ACCOUNTING FOR TAXES ON INCOME (AS 22)
Shrikant Jadhav & Gurunath Bhide, Pune
Accounting is the field of worldwide application and
having a wide range of diversity in its application. In
practical situations, it is many times observed that there
is different treatment of accounting for the same event
or transaction. Thus it was necessary to give uniform
accounting treatment to such transactions so as to attain
the objective of at true and fairness of books of
accounts . It was also intended to give the best possible
treatment to such transactions. Accounting Standards
came with this basic objective.
In India, The Institute of Chartered Accountants of
India being the apex body in the field of Accountancy
issues the Accounting Standards for various matters.
On the same ground Accounting Standard (AS) 22 was
issued by the Institute of Chartered Accountants of
India w.e.f. 1.04.2001
Now with this background we can come across the AS
22 for more discussions.
Basically one should ask himself, why is this standard?
and what this standard means?
For such basic knowledge, we should get oneself
conversant with the Scope and Applicability of this
standard. The scope of the standard as is as follows:
It is mandatory in nature for:
a. All the accounting periods commencing on or
after 1st April 2001, in respect of the following:
i. Enterprise whose equity or debt securities
are listed on a recognized stock exchange
in India and enterprises that are in the
process of issuing equity or debt securities
that will be listed on a recognized stock
exchange in India as evidenced by the
board of directors’ resolution in this
regard.
ii. All the enterprises of a group, if the parent
presents consolidated financial statements
and the accounting standard is mandatory
in nature in respect of any of the
enterprises of that group in terms of (i)
above.
b. All the accounting periods commencing on or
after 1st April 2002, in respect of companies
not covered by (a) above.
c. All the accounting periods commencing on or
after 1st April 2006, in respect of all other
enterprises.
Thus we can now take out the extract as, first clause
has been not applicable being the next two are
overlapping the first one. Thus we can classify the
applicability broadly into two categories as before 1st
April 2006 applicable to some selective entities and
after 1st April 2006.
If the accounting period is commenced before 1st April
2006, the standard is applicable to all the companies.
Here "company" means a company defined under
companies act, 1956.But for the accounting periods
commencing on or after 1st April 2006, standard is
applicable to all the Enterprises where enterprise
includes partnership firms and sole proprietorship
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concerns also. Thus now the standard is going to cover
a large group of entities and job of accountants and
auditors is going to be more challenging.
Objective:
Secondly it is necessary to get conversant with the basic
objective of this standard. Its objective is to prescribe
accounting treatment for taxes on income. As per the
Matching concept of accounting, Taxes on income are
accrued in the same period of the revenue and expenses
to which they are related. i.e. there has to be a
correlation between the revenue for the period and the
expenditure incurred for earning the revenue. But it
generally observed that there are various counts where
accounting income significantly defers from taxable
income. This divergence arises due to difference in
the Accounting Principles & Tax Laws. The standard
helps to explain how to tackle those differences .For
Instance we can quote an example as under.
There is a deduction available for certain assets such
as expenditure on scientific research (capital nature)
under section 35 of the Income Tax Act, 1961. Though
the benefits of such assets are spread over the economic
life of the asset the entity is going to get weighted
deduction under the said section after compliance of
provisions. This situation is contrary to the Matching
Concept of accounting leading towards difference in
taxable income & accounting income.
We will get due knowledge about this in due course
but its important to know basically what is the scope
of this standard. As per bare text of the Accounting
Standard:
1. This Statement should be applied in accounting
for taxes on income. This includes the
determination of the amount of the expense or
saving related to taxes on income in respect of
an accounting period and the disclosure of such
an amount in the financial statements.
2. For the purposes of this statement, taxes on
income include all domestic and foreign taxes,
which are based on taxable income.
3. This statement does not specify when, or how,
an enterprise should account for taxes on
distribution of dividends and other distributions
made by the enterprise.
Thus, this standard has specific scope of application,
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which includes foreign taxes also but excludes taxes
on distribution of profits or funds like Dividend
Distribution Tax under section 115 O of the Income
Tax Act, 1961. We consider Dividend Distribution tax
as an appropriation of profit & any appropriation of
profit is not eligible for deduction under Income Tax
Act. This means it gets automatically escaped from
the net of this standard.
Before we go for working part of the standard, it will
be desirable for us to know the definitions quoted for
the purpose of this standard.
1. Accounting Income (loss): It is the net profit or
loss for a period, as reported in the statement
