Ind AS 12 requires deferred tax to be computed using the balance sheet (temporary difference) approach: for every asset and liability, compare its carrying amount in the financial statements to its tax base — the amount attributed to it for tax purposes — and recognise a deferred tax liability or asset on the resulting difference. A deferred tax LIABILITY arises on a taxable temporary difference (carrying amount exceeds tax base for an asset, typically); a deferred tax ASSET arises on a deductible temporary difference, but only to the extent it's probable that future taxable profit will be available against which the deductible difference can be utilised — that probability test is where real judgment, and real audit attention, belongs.
A worked example of the logic
| Amount | |
|---|---|
| Carrying amount of the asset in the books | ₹80 lakh (after book depreciation) |
| Tax base of the asset (after tax depreciation, typically at a faster rate) | ₹60 lakh |
| Taxable temporary difference | ₹20 lakh |
| Deferred tax liability | ₹20 lakh × the applicable tax rate — because the asset will generate more taxable income in future (lower future tax depreciation available) than it will generate book income |
What drives whether a deferred tax asset can actually be recognised
- 01Is there convincing evidence of probable future taxable profitA history of recent losses is specifically treated as strong evidence AGAINST probable future taxable profits, requiring correspondingly stronger evidence in the other direction to overcome it.
- 02Will the taxable profit arise in the right period and of the right characterA deductible temporary difference needs taxable profit of the same character (business income vs. capital gains, for instance) in the period it can actually be used, per the applicable tax law's own carry-forward rules.
- 03Are there sufficient taxable temporary differences to offset againstAn existing deferred tax liability of the right character and timing can itself be the source of future taxable profit a deferred tax asset is recognised against.
Recognising a large deferred tax asset against a company with recent losses and no firm evidence of a profit-generating plan — a mere management projection with no independent support — is exactly the pattern SA 540's accounting-estimates scrutiny should flag: the asset recognition criteria require convincing, not merely hopeful, evidence.
What doesn't get a deferred tax balance at all
Ind AS 12 specifically excludes recognition for a few situations, most notably the initial recognition of goodwill (no deferred tax liability on goodwill itself) and certain temporary differences arising from the initial recognition of an asset or liability in a transaction that is not a business combination and affects neither accounting nor taxable profit at the time. These exceptions exist because recognising deferred tax in those specific situations would, by the standard's own reasoning, create a circular or economically meaningless adjustment.
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 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.
- Audit documentationInd AS 37: provisions, contingent liabilities and contingent assets — the three-way splitThree categories, three completely different treatments — recognise it, disclose it, or say nothing. Getting the category wrong is the whole misstatement.
- Revenue, receivables & cut-offRevenue recognition testing in a statutory auditThe transfer-of-control test that governs when a sale is recognised, the misstatement patterns that recur in practice, and what evidence ties a recognised sale to an underlying document.
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