10 August 2024
### Provision for Tax and Advance Payment of Tax in Cash Flow Statements
When preparing a Cash Flow Statement, it's important to distinguish between "Provision for Tax" and "Advance Payment of Tax" as they affect cash flows differently. Here’s how to understand and handle them:
#### **1. Provision for Tax:**
- **Definition:** This is an amount set aside from the profit to cover the tax liability expected to be payable in the future. It is a non-cash item and represents a liability on the balance sheet.
- **Impact on Cash Flow Statement:** When preparing the Cash Flow Statement, you need to adjust for changes in provisions for tax. Since it is a non-cash item, it needs to be added back to the net profit in the Operating Activities section.
#### **2. Advance Payment of Tax:**
- **Definition:** This represents the actual cash outflow made during the period towards tax liabilities. It is a cash payment made in advance for future tax liabilities.
- **Impact on Cash Flow Statement:** Advance payments of tax are classified as a cash outflow in the Operating Activities section of the Cash Flow Statement.
### Example to Illustrate
Let’s consider an example to clarify how these items are handled in the Cash Flow Statement.
**Example Scenario:**
- **Net Profit:** ₹1,000,000 - **Provision for Tax (Increase during the year):** ₹200,000 - **Advance Payment of Tax during the year:** ₹150,000
**Cash Flow Statement Preparation:**
1. **Operating Activities:**
- **Net Profit Before Tax:** ₹1,000,000
- **Add: Provision for Tax (Non-Cash Item):** ₹200,000 - **Reason:** Provision for tax is not an actual cash outflow, so it is added back to net profit.
- **Less: Advance Payment of Tax:** ₹150,000 - **Reason:** Advance payment of tax is an actual cash outflow, so it is deducted from net profit.
**Cash Flow from Operating Activities Calculation:**
``` Net Profit Before Tax ₹1,000,000 Add: Provision for Tax ₹200,000 Less: Advance Payment of Tax ₹150,000 ------------------------------------------------------------ Net Cash Flow from Operating Activities ₹1,050,000 ```
**Explanation:**
1. **Provision for Tax:** Since it's a non-cash item, it is added back to net profit to reflect the actual cash flow.
2. **Advance Payment of Tax:** This represents actual cash spent on taxes, so it reduces the net cash flow.
### Key Assumptions:
- **Provision for Tax:** Adjust for changes in the provision for tax as it impacts the accounting profit but not the cash flow. - **Advance Payment of Tax:** Directly affects cash flow as it is a cash outflow related to tax payments.
Understanding these adjustments ensures accurate reporting of cash flows, giving a true picture of the company’s liquidity and operational cash position.
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