Who should file Schedule AL (Assets and Liabilities) in ITR?

Government of India has been introducing various changes to the Income Tax Returns. One such compliance in ITR is the “Schedule AL”. Generally, a taxpayer carrying on business or profession is required to fill in details of assets and liabilities through a Balance Sheet in the ITR. However, in some cases, it is mandatory for taxpayers to disclose their assets and liabilities at the end of the year. Such taxpayer can fill in the details through the Schedule AL.

What is Schedule AL?

This schedule requires the taxpayer to disclose details of various assets owned by them & the corresponding liabilities. But, it is mandatory for specified assessee only. The reason behind it’s inclusion was to have a record of all the assets owned by certain group of people. The disclosure of assets consists of immovable property, movable property and financial assets owned by the taxpayer. The liabilities include all liabilities of the taxpayer in relation to such assets.

When is Schedule AL (Assets and Liabilities) applicable?

Not all the tax payers have to disclose their assets and liabilities. The requirement to furnish particulars of certain assets and liabilities applies individuals and HUFs having an annual income exceeding INR 50 lakh. This requirements are applicable for those filing ITR 2 and ITR 3. This is in addition to the Balance Sheet of the business or profession to be filed in ITR-3.

What if total income of taxpayer is exactly INR 50 lakhs?

Your total income is calculated by subtracting tax saving deductions under Chapter-VI-A from Gross Total Income of a taxpayer. In case, total income of taxpayer is coming exactly INR 50 lakhs, then Schedule AL is not applicable.

For better understanding, lets take an example of Sweksha.

Her gross income per annum is INR 53 lakh. However, she gets a tax deduction of INR 1.5 lakh for investments and expenditures under section 80C and INR 50000 under section 80D. In addition, she has been paying home loan instalments and qualifies for the deduction on home loan interest of INR 1 lakh per annum.
Therefore this brings down her net income to INR 50 lakh. Now, she is not required to file Schedule AL in her ITR.
Further, if there was no home loan interest deduction in that case, the net income would amount to INR 51 lakh. This income would exceed the threshold limit of INR 50 lakh. Consequently, it would be mandatory for Sweksha to fill Schedule AL.

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What details are required to be disclosed in schedule AL?

Taxpayers will have to report the following details in Schedule AL:

  • Immovable Property: Cost of Land and Building owned.
  • Movable Property: Cash in hand, cost of Jewelry, bullion, aircraft, vehicles, yachts, boats.
  • In case of ITR 3 additional details regarding deposits or investments made in banks, investment in shares and securities, loans and advances given, insurance policies, cost of archaeological collections, drawings, paintings, etc. are to be provided.
  • Liability (loans) in relations to the above mentioned assets and investments.

Guidelines to file Schedule AL (Assets and Liabilities)

Here are a few points you must comply to, while filing Schedule AL:

  • You must disclose your assets at cost. Also, you can include any cost of improvement incurred on the asset.
  • The assets mentioned will not include personal accessories i.e. wearing apparel, furniture held for personal use by the taxpayer or dependent any family member.
  • The ‘assets’ to be reported will include land, building along with immovable assets; financial assets such as shares, securities, and deposits; loans and advances, insurance policies, cash in hand, jewellery, vehicles. Further, movable assets such as yachts, aircraft, and boats, and bullion.
  • Jewellery includes :
    • Ornaments made of gold, silver, platinum, any other precious metal, or an alloy made of one or more of such precious metals. It may or may not contain precious or semi-precious stones.
    • Details of precious or semi-precious stones whether or not set in any utensil, furniture, or any other apparel.
  • If the asset is a gift, by will, or any other mode in Section 49(1) and not covered by the above clause:
    • The cost of such asset will be the cost of the previous owner plus the cost of any improvement incurred by the previous owner.
    • If the cost of such asset is not ascertainable and no wealth tax return was filed for that asset, the value can be estimated at the circle rate or bullion rate as per the date of acquisition by the assessee.
  • Non-residents and not ordinarily resident individuals must provide details of their assets situated in India.
  • In the case of liabilities, all liabilities incurred in relation to the assets should be reported such as:
    • Housing loan
    • Vehicle loan
    • Personal loan
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FAQ

Is schedule AL applicable for non residents also ?

Yes, schedule Al is applicable irrespective of residential status to individuals and HUFs if the taxable income exceeds INR 50,00,000

I hold foreign assets during the previous year which have been duly reported in the Schedule FA. Whether I am required to report such foreign asset again in the Schedule AL (if applicable)?

Yes, you are required to mention the same in Schedule AL as well.

Minimum Alternate Tax – MAT

What is Minimum Alternate Tax or MAT?

Minimum alternate tax was launched to reduce the gap between the tax accountability as per income calculation and book profits. To better understand it, MAT was introduced to target companies that make huge profits and pay the dividends to their shareholders but pay very minimal tax under the normal provisions of the income tax act. They do this by taking advantage of the deductions and exemptions allowed under the act. Therefore, with the introduction of MAT, the companies have to pay a fixed percentage of their profits as minimum alternate tax. Also, it is calculated under section 115JB. Below are the 2 provisions under which the companies should pay higher of the tax calculated:

  • Tax liability as per the normal provisions of the income tax act, i.e, tax rate 30% + 4% education cess and surcharge if applicable
  • Tax liability explanation as per the MAT provisions is in section 115JB. The tax rate is 15% with effect from AY 2020-21

Calculation of MAT or Minimum Alternate Tax

MAT includes 18.5% of book profits which include surcharge and cess if they are applicable (15% from AY 2020-21). Here, book profit means the net profit as shown in the profit and loss account for the year as increased and decreased by the following:

Additions to the Net Profit if Debited to the Profit & Loss Account

  • Income tax paid or payable if any calculated as per normal provisions of the income tax act
  • Transfer made to any reserve
  • Dividend proposed or payable
  • Provision for loss of subsidiary companies
  • Depreciation including depreciation on account of revaluation of assets
  • Amount/provision of deferred tax
  • Provision for unascertained liabilities
  • Amount of expense relating to exempt income under sections 10, 11, 12 except section 10AA and 10(38). This means income under section 10AA & long term capital gain are exempt under section 10(38) are subject to MAT.

