Deferred payment liability

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Anil Bhandari

Anil Bhandari (Querist)
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17 February 2012 What is mean by Deferred payment Liability?
Can i have the examples of the same?

Bhaskaran Chackrapani Warrier

Bhaskaran Chackrapani Warrier (Expert)
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19 February 2012 Income for financial statement purposes is determined under generally accepted accounting principles as set forth by the accounting profession. Income for tax purposes is determined according to the Income tax Act,1961/The Income tax Rules,1962. These act/rules often do not follow generally accepted accounting principles. Accordingly, differences will arise between accounting income and taxable income leading to a difference if the tax calculation/ liability.

These differences may be either temporary or permanent in nature. Temporary differences are referred to as “timing differences” because, with time, they reverse or turn around. Permanent differences are forever they do not reverse. Deferred tax liability, therefore, arises due to temporary differences.

Temporary differences involve the recognition of revenue or expense items in one year for tax purposes but in a different year for accounting purposes. Overall the total income is the same for both tax and accounting purposes, it is just the timing that is different.

EXAMPLE-1 : Under accrual system of accounting , revenue is recognized when earned, not when received. Thus if in year 1 a company earns revenue but does not receive it until year 2, it would recognize it as income in year 1. However, for tax purposes, revenue is recognized when received. Thus this item would not be reported on the tax return until year 2. Accordingly, in year 1, the income statement reports this revenue while the tax return does not whereas in year 2, the tax return reports it as revenue while the income statement does not. For both years together, however, the total income is the same meaning thereby the difference is only in timing. Year 1 is called the year of origination of the difference; year 2 is the year of reversal.

SOME MORE EXAMPLES:-

i) Straight-line depreciation used for accounting purposes while WDV method (as per IT Rules,1962) is used for tax purposes.

ii) Percentage-of-completion method for construction contracts used for accounting purposes (AS-7)while the completed-contract method is used for tax purposes.

iii) Expenditures for prepaid items deducted completely this year for tax purposes, but amortized gradually for accounting purposes.