of profit and loss, before deducting income tax
expense or adding income tax saving.
i.e. it is a book profit arrived at applying the
Generally Accepted Accounting Practices.
2. Taxable Income (Tax Loss): It is the amount of
the income (loss) for a period, determined in
accordance with the tax laws, based upon which
income tax payable (recoverable) is determined.
3. Tax Expense (Tax Saving): It is aggregate of
current tax and deferred tax charged or credited
to the statement of profit and loss for the period.
4. Current tax: It is the amount of income tax
determined to be payable (recoverable) in
respect of the taxable income (tax loss) for the
period.
5. Deferred tax: It is the tax effect of timing
differences.
6. Timing Differences: These are the differences
between taxable income and accounting income
for a period that originate in one period and
capable of reversal in one or more subsequent
periods.
Timing differences are temporary differences
between the accounting income & taxable
income, which are capable of reversal in
subsequent periods. In short the impact on tax
due to the difference originated in one period gets
nullified over future period
For this purpose we will consider one example:-
An asset is purchased on 1.04.2001 on which
under Companies Act depreciation is to be
 charged at 18.91% where as Income Tax Act rate
of depreciation is 25%. This leads to Timing
Difference as in the initial years the depreciation
allowable as per income tax in higher than
provided in the books. But in the subsequent years
the situation gets reversed as the depreciation
allowed as per income tax gets reduced as
compared to provided in the books.
7. Permanent Differences: These are the
differences between taxable income and
accounting income for a period that originate
in one period and do not reverse subsequently.
Permanent Difference creates a irreversible
impact on the taxable & accounting income.
e.g. amount deducted under section 80G of the
Income Tax Act, which is allowable to the extent
of 50% only though the entire amount is debited
to profit & loss A/c. once the deduction is allowed
to the extent of 50%, the remaining part is not
going to be allowed as deduction forever.
Now with this much introduction of the standard we
will concentrate towards the main part i.e. Computation
of Deferred Tax Asset or Liability.
Steps involved in recognition of deferred tax asset or
liability:-
1. Compute the profit as per books of accounts:-
Profit as per books of accounts is computed
following the Generally Accepted Accounting
Practices. i.e. profit is calculated by applying all
accounting conventions & principals. E.g.
Concept of Prudence, Concept of mutuality,
Concept of accrual, etc.
2. Ascertain the taxable profits: -
Taxable profit is computed applying the tax laws
that are enacted for the relevant assessment year.
3. Find out the difference in the profit as per books
of accounts & taxable income as calculated in
above two steps.
4. Analyse the causes for differences & classify
them into "Timing Differences" or "Permanent
Differences"
5. Divide the "Timing Differences" into differences
leading towards Deferred Tax Asset and Deferred
Tax Liability separately.
6. Net out the aforesaid timing differences resulting
towards either net deferred tax asset or net
deferred tax liability.
7. Apply the tax rates & tax law that are enacted or
substantively enacted by the balance sheet date
on net timing difference. (When tax rates are
applied as per slabs of income, then average rate
should be used for calculation of deferred tax
asset and liability)
Deferred tax = Net Timing Difference Tax Rate
8. Calculate the tax expense for the period: -
Tax expense is an aggregate of current tax &
deferred tax. The tax expense is to be shown in
the financial statements as a separate disclosure.
Also, the companies act, 1956 allows slight
deviation from Schedule VI for presentation of
Balance sheet.
Therefore,
Tax expense for the period = Current tax + Deferred
Tax
Special points to be kept in mind while computing
deferred tax asset or liability:-
1. Concept of prudence:-
The deferred tax asset so calculated should be
based on concept of prudence i.e. there should
be a reasonable assurance that the future profits
will be available against which the deferred tax
asset can be realized. For example if the company
has got a contract for supply of raw material to a
foreign buyer, this gives a reasonable assurance
about the future available profit to realize the
deferred tax asset.
2. No discounting of deferred tax asset or liability:-
Deferred tax asset or liability should not be
discounted to their present value due to the
practical difficulty of keeping the timely record
of reversals of the timing differences.
3. Provisions of Fringe benefit tax under section
115WJ of the Income Tax Act,1961:-
The Amount of Fringe Benefit Tax is not at all
deductible expenditure for computation of
Taxable Profits. Hence it leads to Permanent
Difference. Hence it should be excluded from the
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 ambit of this standard.
4. Provisions of Minimum Alternate Tax under
section 115JB of the Income Tax Act, 1961: -
In the event of Taxable losses for a corporate
assessees Minimum Alternate Tax might be
payable as per the provisions of aforesaid section.
From the Assessment Year 2006-07, credit for
Minimum Alternate Tax can be carried forward
to next five assessment years. Thus now it leads
to timing Difference. Hence credit available for
Minimum Alternate Tax should be considered for
this standard.