Deletions to the Net Profit

  • Amount withdrawn from any reserves or provisions
  • The amount of income to which any of the provisions of section 10, 11 & 12 except 10AA & 10(38) applies.
  • The amount is withdrawn from revaluation reserve and credited to profit & loss account to the extent of depreciation on account of revaluation of asset
  • Amount of loss brought forward or unabsorbed depreciation, whichever is less as per the books of account. However, the loss shall not include depreciation. (if loss brought forward or unabsorbed depreciation is nil then nothing shall be deducted)
  • Amount of Deferred Tax, is any such amount is credited in the profit & loss account
  • Amount of depreciation debited to the Profit and Loss Account (excluding the depreciation on revaluation of Assets)

Applicability of MAT

As per section 115JB, every taxpayer being a company is liable to pay MAT, if the Income tax is payable on the total income, computed as per the provisions of the income tax act in respect of any year is less than 15% of its book-profit + surcharge (SC) + health & education cess. However, the provisions of MAT are not applicable on:

  • The domestic companies which have opted for tax regimes under Section 115BAA or Section 115BAB;
  • Any income accruing or arising to a company from the life insurance business referred to in Section 115B;
  • Shipping company, the income of which is subject to tonnage taxation.
    [As amended by Finance Act, 2020]. Further, as per Explanation 4 to section 115JB as amended by Finance Act, 2016 with retrospective effect from 1/4/2001, it is clarified that the MAT provisions shall not be applicable and shall be deemed never to have been applicable to an assessee, being a foreign company, if:
    • The assessee is a resident of a country or a specified territory with which India has an agreement referred to in sub-section (1) of section 90 of the Central Government has adopted an agreement under subsection (1) of section 90A and the assessee does not have a permanent establishment in India in accordance with the provisions of such agreement or,
    • The assessee is a resident of a country with which India does not have an agreement of nature referred to in clause (i) and the assessee is not required to seek registration under any law for the time being in force relating to companies.

Further, as per Explanation 4A to section 115JB as inserted by Finance Act, 2018, MAT provisions shall not be applicable to a foreign company, whose total income comprises profits and gains arising from a business referred to in section 44AB, 44BB, 44BBA, or 44BBB and such
income has been offered to tax at the rates specified in those sections

What is Minimum Alternate Tax Credit?

When any amount of tax is paid as minimum alternate tax by the company, it can claim the credit of such taxes paid in accordance with the provision of section 115JAA.

The allowable tax credit is the tax paid as per MAT calculation which is the income tax payable under the normal provision of the income tax act. However, no interest shall be paid on this tax credit by the department.

FAQs

When is MAT applicable?

It is applicable to all the companies including foreign companies.

What is the difference between MAT and Alternate Minimum Tax or AMT?

MAT stands for Minimum Alternate Tax and AMT stands for Alternate Minimum Tax. Initially the concept of MAT was introduced for companies and progressively it has been made applicable to all other taxpayers in the form of AMT.

Section 36 of Income Tax Act, 1961

Section 36 of the Income Tax Act deals with the list of specific expenses which are allowed for the purpose of computation of income chargeable to tax under the business and profession head of income.

INDEX

Section 36(1)(i) – Insurance Premium

Insurance Premium deduction u/s 36(1)(i) is in three parts. First is in respect of risk of damage or destruction of stock in trade second for life of the cattle and last one for health insurance of employees.

Section 36(1)(i) Deduction for insurance premium paid to cover the risk of damage and destruction of stock in trade, used for the purpose of Business & Profession of the assessee.
Section 36(1)(ia) Insurance premium paid by Federal Milk Cooperative Society for the life of cattle owned by the members to primary society supplying milk to it shall be allowed as deduction.
Section 36(1)(ib) Deduction for health insurance premium paid for insurance of employees. Deduction will be allowed for the premium paid by any mode other than cash.

Section 36(1)(ii) – Bonus or Commission to Employees

Statutory bonus or voluntary bonus shall be allowed as deduction in the year of payment subject to provisions of section 43B and it shall be allowed only if bonus paid is not in lieu of dividends or profits.

Section 36(1)(iii) – Interest on Borrowed Capital

The amount of interest paid in respect of capital borrowed for the purpose of Business & Profession of assessee shall be allowed as deduction.
Also deduction shall be allowed subject to the section 43B if the loan is taken from bank, PFI, state financial corporation or state industrial financial corporation.

Moreover, When the capital is borrowed for acquisition of a capital asset, then interest liability pertaining to the period till the date such asset is put to use shall not be allowed as deduction.

Section 36(1)(iiia) – Discount on issue of Zero Coupon Bonds

Discount on a zero-coupon bond is available as a deduction under Section 36. However, pro-rata amount of discount amortized over the life (calendar months) of the zero-coupon bonds will be allowed.

Section 36(1)(iv) – Employer’s contribution to provident fund or superannuation fund

Employer’s contribution to recognized provident fund or a superannuation fund is allowed as a deduction subject to limits laid down for the purpose of recognizing the provident fund or approved superannuation fund, on the payment basis i.e only in the year when it is actually paid by the employer.

Section 36(1)(iva) – Employer’s Contribution to National Pension Scheme (NPS)

Employer can claim deduction for contribution towards a pension fund as specified under Section 80 CCD, however, the deduction allowed will be limited to the extent of 10 percent of employees’ salary.

