All you need to know about tax accounting

What is the definition of tax accounting?

Tax accounting refers to the processes and practices used to prepare tax returns and other tax-related statements, and it thus provides frameworks and rules for calculating taxable earnings.

Furthermore, each country's tax rules vary from Generally Accepted Accounting Principles on many topics. Deferred Tax assets and liabilities are created as a result of this fluctuation. There are also different guidelines for VAT (Value Added Tax) accounting, transfer pricing, and cross-border transactions, all of which fall under the heading of tax accounting.

Tax accounting fundamentals

The purpose of Income Tax accounting is to arrive at taxable profit and tax payable by adjusting the book profit based on accounting principles. All of these calculations and modifications are included in the tax return by tax return accountants, and these statements are maintained in the event of a tax audit. Accounting for taxation has several components, some of which are detailed below.

Deferred Tax Asset

When there is a gap between book profit and taxable profit due to a timing issue, this is generated. There are other expenses, such as provision for dubious debts, that are deducted in the current year's accounting. However, these are only eligible for a tax reduction if the sum is deemed a bad debt, which may occur in the coming years.

In this situation, the taxable profit will be more than the accounting profit, resulting in the person or organization paying more taxes this year. The additional tax paid on incremental profit as a result of the provision amount being rejected for deduction is considered deferred tax, which will be recognised in future years.

Tax liability that has been deferred

When a person or business has to pay less taxes in the current year due to a time discrepancy, deferred tax liability is created. For example, if a $10,000 item is depreciated in accounting books for 8 years using the (SLM) straight-line method, the annual depreciation will be $1,250 ($10,000/8).

If, on the other hand, the tax regulations stipulate that assets must be depreciated at a rate of 20% (WDV) written down value method. For tax purposes, the depreciation in the second year will be $1,600 (($10,000 – 2000 i.e., 20% for the first year) = $8,000*20 percent = $1,600).

For tax reasons, the organization will receive an additional deduction of $350 ($1,600-$1,250). If we use a 30% tax rate, the deferred tax liability is $105 ($350*30%).

Accounting for VAT

Most nations have a Good and Service Tax (GST) or VAT (value-added tax) that is included in practically all bills. Because the organizations receive an Input Tax Credit on the amount previously paid, this should no longer be considered an expense. To claim those inputs, the tax authorities impose certain restrictions on the style of the invoice, the company's name and registration, the contents of the second part, and so on, which must all be met by the tax accounting team prior to claiming VAT/GST input credit.

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