Now we will concentrate on issue of determination of timing difference leading to Deferred Tax Asset or Liability.
How to decide the deferred tax asset or deferred tax liability:-

Situation Tax impact Def. Tax Asset /Liability

1. When accounting income is Tax on taxable income is lesser Deferred tax liability
greater than taxable income than tax on accounting income
2. When accounting income is Tax on taxable income is greater Deferred tax Asset
lesser than taxable income than tax on accounting income

3. When accounting loss is
greater than taxable loss
The opportunity to carry forward Deferred tax Liability
& set off of losses against future
profit gets restricted to the taxable
loss and that results in future more
payment of taxes.

4. When accounting loss is Enterprise is in a position to carry Deferred Tax Asset.

lesser than taxable loss.
5. When there is loss as per books
but taxable income is computed.
6. When there is profit as per
books but taxable loss
forward & set off more loss against
the future profit and that leads to
lowering the future payments of
taxes
Enterprise will have to pay tax on Deferred tax asset
taxable income though its books
of accounts are showing loss
Enterprise will not have to pay tax Deferred tax liability
though there is profit in books

Some examples of Timing Differences:- Some examples of permanent differences:-

1. Depreciation provided in books & allowed by 1. Donations given under section 80G
the Income tax act
2. Tax Holiday benefits
2. Disallowance under section 43B of the income
3. Taxable income on presumptive basis under
tax act
section 44AD, 44AE, 44AC
3. Amortization of preliminary expenses under
4. Standard deduction under section 24(a)
section 35D
5. Capital gain indexation
4. Provision for doubtful debts
6. Weighted deduction under section 35
5. Municipal tax paid are allowed as deduction only
when payment is made during the pervious year 7. Income exempt from tax & expenses relating
there to under section 10
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We will now go for one example to get ourselves more The co. has purchased following Plant & Machinery:-
clarified with the above issues.
Date of purchase Purpose Amount (Rs.)
Illustration:
ABC Co. Ltd. started business on 1/04/2001. Following 1/04/2001 General 30000
information is available from records of the ABC Co. 1/04/2002 Research 25000
Ltd.
Profit before depreciation, amortization of preliminary 1/11/2004 Research 36000
expenses & taxes: -
Company charges depreciation on plant & machinery
Year Rs. @ 15% on Straight Line Method where as the rates of
depreciation as per Income Tax Act for general
2001-02 100000 machinery @ 25% on Written Down Value Method &
for research purpose @ 100%
2002-03 150000
The tax rates for relevant years were 45%, 40%, 35%
2003-04 250000 & 35.875% respectively.

2004-05 300000 During the year 2001-02 Company has written off
Rs. 30000/- preliminary expenses to Profit & Loss
A/c. Under Income Tax Act the qualifying sum for
amortization for 5 years is Rs. 25000.
During 2003-2004 payment of Rs. 140000/- made by bearer cheque, which will be disallowed @ 20 % under
section 40A(3).
Prepare Profit and Loss Statement using AS 22.