Moreover, salary includes dearness allowance but excludes other perquisites and other allowances.

Section 36(1)(v) – Employer contribution towards Approved Gratuity Fund

Deduction is allowed for the amount paid towards the approved gratuity fund created by employer exclusively for the benefit of his employees under an irrevocable trusts. However, it is subject to the provisions of section 43B.

Section 36(1)(va) – Employees’ Contribution to Staff Welfare Schemes

Any sum deducted from the salary of the employee as his contribution to any provident fund or superannuation fund or ESI or any other fund for the welfare of such employee is treated as an income of the employer as per section 2(24)(x). However, if such contribution is actually paid on or before the due date the deduction will be allowed for the same under this clause.

Section 36(1)(vi) – Allowance in respect of Dead or Permanently useless Animals

Expenditure on the purchase of animals for the purpose of business or profession is a capital expenditure. However, there is no depreciation allowance on such capital expenditure.

Moreover, one has write off such capital expenditure as a loss in the year in which the animal dies or becomes permanently useless.

Further, deduction amount will be the cost of animal minus the proceeds of sale of the carcasses or the animals.

Section 36(1)(vii) – Bad debts written off

Deduction for bad debts could be claimed if such bad debts are related to the profession or business and must have been considered while computing the income from such profession or business. However, the deduction isn’t available for any provision for the bad debts.

Moreover, If the bad debt represents money lent then it is not available as deduction except if assessee has lent money in the ordinary course of the business of banking or money-lending.

Section 36(1)(viia) – Provision for Bad and Doubtful Debts relating to Rural Branches of Commercial Banks

Deduction for provision for bad debts is available to banks and financial institutions. Also, the amount of deduction for Indian Banks will be equal to 8.5 percent of their gross total income plus 10 percent of their aggregate average advances made by the rural branches. Moreover, For banks that are incorporated outside India and other non banking financial institutions, the deduction will be limited to the extent of 5 percent of their gross total income

Section 36(1)(viii) – Transfer to Special Reserve

When any profit from eligible business is transferred to the reserve it can be claimed as a deduction. The amount allowed as a deduction is lower of the following.

  • 20% of the profit computed as per section 28 before deduction u/s 36(1)(viii)
  • Actual amount transferred to special reserve
  • 200% of (Paid-up capital+ General reserve) – Opening balance in special reserve

Further, Eligible business means Financial corporation engaged in providing long term finance (5 years or more) for industrial, agricultural, infrastructure and housing development companies.

Note : If any amount withdrawn from this reserve, one has to consider it as business income in the year of withdrawal.

Section 36(1)(ix) – Family Planning Expenditure

This expense is allowed as a deduction to the company, when such expenditure is capital in nature, in five equal annual installments. First installment is allowed in the year in which the expense is incurred. (For revenue expenses 100% deduction is allowed)

Section 36(1)(xv) – Securities Transaction Tax

Trader can claim the deduction of STT when shares/units/commodities are stock-in trade.

Section 36(1)(xvi) – Commodities Transaction Tax

A public financial institution can claim deduction for its contribution to notified credit guarantee trust for small industries(i.e. Credit Guarantee Fund Trust for Micro and Small Enterprises). Couldn’t find it online

Section 36(1)(xvii) – Expenditure by Co-Operative Society for purchase of Sugarcane

Cooperative society engaged in the business of manufacturing of sugar can claim the deduction for purchase of sugarcane at a price which is equal to or less than the price fixed by the government.

Section 36(1)(xviii) – Marked to Market Loss

Deduction is available for marked to market loss or any other expected loss as computed in the manner provided in ICDS (Income Computation & Disclosure Standards).

FAQs

What is Section 43B?

As per the income tax act, 1961 Section 43B states that certain payments can be claimed as an expense in the year of payment and not in the year of occurrence the liability.

Is deduction available for payment of health insurance premium for insurance of employees?

Yes, deduction is available for payment of health insurance premium for insurance of employees

Is deduction available for provision of bad debts?

No, deduction is not available for provision of bad debts.

Deferred Tax Asset (DTA)

An organization prepares two different financial reports every financial year – an income statement and a tax statement. The motive behind the preparation of two different reports was a difference in guidelines. Hence, this disparity creates the scope for the Deferred Tax. Deferred Tax Liability (DTL) or Deferred Tax Asset (DTA) is an important part of Financial Statements.

What is Deferred Tax Asset (DTA)?

A part of deferred tax is a deferred tax asset, which is commonly known as DTA. Deferred-tax assets are created when a company’s recorded income tax that is reported in its income statement is lower than that paid to the tax authority. It originates when the payment of the tax amount is complete or has been carried forward but it has still not been acknowledged in the statement of income. The actual value of the deferred tax asset is generated by comparing the book income with the taxable income.

How DTA is created?

At this point, readers might wonder how a company’s recorded income tax could be less than it pays to the authority. Let’s take an example where a company has made a profit of INR 10,000 before taxes, and it includes INR 4000 as bad debts that it has suffered. Now, to make a profit on tax payment, the company will account for this bad debt for the future when it recovers the sum. Therefore, taxable income after this will be INR 14,000 and if the income tax rate is 30%, for example; then the company has to pay a tax of INR 4200 (14,000*30%).

On the other hand, if these bad debts weren’t permissible, the company would have to pay a tax of INR 3000 (10,000*30%). Thus, for just INR 1200 more, the company has created a deferred tax.

Listed below are a few scenarios which result in DTA arising for a company:

The difference in the depreciation method

A deferred tax asset is created when there is a difference between the approach in which a company calculates depreciation on its assets and the method of depreciation calculation as prescribed by the IT Department.

