

Advantage

Disadvantages

Only a small business entity can maintain only tax accounting.It will not give the correct picture of operational cost and benefit.Companies that must get their accounts audited can’t follow only the income tax accounting method.

Conclusion

After reading the above, we understood that there is a difference between accounting profit and taxable profit. Before arriving at a profit as per income tax, we have to understandProvision for Income Tax is the estimated income tax for current year and is the amount that the entity might have to deposit to settle their tax liabilities. It is adjusted for the expenses allowed to be deducted according the relevant tax laws.read more provisions under income taxProvisions Under Income TaxProvision for Income Tax is the estimated income tax for current year and is the amount that the entity might have to deposit to settle their tax liabilities. It is adjusted for the expenses allowed to be deducted according the relevant tax laws.read more and calculate taxable profit. Suppose an entity follows a taxAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company’s performance and ensuring the smooth operation of the firm.read more accounting systemAccounting SystemAccounting systems are used by organizations to record financial information such as income, expenses, and other accounting activities. They serve as a key tool for monitoring and tracking the company’s performance and ensuring the smooth operation of the firm.read more at the end of the year. In that case, they need not be required to calculate taxable profit, but this is limited only to those organizations on which companies Act is not applicable and need not be required to maintain books of Accounts as per accounting standard.

Accounting for Income Tax#

Key Terms in Accounting for Income Tax#

Journal Entry of Income Tax Accounting#

Deferred Tax Assets and Deferred Tax Liabilities#

Advantage#

Disadvantages#

Conclusion#

Recommended Articles#