SOLUTION:

PARTICULARS YEAR ENDING

31.03.2002 31.03.2003 31.03.2004 31.03.2005

Profit before depreciation and 100000 150000 250000 300000

amortisation of expenses
Less :
1. depreciation 4500 8250 8250 10500

2. preliminary expenses 30000 - - -

Profit before Tax 65500 141750 241750 289500

Less : Tax Expense

Current Tax (note 1) 39375 45750 94073 91781

Deferred Tax (note 2) (7650) 10950 339 12077

Sub total 31725 56700 94412 103858

Profit Carried to Balance Sheet 33775 85050 147338 185642

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Note 1: Computation of current tax.

PARTICULARS YEAR
2001-02 2002-03 2003-04 2004-05

Profit before tax 65500 141750 241750 289500

Add back/add:

1. Depreciation. as per books 4500 8250 8250 10500

2. Preliminary Expenses 30000 - - -

3. Disallowed u/s 40A(3) - - 28000 -

(A) 100000 150000 278000 300000

Less:

Depre. As per IT Act 7500 5625 4219 3164

R&D Expenditure u/s 35 - 25000 - 36000-

Amount of Preliminary. Expenses 5000 5000 5000 5000

Sub total (B) 12500 35625 9219 44164

Taxable Profit (A-B) 87500 114375 268781 255836

Tax Rates 45% 40% 35% 35.875%

Current Tax 39375 45750 94073 91781

Calculation of depreciation as per Companies Act, 1956:-

Method:- Straight line Method
Rate of Depreciation: - 15%

Year Cost at the Depreciation Acquisition Cost of Depreciation Total

(1) beginning on opening during the Acquisition on addition Rs. (3+6) =
(2) balance (3) year (date) (4) (5) (6) (7)

2001-02 -- -- 1/04/2001 30000 4500 4500

2002-03 30000 4500 1/04/2002 25000 3750 8250

2003-04 55000 8250 --- --- --- 8250

2004-05 55000 8250 1/11/2004 36000 2250 10500

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Calculation of depreciation as per Income Tax, 1961:-
Method:- Reducing Balance method
Rate of Depreciation:- 25% for general purpose machinery on W.D.V..

Year Opening Additions during Deduction Depreciation Closing

balance the year during for the year Balance
the year

2001-02 -- 30000 (1/04/2001) Nil 7500 22500

2002-03 22500 Nil 5625 16875

2003-04 16875 Nil Nil 4219 12656

2004-05 12656 Nil 3164 9492

Note II: Computation of Deferred Tax Asset or Liability:-

Particulars 2001-02 2002-03 2003-04 2004-05

Profit as per books 65500 141750 241750 289500

Taxable Profit 87500 114375 268781 255836

Difference (absolute terms) 22000 (27375) 27031 (33664)

Segregation in

1. Permanent Difference.

a. Disallowance u/s 40A(3) - - 28000 -

b. Non qualifying amount of 5000*
Preliminary Expenses

2. Net Timing Difference 17000 (27375) (969) (33664)

Prima-facie Classification of Timing Differences :-

Year Timing Rate of Tax Deferred Tax Whether Deferred Tax Asset or
Difference Liability should be created

2001-02 17000 45% 7650 Deferred Tax Asset

2002-03 27375 40% 10950 Deferred Tax Liability

2003-04 969 35% 339 Deferred Tax Liability

2004-05 33664 35.875% 12077 Deferred Tax Liability

*Rs.30000 Written off to Profit & Loss A/c -- Amortization Allowed Under Income Tax Rs.25000 = Non-
qualifying Amount Rs.5000

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Presentation and Disclosure Requirements:-
1. Deferred Tax Asset or Liability should be
distinguished from assets & liabilities
representing current tax for the period. It should
be separately in the balance so as a distinguishing
from current assets & liabilities.
Though the standard requires separate disclosure
for the Deferred Tax Asset or Liability, it does
not specify the place in the Balance Sheet. It is
at the discretion of the Management but provided
*****
it should give the separate identification.
2. The major components in the Deferred Tax Assets
or Liabilities should be disclosed separately. This
means that the items contributing toward
recognition of Deferred Tax Asset or Liability
should be clearly spelt out in the notes to
accounts.
3. The nature of evidence supporting the recognition
of Deferred Tax Asset or Liability should be spelt
out in the Notes to accounts.