What is Deffered TaxSolutionAnswer This means that payment o

What is Deffered Tax?

Solution

Answer

This means that payment of tax has been deferred (or postponed) to later future date.

---One of the main reason for such ‘temporary difference’ is the difference between depreciation as per accounting records and depreciation allowed under income Tax.

---In the following example, Income without considering Depreciation expense is $ 200000 for both for accounting record as well as for taxable records. Depreciation as per books is $10,000 while income tax law allows $ 15,000 depreciation.

Accounting Income

Taxable Income

Net Income without considering Depreciation expense

$       2,00,000.00

$                 2,00,000.00

Depreciation expense

$           10,000.00

$                     15,000.00

Income after depreciation

$       1,90,000.00

$                 1,85,000.00

Tax Rate

10%

10%

Income taxes to be paid

$19,000

$18,500

---As a result, the taxable income will be $ 185,000 while Accounting income will be $ 190,000 (more than taxable income). This means that due to ‘temporary difference’ of $ 5,000 (of depreciation expense), the company will have to pay LOWER taxes in current period.

---Income tax rate is 10%.
---As per accounting income, income tax to be paid by the company comes at $19,000 [ 190000 x 10%]
---However, in current period the company has to pay tax on the basis of taxable income of $ 185,000, hence income tax to be paid will be $18,500 [185000 x 10%]

---Hence, payment of $ 500 of income tax (19000 – 18500) has been deferred to be paid in future. This is called Deferred Tax.

---This difference of $ 500 will lead to creation of Deferred Tax Liability, and will be shown under Income tax expense as ‘deferred tax expense’.

---The application of computing deferred tax is based on accrual and matching concept of accounting.