For example, a company owns a computer worth INR 50,000 and has a lifespan of 5 years. 30% tax is charged on this machinery. Thus the company will pay,
For its own books: 50,000/5= 10,000 then 10,000*30%= INR 3000. In their tax document: 50,000*40%= 20000 then 20000*30%= INR 6000
Thus, the company is paying more taxes for its assets and creating a DTA.

Rate of Depreciation

At times, companies use a lower depreciation rate for their books compared to the one that applies for filing their taxes. For example, a company uses 10% depreciation rate for their books and 15% rate for their tax purposes. This variance in the final amount generates a deferred tax asset for companies.

Expenses 

As per Income Tax Act, few expenses are not allowable while calculating income from a business. Thus this creates DTAs in the company accounts. For example:

Particulars As per company books (INR) As per taxes (INR)
Income 12,000 12,000
Expense 6,000 6,000
Any particular expense 2,000 0
Taxable income 4,000 6,000
Tax (30%) 1,200 1,800

This difference in tax payment creates a DTA of INR 600 in the balance sheet.

Bad debts

Bad debts are other instruments that create deferred tax assets. Companies do not consider bad debts until it is written off; this difference in the taxable income of their book and their tax documents creates a DTA.

Carry forward of losses

A deferred tax asset can also occur due to losses that are carried over to a new accounting period from a previous accounting period and can then be claimed in the new period as an asset. This reduces a company’s tax liability.  Hence, a loss like this can be an asset owing to its benefits.

Calculation of DTA

DTA can be calculated manually through the following steps:

  • Make a list of all the assets and liabilities.
  • Calculate the tax bases.
  • Figure out the temporary difference.
  • Calculate the tax liability rate.
  • Figure out the tax assets.
  • Then enter them into the accounts.

Benefits of Deferred Tax Assets

The benefit of a deferred tax asset is that it lowers a company’s future liability. It is like a pre-paid tax that helps companies to reduce their future liabilities. DTA brings value to every company. It represents the payment of taxes of a company but is not recognizable in its financial statements.

FAQ

Where does deferred tax asset go on balance sheet?

DTA is mentioned under non-current assets in the company’s balance sheet.

Is it mandatory to create DTA?

No, DTA creation is not mandatory. Furthermore, companies use this method to avail its benefits in the future.

How does a deferred tax asset work?

A deferred tax on the company’s balance sheet is generally seen as a good sign, as it will work towards the company’s future tax benefit. Thus, it works like a pre-paid tax, which can help the company in reducing the tax amount in the future.

Deferred Tax Liability (DTL)

The tax system in India is often considered a complex one because of various elements which make up the entire tax structure. In order to understand deferred tax liability better, it is essential to note there are two different financial reports which an organization prepares every fiscal year – an income statement and a tax statement. The motive behind the preparation of a company’s income statement and tax statement was a difference in guidelines. Hence, this disparity creates the scope for deferred tax.

What is Deferred Tax Liability (DTL)?

Deferred tax liability is specifically created when a tax obligation accumulated in one financial year but is due in a subsequent year. A DTL indicates that the organisation may have to pay more tax in future for a transaction in the current period. The deferral comes from the difference in timing between when the tax is accrued and when the tax is paid.

A common example of DTL would be depreciation. When the depreciation rate as per the Income-tax act is higher than the depreciation rate as per the Companies Act (generally in the initial years), the entity ends up paying less tax for the current period. This creates deferred tax liability in the books.

How is Deferred Tax Liability created?

Deferred Income Tax Liability can arise in several cases. Recognizing these circumstances and their subsequent effect on a company’s financial records is therefore important. Furthermore, it simplifies the processes for auditors and analysts when these instances are appropriately recognized and recorded in the financial statements of a company. Listed below are a few reasons which result in DTL arising for a company.

Variance in depreciation methods and rates

A deferred tax is created when there is a difference between the approach in which a company calculates depreciation on its assets and the method of depreciation calculation as prescribed by the IT Department. This variance from the tax laws creates a temporary discrepancy between depreciation figures mentioned in a company’s financial statements and the corresponding tax reports.

When depreciation on an asset is at a lower rate than the income tax department, this inflates gross profit in its books in comparison to the tax statement for that year. The difference between those two figures would eventually narrow over the following years.

For example, The company XYZ assumes that a manufacturing machine costs INR 4,00,000 having a depreciation rate of 15%. However, regular financial accounting will take into account 10% depreciation. It has generated revenues worth INR 10 lakh in that year and incurred expenses of INR 6 lakh excluding depreciation on assets. The below table mentions the comparison between the two reports:

Particulars For books (in INR) For tax purposes (in INR) Difference (in INR)
Revenues 10,00,000 10,00,000 Nil
Expenses (6,00,000) (6,00,000) Nil
Depreciation (40,000) (60,000) 20,000
Gross Profit 3,60,000 3,40,000 20,000
Tax @ 25% (90,000) (85000) 5000
Net Profit 2,70,000 255000 15000

Therefore, the tax liability as per books is INR 90,000 and for tax purpose it is INR 85,000. The temporary difference creates a deferred tax liability of INR 5,000 for the company which it shall account for in a subsequent year.

Treatment of revenues and expenses

As per the Income Tax Act, tax cannot be levied only on revenues that are not realized by companies. Hence, it creates a disparity in the revenue shown in an income statement and tax reports. This disparity in the treatment of revenues creates a deferred tax liability, as tax shall be paid in a subsequent year when such revenue is realized.

