Mastering AS 22: A Comprehensive Guide to Accounting for Taxes on Income

Accounting for income taxes is a critical aspect of financial reporting. It affects not only a company’s financial position but also its future tax obligations. 

The AS 22 Accounting Standard, issued by the Institute of Chartered Accountants of India (ICAI), governs how companies account for taxes on income, particularly deferred taxes. 

This guide helps you understand AS 22 with clarity, using practical examples to illustrate its application.

Read on…

Understanding the Objectives of AS 22

The primary objective of AS 22 is to prescribe how a company should account for current and future tax consequences of:

• The future recovery (settlement) of the carrying amount of assets (liabilities).
  
• Transactions and events recognized in the financial statements during the current period.

It ensures the matching of tax expenses with accounting income, so that the financial statements reflect a true and fair view of the company’s performance and obligations.

Scope and Applicability of AS 22

AS 22 applies to all enterprises that are required to prepare financial statements under the Companies Act, 2013 or similar laws.

• It is mandatory for companies and LLPs, especially those covered under tax audits.
  
• It does not apply to entities that follow cash accounting or are not subject to direct tax laws.
  
• AS 22 is aligned with Indian income tax laws and does not cover deferred taxes arising from assets not recognised in the books.

Key Definitions and Terminology in AS 22

Let’s break down a few key terms:

• Accounting Income: Net profit or loss as per the profit & loss account before tax.
  
• Taxable Income: Income computed as per income tax laws, which forms the base for income tax calculation on salary or business earnings.
  
• Current Tax: The amount of tax payable for a period, based on taxable income.
  
• Deferred Tax: Future tax consequences due to differences between accounting income and taxable income.
  
• Timing Differences: Differences that originate in one period and reverse in another.
  
• Permanent Differences: Differences that do not reverse over time (e.g., disallowed expenses).

Recognition of Tax Effects: Current and Deferred

Current Tax Expense

The current tax is straightforward, computed using the prevailing tax rate on taxable income. For salaried employees, this includes income tax calculation on salary, while for businesses, it involves computing taxable profits as per the Income Tax Act.

Example:
If a company earns Rs 10,00,000 as per tax rules and the applicable tax rate is 30%, the current tax liability would be Rs 3,00,000.

Deferred Tax Assets and Liabilities

These arise due to timing differences and affect taxes payable in future years.

Calculation of Deferred Tax Assets

A Deferred Tax Asset (DTA) arises when taxable income is higher than accounting income, leading to future tax benefits.

Example:
A company makes a provision for doubtful debts of Rs 1,00,000 in its financials, but this is not allowed for tax purposes. Taxable income is higher now, but this difference will reverse when the actual bad debt occurs.

If the tax rate is 30%,
Deferred Tax Asset = Rs 1,00,000 × 30% = ₹30,000

Calculation of Deferred Tax Liabilities

A Deferred Tax Liability (DTL) occurs when accounting income is higher than taxable income due to temporary differences.

Example:
A company uses a straight-line method (SLM) for depreciation in books but written down value (WDV) for tax purposes. This results in lower taxable income in early years and a future liability.

If depreciation difference is Rs 2,00,000, and the tax rate is 30% –
Deferred Tax Liability = Rs 2,00,000 × 30% = Rs 60,000

Types of Tax Differences: Permanent and Timing

Tax differences are classified into permanent and timing differences. Permanent differences do not reverse over time, while timing differences arise in one period and reverse in another, impacting the recognition of deferred tax assets or liabilities.

Permanent Differences: Examples and Implications

These do not reverse over time and hence do not give rise to deferred tax.

Examples:

• Penalties or fines (disallowed under tax laws)
  
• Donations to NGOs without 80G benefit
  
• Income exempt under Section 10

Implication: These differences only affect current tax; no DTA or DTL is created.

Timing Differences: Analysis and Impact on Deferred Taxes

Identifying Timing Differences

Timing differences arise when income or expense is recognized in different periods in books and tax computation.

Common Sources:

• Depreciation methods
  
• Provisions for expenses
  
• Preliminary expenses amortization
  
• Gratuity payments

Impact on Future Taxable Income/Expense

Timing differences will reverse in future years, affecting income tax of those periods. This necessitates the recognition of DTA or DTL, ensuring income is matched with its tax impact.

Accounting for Deferred Tax Assets and Liabilities

Valuation and Measurement of Deferred Tax Assets

Deferred Tax Assets are measured using enacted or substantively enacted tax rates at the balance sheet date.

Key condition: There must be reasonable certainty that future taxable income will be available.

In case of carry-forward losses, virtual certainty supported by convincing evidence is required.

