Open any private limited company's audited financials and turn to the statement of profit and loss. The "profit before tax" line is computed from the books — accrual basis, with provisions, depreciation per Schedule II, fair value adjustments where applicable. Now open its income tax return. The "taxable income" line is computed from the same underlying transactions — but with depreciation under Section 32, disallowances under Sections 40 / 43B, exemptions under Section 10, and a dozen other adjustments. The two numbers will never agree. That's the design of the accrual-vs-tax system, not an error.
The gap between accounting profit and taxable profit lives in two places. One part reverses eventually — a timing difference that the tax department will catch up on in a later year. The other never reverses — it's a permanent feature of how that item is treated for tax purposes. Deferred tax accounting exists to make sure the P&L reflects the economic tax cost of this year's profit, not just the cash tax payable for this year. Without it, the P&L flatters in a year where book profit is high but tax-deductible expenses haven't yet been claimed, and depresses in a year where the reverse is true.
This article is for the CA, controller, or CFO doing the year-end close — or signing off on the audit file. It covers what creates deferred tax and what doesn't, how the standards differ between AS 22 and Ind AS 12, how to actually compute the numbers, every journal entry that follows, and the audit-evidence checklist that holds up to scrutiny.
Two standards, two mental models
The first thing that catches first-time practitioners is that AS 22 and Ind AS 12 — though both about the same economic phenomenon — work from genuinely different conceptual bases. Knowing which one you're on, and what its mental model is, makes the rest of the work mechanical. Getting them confused makes the audit file unreliable.
AS 22 (Accounting for Taxes on Income) — the P&L approach
AS 22 is the standard that applies to companies preparing accounts under Indian GAAP / Companies Accounting Standards. It is built on the concept of timing differences — items of income or expense that are recognised in the P&L of one period but in the tax computation of a different period.
The exercise under AS 22 is to walk through the P&L line by line, identify every item that is treated differently for tax than for books, decide whether the difference will reverse (timing) or not (permanent), and multiply the reversing differences by the applicable tax rate to arrive at the deferred tax for the year.
Ind AS 12 (Income Taxes) — the balance-sheet approach
Ind AS 12 applies to companies on Ind AS — by phased applicability, most listed companies, all unlisted companies above the net-worth threshold of ₹250 crore, and their subsidiaries / associates. The mental model is different. Instead of starting from the P&L, you start from the balance sheet. For every asset and liability, you compute:
- Carrying Amount — what's in the books
- Tax Base — what the tax authority's records would show for the same asset or liability (i.e., the amount that will be deductible against future taxable income, or taxable against future revenue)
The difference is a temporary difference. Multiply by the applicable tax rate and you have the deferred tax. Where the carrying amount exceeds the tax base for an asset (or the tax base exceeds the carrying amount for a liability), the result is a DTL. The reverse creates a DTA.
The balance-sheet approach picks up some items that the P&L approach misses entirely — fair value remeasurements of financial instruments, revaluation of property, plant and equipment, business combination adjustments, and unrealised gains on investments. This is why a switch from AS 22 to Ind AS 12 usually produces a one-time spike in the deferred tax balance: items that weren't on the P&L radar suddenly are.
Permanent differences — the items that create no deferred tax
Some items hit the P&L (or the tax computation) and stay there forever. They are recognised once, in one set of books, and never make their way to the other side. These produce a difference between book and tax profit that never reverses. Because deferred tax exists to defer the tax effect of a temporary mismatch, permanent items create no deferred tax — only a permanent variance in effective tax rate.