Let us take an example, Company X in FY 2019-20, sold goods worth INR 12 lakh at credit out of which he received INR 6 lakh in that year and the rest will be paid by the debtors in the following year. Expenses incurred during the year were INR 4 lakh. The tax calculation for both its income statement and tax report is as below:

Particulars Income Statement (in INR) Tax report (in INR) Difference (in INR)
Sales 12,00,000 6,00,000 6,00,000
Expenses (4,00,000) (4,00,000) Nil
Gross Profit 8,00,000 2,00,000 6,00,000
Tax @ 25% 2,00,000 50,000 1,50,000

The difference in tax liability between the income statement and its tax report is INR 1.5 lakh, which the company is liable to settle in the following year when it realizes the rest of the revenue, thus creating a deferred tax liability.

Carry forward of current profits

Often companies have an option to carry forward their profits for one year to a subsequent year in order to effectively bring down their tax liabilities. In such a case, since the company will be liable to pay taxes on the carry-forwarded profit in the next year the deferred tax liability is created.

Difference between Deferred Tax Asset and Deferred Tax Liability

Deferred tax liability or asset arises from a variance in accounting principles and tax guidelines. To better understand the differences between DTA and DTL, a detailed comparison between these two is mentioned in the table below:

Parameters Deferred Tax Asset Deferred Tax Liability
Basis of recognition When tax accrues in a later period, however, it is paid in advance in the current year, it is recorded as a deferred tax asset. When tax accrues in the current year but is paid in a later period, it is considered a deferred tax liability.
Creation When profits in a company’s income statement are lower than the one mentioned in the tax reports. When profits in a company’s income statement are higher than what is mentioned in its tax reports.
Treatment It appears in the Balance Sheet under Non-current assets. It appears in the Balance Sheet under Non-current liabilities.

FAQs

What is the entry for deferred tax liability?

The Deferred Tax is created at the normal tax rate. The book entries of DTL is as follows:
Profit & Loss A/c Dr.
To Deferred Tax Liability A/c

Where does deferred tax liability go on balance sheet?

DTL appears in the Balance Sheet under Non-current liabilities.

When to reverse a deferred tax liability?

As deferred tax liabilities are created by temporary differences, a reversal of a DTL depends on the reversal of the temporary difference that created it.

Variable Cost

It is important for an organization to understand nature of cost to calculate how much it is spending on production. Cost can be either variable cost or fixed cost based on its nature. Unlike fixed costs, variable costs are directly related to sales volume. That means, the variable expense increases or decreases in the same proportion to the quantity of the output. 

What is Variable Cost?

There are various types of costs that an organization needs to incur for production such as variable costs, fix costs, and semi-variable costs. Unlike fixed costs, variable costs are dependent on the production or output of goods or services. Fix costs often relate to time period , and generally do not change over time.

Variable costs associated with the production of goods or services include direct material, wages and other operating expenses.

Semi-variable costs have components some that are fix and some that are variable. These costs are partly fix up to a level of production and then increase with the production volume. Most common examples of Semi-variable costs are electricity and wages for sales force.

Like electricity costs are fix up to a certain number of units of consumption. The cost increases with the next set of units consumed and tends to increase after the level fixed. Also, a portion of wage for a salesperson may be a fixed salary and the rest may be sales commission.

Examples of variable cost

  • Direct Materials – the raw materials used in production of product
  • Production Supplies – the supplies that are necessary for the machinery that help produce the product, such as supplies that help maintain equipments.
  • Sales Commissions – the part of a worker’s salary based on the sales they do.
  • Credit Card Fees – the fees that the merchant has to pay in order to offer credit card services to their customers

Other examples of variable costs are delivery charges, shipping charges, salaries,​ and wages. Performance bonuses to employees are also variable costs.  In many instances, reducing variable costs are easier to manage without major disruptions than changing fixed costs. 

Conclusion

Variable costs are not only a major part of running a business, they also can be key to turning breaking-even into profits. Or existing profits into larger profits. Also, it is easier to recover the variable costs from sales.

Keeping track of variable costs can provide crucial insight into where cash outflow is going and to what extent. The profits of a business directly inflate by adjusting the variable costs but maintaining sales prices.

FAQs

What are three examples of variable expenses?

Common variable costs for businesses include:
– Raw materials
– Packaging
– Shipping
– Labour
– Commission
– Credit card fees

Is salary a variable cost?

Annual salaries are fix costs but other types of compensation, such as commissions or overtime, are variable costs.

What is fix cost and variable cost with example?

Fix costs relate to a particular period i.e. they remain constant for a period of time. Variable costs are volume-related and change with the changes in output level. Examples. Depreciation, interest paid on capital, rent, salary, property taxes, insurance premium, etc.

Fixed Cost

Cost can be classified in several ways such as fixed cost or variable cost, depending on its nature. One of the most popular methods is classification according to fixed costs and variable costs. Unlike variable costs, fixed costs are not dependent on the production or output of goods or services. Moreover, fix costs often relate to time period, and generally do not change over time.

What is a Fixed Cost

A fixed cost is an expense that does not change as production volume increases or decreases within a relevant range. In other words, fix costs do not change as long as operations stay within a certain size. Fixed costs are less controllable by an organization because they aren’t based on volume or operations.

As an example of a fixed cost, the rent on a building will not change until the lease runs out or is re-negotiated, irrespective of the level of activity within that building. Examples of other fixed costs are insurance, depreciation, and property taxes. Fixed costs generally incur on a regular basis, and so they are period costs.

Moreover, for marketing, it is important to understand how costs vary depending upon their nature i.e. variable or fix costs. This distinction is also essential in forecasting the earnings, preparing reports and budgets.

Difference Between Fixed Cost and Variable Cost?

  Fixed Costs Variable Costs
Meaning Fixed costs are expenses that remain constant for a period of time irrespective of the level of outputs. Variable costs are expenses that change directly and proportionally to the changes in business activity level or volume. 
Incurred when Even if the output is nil, fixed costs are incurred. The cost increases/decreases based on the output 
Also known as Fixed costs are also known as overhead costs, period costs or supplementary costs. Variable costs are also referred to as prime costs or direct costs as it directly affects the output levels.
Nature Fixed costs are time-related i.e. they remain constant for a period of time. Variable costs are volume-related and change with the changes in output level.
Examples Depreciation, interest paid on capital, rent, salary, property taxes, insurance premium, etc. Commission on sales, credit card fees, wages of part-time staff, etc.