Valuation and Measurement of Deferred Tax Liabilities

Deferred tax liabilities are also measured at enacted tax rates. Since they indicate tax payable in future due to income already earned, they are generally recognized without additional conditions.

Recognition and Derecognition Criteria

Recognition:

• DTA is recognized only when there’s probable future taxable income.
  
• DTL is always recognized if timing differences exist.

Derecognition:

• If circumstances change and future taxable income is no longer probable, DTA must be reversed.
  
• DTL is reversed when timing differences are realized or expired.

Disclosure Requirements under AS 22

Required Disclosures in Financial Statements

• The major components of DTA and DTL
  
• The nature of timing differences
  
• Amount of DTA/DTL recognized in P&L

Presentation of Deferred Tax Assets and Liabilities

• DTA and DTL are not netted off, unless from the same governing authority.
  
• They are shown as non-current assets or liabilities.
  

Practical Application and Examples of AS 22

Case Studies Illustrating AS 22 Principles

Case Study 1: Provision for Gratuity

ABC Ltd. creates a provision of Rs 1,50,000 for gratuity in books, but this is allowed for tax only on payment.

• DTA = Rs 1,50,000 × 30% = Rs 45,000
  
• This is reversed when gratuity is paid in the next year.
  

Case Study 2: Depreciation Difference

XYZ Ltd. has a depreciation difference of Rs 5,00,000 (SLM in books and WDV in tax). It results in:

• DTL = Rs 5,00,000 × 30% = Rs 1,50,000

This DTL is reduced in future years as the difference narrows.

Common Scenarios and Solutions

Scenario	AS 22 Treatment
Disallowed expense (penalty)	Permanent difference – no DTA
Provision for doubtful debts	Timing difference – DTA
Income from agriculture	Permanent difference – ignored
Preliminary expenses amortized over years	DTA allowed on balance amount
Different depreciation methods	DTL in initial years

Amendments and Updates to AS 22

While AS 22 Accounting Standard has not undergone many structural changes, it is important to note its convergence with Ind AS 12 in case of large enterprises.

Recent emphasis includes:

• Proper recognition of DTA on Minimum Alternate Tax (MAT) credit.
  
• More stringent documentation for virtual certainty in DTA.
  

For professionals and businesses subscribing to stock advisory services, especially for financial planning or tax estimation, staying updated with any future revisions to AS 22 is crucial.

Conclusion

The AS 22 Accounting Standard plays a crucial role in aligning the tax implications with financial performance. By focusing on both current and deferred tax, it ensures transparency in reporting and helps investors, tax professionals, and analysts make informed decisions.

In today’s era of complex transactions and dynamic regulations, aligning with a competent stock advisory service and staying informed about tax standards like AS 22 can offer a significant edge.

Frequently Asked Questions (FAQs)

What is the accounting entry for income tax paid?
The accounting entry for income tax paid involves debiting the income tax payable account and crediting the bank account.

What is the accounting entry for tax payable?
The accounting entry for tax payable includes debiting the income tax expense account and crediting the income tax payable account. 

Is income tax paid an expense or a liability?
Income tax is both an expense and a liability. When the tax is calculated for the period, it becomes an expense. Until the amount is paid, it is shown as a liability in the balance sheet under current liabilities or provisions.

Is income tax debited or credited?
Income tax is debited to the Profit & Loss account because it represents a cost incurred by the business. 

What are the key differences between AS 22 and IAS 12?

Accounting Standard 22 (AS 22) is based on timing differences, whereas International Accounting Standard 12 (IAS 12) follows the temporary difference approach. AS 22 applies under Indian Generally Accepted Accounting Principles (Indian GAAP), while IAS 12 is aligned with International Financial Reporting Standards (IFRS). The conditions for recognizing Deferred Tax Assets (DTA) and the treatment of revaluation gains also differ significantly between the two standards.

What does tax reconciliation entail?
Tax reconciliation involves comparing accounting income with taxable income to identify differences. 

What is the basic principle for accounting for income taxes under AS 22?

It’s the matching principle: tax expenses should be recognized in the same period as the related income or expense, ensuring fair presentation of financial results.

How to handle changes in tax rates?

If the enacted or substantively enacted tax rate changes, the DTA and DTL are recomputed using the new rate, and the change is reflected in the profit & loss account.

How to account for uncertain tax positions?

Although AS 22 does not provide a detailed framework for uncertain tax positions, best practices involve disclosing contingent liabilities, refraining from recognizing deferred tax assets unless there is reasonable certainty, and seeking guidance from tax experts or professional tax  services.