Given below are two statements: Statement I : Deferred Tax Liabilities (Net) is the amount of tax on the temporary difference between the accounting income and taxable income. It arises when the accounting income is more than the taxable income. Statement II : Deferred Tax Liabilities (Net) and Deferred Tax Assets (Net) are only book entries i.e. they are neither actual liability nor actual asset. In the light of the above statements, choose the correct answer from the options given below:
Both Statement I and Statement II are true.
Understanding Deferred Tax Liabilities and Assets
This question asks us to evaluate two statements regarding Deferred Tax Liabilities (Net) and Deferred Tax Assets (Net).
Let's analyze each statement carefully.
Analysis of Statement I: Deferred Tax Liabilities (Net)
Statement I says: "Deferred Tax Liabilities (Net) is the amount of tax on the temporary difference between the accounting income and taxable income. It arises when the accounting income is more than the taxable income."
- Deferred Tax Liabilities (DTL) are indeed recognized for temporary differences between the carrying amount of assets and liabilities in the financial statements and their tax bases. These differences lead to amounts that will be taxable in future periods when the carrying amount of the asset is recovered or the liability is settled.
- Temporary differences occur because revenues and expenses may be recognized in accounting income in one period but included in taxable income in a different period.
- A taxable temporary difference is one that results in taxable amounts in future periods. These give rise to Deferred Tax Liabilities.
- When accounting income is greater than taxable income in the current period, it is often due to revenue or gains recognized for accounting purposes but taxed later, or expenses or losses deducted for tax purposes but recognized for accounting purposes later. This creates a taxable temporary difference, leading to a Deferred Tax Liability. For example, if accounting depreciation is less than tax depreciation, accounting income will be higher than taxable income, creating a taxable temporary difference that reverses over time, leading to DTL.
Therefore, Statement I accurately describes Deferred Tax Liabilities arising from temporary differences and their connection to accounting income being more than taxable income.
Conclusion for Statement I: Statement I is true.
Analysis of Statement II: Nature of Deferred Tax Entries
Statement II says: "Deferred Tax Liabilities (Net) and Deferred Tax Assets (Net) are only book entries i.e. they are neither actual liability nor actual asset."
- Deferred Tax Liabilities (DTL) and Deferred Tax Assets (DTA) are indeed 'book entries' in the sense that they are recognized in the financial statements (balance sheet) based on accounting rules (like Ind AS 12 or IAS 12). They are not typically settled or realized through immediate cash payments or receipts.
- DTL represents the future tax consequences of taxable temporary differences that will result in taxable amounts in future periods. While classified as a liability on the balance sheet, it doesn't represent a current cash outflow obligation like a trade payable.
- DTA represents the future tax consequences of deductible temporary differences and unused tax losses/credits that will result in amounts deductible from taxable income in future periods. While classified as an asset, it doesn't represent a current cash inflow like cash or a receivable.
- Their 'asset' or 'liability' status is derived from their expected future impact on taxable income and hence on tax payments. They represent future economic outflows (for DTL) or inflows/savings (for DTA) related to income tax, but not present, immediate obligations or resources.
- The statement claims they are "neither actual liability nor actual asset." The term "actual" here seems to differentiate them from current or immediately realizable/settlable liabilities or assets that involve present cash flows or rights. In this context, where 'actual' might imply immediate or current cash impact, the statement holds true as DTL/DTA relate to future tax effects and are purely accounting recognitions of these future effects. They are recognized based on accounting principles rather than being a tangible asset or an immediately due debt.
Given the likely interpretation intended in the context of the options where both statements are true, Statement II emphasizes their nature as accounting constructs that reflect future tax impacts rather than current, tangible assets or liabilities with immediate cash implications.
Conclusion for Statement II: Statement II is true, understanding 'actual' in the sense of current or immediate cash-based items.
Combining the Conclusions
Based on our analysis:
- Statement I is true.
- Statement II is true.
Therefore, both statements are true.
| Statement | Evaluation | Reasoning |
|---|---|---|
| Statement I: DTL from temporary difference when accounting income > taxable income. | True | Taxable temporary differences arise when accounting income is higher than taxable income due to timing differences. These differences lead to future taxable amounts, creating DTL. |
| Statement II: DTL and DTA are only book entries, neither actual liability nor actual asset. | True | DTL/DTA are accounting recognitions of future tax effects. They don't represent current, immediate cash obligations (liabilities) or resources (assets). Their 'actual' nature is defined by accounting rules regarding future impacts, not present cash flows. |
Comparing our conclusions with the given options:
- Option 1: Both Statement I and Statement II are true. (Matches our conclusion)
- Option 2: Both Statement I and Statement II are false. (Does not match)
- Option 3: Statement I is true but Statement II is false. (Does not match)
- Option 4: Statement I is false but Statement II is true. (Does not match)
Revision Table: Key Concepts on Deferred Tax
| Concept | Description | Impact on Financial Statements |
|---|---|---|
| Temporary Difference | Difference between the carrying amount of an asset/liability and its tax base. These differences reverse over time. | Causes deferred tax assets or liabilities. |
| Taxable Temporary Difference | Results in taxable amounts in future periods when the asset/liability is recovered/settled. Arises when accounting income > taxable income initially. | Leads to Deferred Tax Liability ($\text{DTL}$). |
| Deductible Temporary Difference | Results in amounts deductible from taxable income in future periods. Arises when accounting income < taxable income initially. | Leads to Deferred Tax Asset ($\text{DTA}$). |
| Deferred Tax Liability ($\text{DTL}$) | Amount of income taxes payable in future periods in respect of taxable temporary differences. | Reported as a liability on the Balance Sheet. |
| Deferred Tax Asset ($\text{DTA}$) | Amount of income taxes recoverable in future periods in respect of deductible temporary differences, unused tax losses, and unused tax credits. | Reported as an asset on the Balance Sheet. |
Additional Information: Accounting vs. Taxable Income
Understanding the difference between accounting income and taxable income is crucial for grasping deferred tax. Accounting income is calculated based on accounting standards (like GAAP or Ind AS) and reflects the company's financial performance. Taxable income is calculated based on tax laws and regulations and is used to determine the current tax liability.
Differences arise due to two main reasons:
- Permanent Differences: Items included in either accounting income or taxable income but never in the other. These do not reverse and do not create deferred tax effects. Examples include certain fines, penalties, or tax-exempt income.
- Temporary Differences: Items included in both accounting income and taxable income but in different periods. These differences will reverse over time. Examples include differences in depreciation methods (accounting vs. tax), provisions, or deferred revenue. These are the source of deferred tax assets and liabilities.
Deferred tax accounting ensures that the income tax expense recognized in the statement of profit and loss is matched with the accounting income of the period, reflecting the tax consequences of all items included in that income, regardless of when they are taxed or tax-deductible.
Important Questions from Balance sheet statement
___________ is a record of assets and liabilities of any firm.
A businessman can find out what his business owns and what it owes from _______.
Which of the following options is an INCORRECT pair considering a firm's balance sheet?
A trial balance shows
(i) Credit balances
(ii) Debit balances
Which of the following pairs is NOT correctly matched in the context of account balances shown in the Trial Balance?