Nature of Cost

As discussed, Fixed costs are not permanently fix but they change over time. Also they are fix by contractual obligation, in relation to the the relevant period. For example, a company may have unexpected and unpredictable expenses unrelated to production, such as warehouse costs.

Some fixed costs such as investments in infrastructure can not be substantially decreased in a limited time span are referred as fixed committed costs. While discretionary fixed costs depend on management decisions.

Examples of discretionary costs include spending on advertising, insurance premiums, machine maintenance, and research & development; the discretionary fixed costs can be excessive.

FAQs

Can a fixed cost change?

Yes. Fixed costs can change if the costs of operations changes. For example, if rent goes up, the fixed costs might be re-evaluated.

Is Depreciation a fixed cost?

Depreciation is the regular charge on tangible or intangible asset over the course of its useful life irrespective of output. Therefore, Its is considered as a fixed cost.

Is Advertising a Fixed Cost?

Advertising costs may fluctuate over time, as management may decide but advertising isn’t affected by sales or production levels so it is said to be a fixed cost.

Deferred Tax : Definition, Types, and Treatment

There are two different financial reports which an organization prepares every fiscal year – an income statement and a tax statement. The motive behind the creation of two different financial reports was a difference in guidelines behind the preparation of a company’s income statement and tax statement. Therefore, this disparity creates the scope for deferred tax. It is an important accounting measure.

What is Deferred Tax?

It is brought into accounts to make a clear picture of current tax and future tax. Current tax is the amount of income tax to be payable (recoverable) in respect of the taxable income (tax loss) for a period. Furthermore, a deferred tax of any type appears in the balance sheet of an organization.

Timing Differences

Because of certain items which are specifically allowed or disallowed each year for tax purposes, there occurs a difference between the book profit and taxable profit. The difference between the book and the taxable income or expense refers to the timing difference. Deferred tax is the tax effect of timing differences. It can be either of the following:

  • Temporary differences are the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods.
  • Permanent differences are the differences between taxable income and accounting income for a period that originate in one period and do not reverse subsequently.”

Types of Deferred Tax

  • Deferred Tax Liability (DTL): DTL generally arises where tax relief is provided in advance of an accounting expense/unpaid liabilities, or income is accrued but not taxed until received. In simple words, the deferred tax liability arises when there is a timing difference between when a tax liability accrues and when a company is liable to pay it.
  • Deferred Tax Assets (DTA): When there is a difference between the income statement of an organization and its corresponding tax statement that means the company pays its tax liability for another period in advance or is able to reduce its tax liability for a subsequent period in a particular, financial year. Then the difference amount is recorded as DTA.

The effects of deferred taxes i.e. DTA and DTL in the financial statements are as under:

Sl.No Profit Status Current Treatment Future Treatment Effect
1 Book profit higher than the Taxable profit Pay less tax now Pay more tax in future Creates Deferred Tax Liability (DTL)
2 Book profit is less than the Taxable profit Pay more tax now Pay less tax in future Creates Deferred Tax Asset (DTA)

Scenarios where Deferred Tax is Recorded

Unrealized revenues and expenses

As per the Income Tax Act, tax cannot be levied on revenues which have yet not been realised by companies. Thus, if there are unrealised receivables from debtors, then although as per accounting laws it shall be recorded in the income statement; it is not considered for taxation. This disparity in treatment of revenues creates a deferred tax liability because companies are have to pay tax on a later date when they realise such receivables.

Similarly, when there are expenses which a company has recorded in its books but has not yet incurred is not considered for tax calculations. Thereby, such company’s gross profit in its books is lower than what appears in its tax statement. Consequently, an organisation ends up paying advance tax for a higher profit in tax statements. Hence, that creates a deferred tax asset.

The difference in the depreciation calculation method

A deferred tax is created when there is a difference between the approach in which a company calculates depreciation on its assets and the method of depreciation calculation as prescribed by the IT Department.

For example, Company X calculates depreciation in the straight-line method; whereas the Income Tax Department follows the Written Down Value depreciation method. This company has a computer worth INR 1,00,000 with an estimated lifetime of 5 years and it expects no salvage value for the same. Hence, depreciation as per their calculation shall be INR 20,000. Now, as per the Income Tax Department depreciation is INR 25,000. As seen, IT department considers higher depreciation, which implies a lower tax liability for the company for that particular financial year. However, company X will adjust depreciation in the subsequent years so that it eliminates such inconsistency between the two depreciation figures by the end of the machinery’s lifetime. Hence, it poses a future financial obligation accruing in that particular year, thus creating a deferred tax liability.

Difference in Depreciation Percentage

If there is a difference in the percentage of depreciation calculation that takes place by an organisation on its assets and considered by the IT department, then a deferred tax can be created.

For instance, company B has assets worth INR 80,000 on which it calculates 10% depreciation whereas as per the IT department, depreciation shall be calculated at the rate of 15%. As per the IT Department, depreciation is INR 12,000, while as per the company’s calculation depreciation is INR 8,000. This temporary difference of INR 4,000 will create a deferred tax asset as the company is paying an additional tax of INR 1000 (25% x 4000) in its current fiscal year.

Gross loss

DTA is created when a company realizes gross loss in a particular year. As it creates an opportunity for a company to carry forward it to the next year to adjust with subsequent profits, thus reducing that year’s tax liability. DTA is recorded in the year when such loss is realised.