| Permanent difference | Why permanent | Tax law reference |
|---|---|---|
| Donations exceeding 80G limits | Book records 100%; tax allows 50% or 100% only up to qualifying ceiling. Excess is permanently disallowed. | Sec 80G |
| Penalties under any law | Permanently disallowed for tax — never deductible. | Sec 37(1) Explanation |
| CSR expenditure under Sec 135 Companies Act | Mandatory in books; explicitly non-deductible for tax. | Sec 37(1) Explanation 2 |
| Section 14A disallowance | Expenses linked to exempt income — books record full expense; tax disallows under Rule 8D. | Sec 14A |
| Tax-free interest (PSU bonds, etc.) | Income in books; permanently exempt under Section 10. | Sec 10(15) |
| Agricultural income | Recognised in books; permanently exempt. | Sec 10(1) |
| Dividends from foreign subsidiary (post-DDT abolition) | Taxed at slab rate in books; foreign tax credit may give partial relief — but the rate difference is permanent. | Sec 115BBD (now subsumed) |
| Profit on sale of agricultural land (rural) | Book gain recognised; tax exemption is permanent. | Sec 2(14)(iii) |
The audit-file approach with permanent differences is straightforward: list them, multiply each by the statutory tax rate to compute the "tax effect of permanent differences," and reconcile that number into the effective tax rate disclosure required by Ind AS 12 (or, less formally, by good practice under AS 22). They do not create any DTA or DTL.
Temporary / timing differences — the items that do create deferred tax
These are the items where book and tax treatment diverge today but will eventually align. Either the books recognise an expense earlier than tax does (creating a DTA — future tax savings), or the tax allows a deduction earlier than the books recognise the expense (creating a DTL — future tax outflow). The single biggest source of timing differences for most Indian companies is depreciation; the others come and go depending on the business.
The eight that show up in most Indian audit files
| Item | Book treatment | Tax treatment | Type of difference |
|---|---|---|---|
| Depreciation | WDV / SLM per Schedule II Companies Act | WDV at rates prescribed under Sec 32 / Rule 5 | Usually tax dep > book dep in early years → DTL |
| Provision for doubtful debts / bad debts | Provision charged when receivable doubtful | Allowed only on actual write-off under Sec 36(1)(vii) | Book expense earlier → DTA |
| Provision for warranties, leave encashment, gratuity (non-funded) | Provision charged when liability arises | Allowed only on actual payment under Sec 43B | Book expense earlier → DTA |
| Bonus and statutory employer contributions | Recognised when liability accrues | Allowed under Sec 43B only if paid before tax return due date | Timing → DTA if unpaid at year-end |
| Section 35DD (amalgamation expenses) | Expensed in year incurred | Allowed over 5 years | Book expense earlier → DTA |
| VRS expenditure | Expensed in year incurred | Allowed over 5 years under Sec 35DDA | Book expense earlier → DTA |
| Unabsorbed business loss / depreciation | Carried forward in books at zero impact | Will reduce future taxable income | Future tax saving → DTA (subject to prudence test) |
| Fair value gain on investments (Ind AS only) | Recognised in P&L or OCI | Taxed only on sale | Book gain earlier → DTL |
DTA vs DTL — the simple test
Practitioners often overthink which side of the balance sheet a deferred tax item lands on. The test is one sentence:
If the timing difference will increase your future taxable profit (or reduce a future tax saving), it's a DTL. If it will reduce your future taxable profit (or increase a future deduction), it's a DTA.
Apply it to the depreciation case. Year 1, tax depreciation is ₹15 lakh, book depreciation is ₹10 lakh — tax deduction is higher by ₹5 lakh, meaning current taxable profit is lower by ₹5 lakh. Future years, this reverses: tax dep falls below book dep, and future taxable profit will be higher than future book profit. Future tax liability higher → DTL today.
Apply it to provision for doubtful debts. Year 1, books expense ₹3 lakh; tax disallows the provision (no actual write-off). Current taxable profit is higher by ₹3 lakh. Future year, when the actual write-off happens, tax allows the deduction. Future taxable profit will be lower than future book profit. Future tax liability lower → DTA today.
The DTA prudence test — when you can recognise, when you can't
A DTA is only as good as the future taxable profit against which it can be recovered. If a loss-making company computes a notional ₹50 lakh DTA on its carry-forward losses but is not realistically going to turn profitable inside the eight-year carry-forward window, that DTA is fiction. Both standards have a prudence test, with subtly different language.
