Deferred Taxation, Meaning, Importance, Types, Calculation

Deferred taxation can be a tricky concept for aspiring Chartered Accountants (CAs). It's one of those topics that can seem abstract and challenging at first, but once you grasp the fundamentals, it can become one of the more straightforward areas of accounting. In this guide, we’ll break down deferred taxation into digestible parts, ensuring you understand every aspect needed to ace your CA Exams .

What Is Deferred Taxation?

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Importance of Deferred Taxation

• Accurate Financial Reporting: It ensures that financial statements accurately reflect a company's tax liabilities and assets, leading to more transparent and reliable financial reporting.
• Tax Planning: By recognizing deferred tax assets and liabilities, companies can plan better for future tax payments and benefits, optimizing their tax strategies.
• Compliance: Mastery of its principles is essential for compliance with accounting standards like IAS 12 and Ind AS 12, which govern the treatment of income taxes.

Types of Deferred Taxation

Deferred Tax Assets (DTA):

Deferred Tax Liabilities (DTL):

Also Check: Difference Between Tax Planning and Tax Management

Calculation of Deferred Taxation

• Identify Temporary Differences: Determine the differences between the tax base and carrying amounts of assets and liabilities.
• Tax Rates: Apply the relevant tax rates to these temporary differences.
• Recognize DTA or DTL: Based on the calculation, recognize deferred tax assets or liabilities in the financial statements.

Impact of Deferred Taxation on Financial Statements

Balance Sheet: Deferred tax assets and liabilities are reported on the balance sheet, affecting the net asset position of the company.

Cash Flow: While deferred taxation itself does not directly impact cash flow, it influences future cash flows related to tax payments and refunds.

Common Scenarios Leading to Deferred Taxation

• Depreciation Differences: Different depreciation methods and rates for accounting and tax purposes often lead to temporary differences.
• Provisions and Reserves: Timing differences in recognizing provisions and reserves for accounting and tax purposes can result in deferred tax.
• Loss Carryforwards: Companies can carry forward tax losses to offset future taxable income, leading to deferred tax assets.

Practical Examples of Deferred Taxation

Example 1: A company uses straight-line depreciation for accounting purposes but accelerated depreciation for tax purposes. This leads to higher depreciation expenses and lower taxable income in the initial years, creating a deferred tax liability.

Example 2: A company recognizes a provision for doubtful debts in its financial statements but can only deduct these debts for tax purposes when they are written off. This timing difference results in a deferred tax asset.