Deferred Tax Calculation

It is merely the difference between gross profit in a Profit & Loss Account and a tax statement. Let us take an example for a better understanding of its treatment:

Particulars As per Books (INR) As per Tax   (INR)
Total income 1000000 1000000
Expenses 400000 400000
Gross profit before depreciation and tax 600000 600000
Depreciation 100000 80000
Gross Profit after depreciation 5000000 520000

Here, as the depreciation computed varies by INR 20,000, the taxable incomes in both cases also vary by the same amount. Hence, its tax liability shall be 25% on INR 5,20,000, i.e. INR 1,30,000. However, as per its books, its tax liability should have been INR 1,25,000. An additional INR 5,000 is payable as tax in the current year, and it creates a DTA.

Benefits of Deferred Tax

The difference between the two statements creates the scope for deferred tax. Thus, there is no pronounced benefit to it per se. However, recognizing such liabilities prepares the organization for future expenses. On the other hand, recognition of such assets can significantly reduce tax liabilities for the future.

FAQ

How the amount of deferred tax asset or liability would be measured?

These assets and liabilities shall be measured at the tax rates that are expected to apply to the period when the asset is realized or the liability is settled, based on existing tax rates at that time.

How do I pass deferred tax entry?

One should create either its liability or assets by debiting or crediting profit & loss a/c respectively. Furthermore, the deferred tax is to be created at the normal tax rate.

Is Deferred tax a current asset?

A deferred tax can surely be a company’s current asset as it helps in decreasing the taxable income. It appears on the company’s balance sheets under the heading of Current Asset itself.

AS 22 – Accounting for Taxes on Income

The objective of Accounting standard 22 (AS 22) is to prescribe accounting treatment of taxes on income. Taxable income may be different from the accounting income causing problems in matching taxes against revenue for a period.

Types of Income

  • Accounting income is the net profit or loss for a period, as reported in the statement of profit and loss, before deducting income tax expense or adding income tax saving.
  • Taxable income is the amount of the income (loss) for a period, determined in accordance with the tax laws, based upon which income tax payable is determined.

Taxable income may be different from the accounting income due to various reasons as follows:

  • Some items which are debited in profit and loss account are not allowed as expenses as per Income Tax
  • Some expenses which are wholly debited in Profit and loss account but are allowed as expenses in part or amortized over some years

Above differences are of two types:

  1. Timing Difference
  2. Permanent Difference

To calculate and recognize such difference in Financial Statement is an object of this standard.

What is Timing Difference?

Timing difference are differences that originate in one period and get adjust or reversed in subsequent period. Some example of timing differences are as follows:

  • Provision for Bad/Doubtful debts
    Reason for difference:
    For computing Accounting income – 100% deduction allowed in same year.
    For computing Taxable income – Only actual bad debts are allowed
  • Expense allowable on payment basis, like expense u/s 43B of Income tax Act
    Reason for difference:
    For computing Accounting income – Expenses allowed on accrual basis.
    For computing Taxable income – Expenses allowed on payment basis
  • Allowance of Excessive depreciation u/s 32 and 32AC of Income Tax Act
    Reason for difference
    :
    For computing Accounting income – Depreciation allowed as per SLM
    For computing Taxable income – Excessive depreciation allowed.

    Likewise, charging depreciation under different methods for the purpose of accounting income and taxable income is also a timing difference
  • Preliminary expenses
    Reason for difference:
    For computing Accounting income – Fully deductible in first year
    For computing Taxable income – Allowed in the five installment u/s 35D of Income Tax Act

What is Permanent Difference?

Permanent difference are the differences between Taxable income and Accounting income for a period that originate in one period and do not reverse subsequently. Some example of permanent differences are as follows:

  1. Amortization of goodwill considered as disallowable expense for computing Taxable income
  2. Personal expenditure disallowed by tax authorities
  3. Penalty (Not being compensatory) is disallowable expense for computing Taxable income
  4. Payments disallowed U/s 40(A)(3) of Income Tax Act
  5. Donations to the extent not allowed for computing Taxable income
  6. Remuneration to partners disallowed U/s 40(b) of Income Tax Act

Application of AS 22

AS 22 requires recognition of deferred tax for all timing differences. This is based on the matching principle that the financial statements for a period should recognize the effect of all the transactions during the year , whether current or deferred.

So, AS 22 is applicable when there are differences between taxable income and accounting income. If taxable income is greater than accounting income, then it will result in deferred tax asset. And if accounting income is greater than taxable income, then it will result in deferred tax liability.

What is Deferred Tax Asset?

Deferred Tax Asset (DTA) arises when the income as per Income tax Act is higher than the income as per Profit & Loss account. Therefore, tax payable is more due to higher income as per Income Tax Act but actual income as per Profit & Loss account is less.

Moreover, DTA is an asset is created in books of accounts since some amount of tax is paid in advance for which benefit will be received in future.

What is Deferred Tax Liability?

Deferred Tax Liability (DTL) arises when the income as per Income tax Act is lower than the income as per Profit & Loss account. Therefore, tax payable is less due to lower income as per Income Tax Act but actual income as per Profit & Loss account is more.

Moreover, DTL is a provision created in books since amount of taxpaid is less than actual amount as per books and the same is to be paid in future years.

