Testing deferred tax asset recoverability means tracing each recognised deferred tax asset back to the specific temporary difference or carried-forward loss that created it, then testing whether the entity's own evidence supports a probable future taxable profit sufficient to use it within the period that evidence covers. The arithmetic — temporary difference times tax rate — is mechanical. The recoverability conclusion is a judgement about the future and has to be documented as one.
Why this working paper fails more often on judgement than on arithmetic
Deferred tax asset errors rarely come from a wrong rate applied to a right number. They come from an asset recognised against a profit forecast nobody tested, or carried forward unchanged from last year without asking whether the facts that supported it then still hold.
The testing sequence
- 01Obtain the full deferred tax working and reconcile it to the tax baseEvery line should tie to a specific temporary difference between the carrying amount and the tax base of an asset or liability, or to a carried-forward unabsorbed loss or depreciation. A deferred tax line with no identifiable source is not yet auditable.
- 02Recompute the deferred tax balance using the rate expected to apply when the difference reversesNot the current rate by default. Where a rate change has been enacted or substantively enacted, the recomputation should use the future rate, and the client's working should show it was used.
- 03Separate assets recognised against temporary differences from assets recognised against carried-forward lossesThe recognition threshold differs: losses need stronger evidence of future taxable profit, and the time window matters because losses expire under the Income-tax Act.
- 04Obtain the profit forecast the recognition decision relies on and test its own history for reliabilityCompare the prior year's forecast to what actually happened. A forecast that has missed its own numbers for two years running is weak support for recognising a new asset this year.
- 05Test whether the forecast horizon matches the period in which the asset can actually be usedA loss that expires in four years cannot be supported by a forecast that only shows profit in year six. Map the expiry schedule against the forecast period line by line.
- 06Identify convincing other evidence where the entity has a recent history of lossesInd AS 12 sets a higher bar here — a forecast alone is not enough. Look for firm sales orders, contracted revenue, or other evidence beyond management's own projection.
- 07Reperform the carry-forward and expiry scheduleConfirm unused amounts are tracked by the year they arose and that none recognised as an asset has already expired or is about to, unused.
| Question | Evidence |
|---|---|
| What created this deferred tax asset | Temporary difference or loss schedule, tied to the tax computation |
| Will there be enough taxable profit to use it | Board-approved forecast, tested against the entity's own forecasting track record |
| Within what window | Statutory expiry schedule for carried-forward losses, mapped against the forecast period |
| Is a forecast alone sufficient | Only where there is no recent history of losses; otherwise convincing other evidence is required |
A deferred tax asset carried forward unchanged from the prior year, with no fresh recoverability assessment performed this year, is a red flag on its own — recoverability is assessed at each reporting date, not once at initial recognition.
How we think about this
The rollforward of temporary differences and the arithmetic of the tax effect should match, to the rupee, every time — that part is deterministic and worth automating fully. Whether the forecast behind recognition is credible is not a computation at all; it is a judgement about management's evidence, and no reconciliation tool can make that call for the auditor.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
Related resources
- Audit documentationInd AS 12: income taxes, and how a deferred tax balance actually gets builtDeferred tax isn't computed from the profit and loss difference between book and tax. It's computed balance sheet item by balance sheet item, and that distinction changes the whole calculation.
- Audit workflow & automationSA 540: auditing accounting estimates, where judgment replaces a verifiable numberAn estimate can't be vouched to a source document the way an invoice can. SA 540 is about what replaces vouching when there's no single right answer to check against.
- Audit workflow & automationSA 570: going concern, and when it actually changes the audit reportMost going-concern evaluations end exactly where they should: no material uncertainty, no change to the report. The standard is about the minority of cases where that's not true.
- Audit data & extractsTrial balance mapping for audit softwareMapping a client's idiosyncratic ledgers to a standard chart of accounts is the step that decides whether analytics and disclosures work at all, and the one most firms rush.
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