Computation of DTA/DTL

Computation of Accounting Income Year
Particulars One Two Three
Profit Before Depreciation & Tax 2,00,000 2,50,000 200,000
Less: Depreciation -20,000 -20,000 -30,000
Accounting Profit (PBT)   (A) 180,000 230,000 170,000
Computation of Taxable Income Year
Particulars One Two Three
Accounting Profit (PBT)   (A) 180,000 230,000 170,000
Add: Depreciation as per books 20,000 20,000 30,000
Less: Depreciation as per income tax Act -70,000
Taxable Profit 130,000 250,000 200,000
Tax rate 30% 30% 30 %
Current tax 39,000 75,000 60,000
Deferred Tax Computation Year
Particulars One Two Three
Opening balance of timing difference -50,000 -30,000
Addition -50,000
Deletion 20,000 30,000
Closing Balance -50,000 -30,000
Tax rate 30% 30% 30 %
Deferred Tax -15,000 -6,000
DTA/DTL to be shown in Balance Sheet DTL DTL NIL
Amount for P&L -15,000 6,000 9,000
To be Debited/Credited to P&L Debited Credited Credited
Reason for Debit/Credit Creation of DTL Reversal of DTL Reversal of DTL
Tax Expense in books Year
Particulars One Two Three
Current Tax 39,000 75,000 60,000
Deferred Tax 12,000 -6,000 -9,000
Total Tax 54,000 69,000 51,000
Accounting Profit (PBT)   (A) 180,000 230,000 170,000
Profit After Tax (A-B) 126,000 161,000 119,000

FAQs

How to measure the deferred tax asset and liability?

Deferred tax should be measured using the tax rates and tax laws prevailing as on balance sheet date.

Is deferred tax calculated on permanent differences?

No, deferred tax is calculated only on timing differences.

What type of account is income tax payable?

Income tax payable is a type of account in the current liabilities section of a company’s balance sheet. It is compiled of taxes due to the government within one year.

AS 2 – Valuation of Inventories

AS 2 is the Accounting Standard for the valuation of inventories and their accounting treatment. This accounting standard covers methods to value the inventory of a business and its disclosure in the financial statements. The general rule mentions valuing inventories i.e. closing stock of a business at cost or market value whichever is lower. Let us understand AS 2 in detail.

Applicability of AS 2

AS 2 applies to the valuation of following types of inventory:

  • Raw Materials – input goods or services consumed during the production process of rendering of services.
  • Work In Progress – input goods or services that are in the process of production.
  • Finished Goods – final goods or services held for sale in the normal course of business.

AS 2 for Valuation of Inventories is not applicable in the following cases:

  • Work in progress i.e. WIP stock in the construction business
  • WIP stock in the service business
  • Shares, debentures, or other financial instruments held as stock-in-trade
  • Stock of livestock, mineral oils, agricultural and forest product, etc.

    In the above cases, inventory valuation is at net realisable value.

Valuation of Inventory

Follow these steps for valuation of inventory:

  1. Calculate Cost of Inventory

    Cost of Inventory is the sum of purchase cost, conversion cost and other direct costs to bring the inventory in its present condition.

  2. Calculate Net Realisable Value (Market Value)

    Net Realisable Value is the estimated selling price of the inventory in the market i.e. the market value of the inventory.

  3. Lower of Step 1 or Step 2

    Valuation of inventory is the lower of cost or net realisable value (NRV).

For valuation of inventory, we should understand the following terms:

  • Purchase Cost – It is the price at which inventory is purchased. It also includes freight inwards, duties and taxes, trade discounts, rebates, duty drawbacks, and other expenses directly related to purchase.
  • Conversion Cost – It is the cost incurred in the process of production to convert the raw materials into finished goods. Conversion Costs include both fixed costs (depreciation, maintenance expense, etc) and variable cost (labour cost, raw material cost, etc) incurred in the process of production.
  • Other Cost – Any other cost incurred to bring the inventory in its current location and condition should form part of inventory valuation. Other costs include selling and distribution expense, abnormal loss of material or labour, storage cost, etc.
  • Net Realisable Value – NRV is the estimated selling price of the inventory after deducting the estimated costs of completion and expenses on the sale of such inventory.

Methods of Inventory Valuation

  • First In First Out (FIFO) – As per this method, it is assumed that the goods that come in first are sold out first. The cost of goods sold comprises the cost of goods produced first. The closing inventory will include the goods purchased recently.
  • Weighted Average Cost Method (WAC) – Under this method, the average cost of each sale item is calculated. The closing inventory is calculated by taking the weighted average cost of items at the beginning of the year and purchased during the year.
  • Specific Identification Method – If each item in the closing inventory is easily identifiable, the business should use a specific identification method to value the inventory. Thus, include the items sold at a specific cost in the cost of goods sold and the cost of items left on hand in the closing stock.

Accounting Disclosure

As per AS 2, the financial statements must reflect the following details of inventory of a business:

  • Accounting policy and method used for valuation of inventory
  • Classification of inventory i.e. raw material, work-in-progress, or finished goods
  • Carrying amount of inventory = Fair Value – Sale Cost
  • Amount of inventory that business recognizes as an expense
  • Amount of inventory that business writes down and recognizes as an expense
  • Reversal amount of a write-down identified as a reduction in the inventory amount

AS 2 for Manufacturers & Traders

Any manufacturing or trading business that has inventory or stock must follow the accounting principles for the valuation of a stock.

  • Opening Stock – Value of the closing stock of the previous year
  • Purchases – Sum of the purchase value and direct expenses incurred during the financial year
  • Sales – Sum of sales value during the financial year
  • Closing Stock – Value of closing inventory should be lower of cost or market value
  • Gross Profit = Opening Stock + Purchases – Sales – Closing Stock

The business should calculate the net profit by deducting other expenses from gross profit, report it as taxable income under the head PGBP and file ITR on income tax website.

FAQs

What is the cost of inventory for a service provider?

The cost of inventory for a service provider includes labour cost and the cost of personnel who provide the services. It does not include the expenses not directly related to the service.

How to calculate value of inventory using weighted average cost method?

As per the weighted average cost method, you should calculate the value of closing inventory by using the average price of inward values of the inventory. The formula is as below:
Average cost per unit = Total inward value / Total inward quantity