AS 22 — virtual certainty
Under AS 22 paragraph 17, a DTA in respect of unabsorbed depreciation or carry-forward losses must be recognised "only to the extent that there is virtual certainty supported by convincing evidence" that sufficient future taxable income will be available. For other DTAs (provisions, Section 43B disallowances), the test is "reasonable certainty."
Virtual certainty is a higher bar than reasonable certainty. In practice for an Indian SME, the audit file should contain at minimum:
- A board-approved business plan or budget showing projected taxable profits sufficient to absorb the unabsorbed loss/depreciation.
- Historical track record — at least two of the last three years should be profitable, or there must be a documented and external reason for the recent losses (e.g., one-off restructuring, COVID, plant shutdown).
- Tax computation showing the loss is genuinely available — not subject to Section 79 lapse on shareholding change, not time-barred, not subject to disallowance.
Ind AS 12 — probable
Ind AS 12 uses the term "probable" — defined as more likely than not (> 50%). It's a lower bar than AS 22's virtual certainty for unabsorbed losses, but the documentation expectation is similar in practice. Auditors will still look for forecasts, historical track record, and absence of structural reasons that taxable profits may not materialise.
The recognition decision is reassessed at each reporting date. A DTA recognised one year can — and should — be derecognised in a later year if the prudence basis weakens. The reverse is also true: an unrecognised DTA can be brought onto the books when the prudence test is now met.
Calculating the number — a worked example
Consider PBA Industries Pvt Ltd, a small manufacturing company on Indian GAAP (AS 22). One block of machinery, no fair value items, simple provisions. Statutory income tax rate: 25% (Sec 115BAA, including surcharge and cess for simplicity rounded to 25%).
FY 2025-26 — Year 1 of the asset
Machinery acquired on 1 April 2025 for ₹50,00,000. Useful life under Schedule II: 10 years (SLM). Tax depreciation rate under Section 32: 15% WDV.
| Particulars | Books | Tax | Difference |
|---|---|---|---|
| Cost of asset | ₹50,00,000 | ₹50,00,000 | — |
| Depreciation rate | 10% SLM | 15% WDV | — |
| Depreciation for the year | ₹5,00,000 | ₹7,50,000 | ₹2,50,000 (tax higher) |
| Closing WDV / Carrying Amount | ₹45,00,000 | ₹42,50,000 | ₹2,50,000 |
The timing difference is ₹2,50,000. Tax has allowed more depreciation than books, so current taxable profit is lower today and will be higher in future years — a DTL. Compute:
DTL = ₹2,50,000 × 25% = ₹62,500
Additionally, the company has a Provision for Doubtful Debts of ₹1,00,000 (disallowed under Section 36(1)(vii) since no actual write-off). Current taxable profit is higher by ₹1,00,000; future write-off will reduce future taxable profit. DTA:
DTA = ₹1,00,000 × 25% = ₹25,000
Net deferred tax position at 31 March 2026 = DTL ₹62,500 − DTA ₹25,000 = Net DTL ₹37,500
(Under AS 22, DTA and DTL are netted only if they relate to the same governing tax law, which is typically the case for an Indian company. Under Ind AS 12, netting is permitted when there is a legally enforceable right of set-off.)
The journal entries — every entry, from creation to reversal
Now the entries the user actually opens a working paper for. Tax-rate adjustments are shown at 25% throughout; the principle is identical at any rate.
Year 1 — Initial creation
Two separate entries on 31 March 2026, one for each side of the deferred tax position:
Entry 1 — Creating the DTL on depreciation timing difference
| Account | Dr (₹) | Cr (₹) |
|---|---|---|
| Deferred Tax Expense (P&L) | 62,500 | |
| To Deferred Tax Liability (Balance Sheet) | 62,500 | |
| (Being deferred tax liability created on excess of tax depreciation over book depreciation @ 25%) | ||
Entry 2 — Creating the DTA on provision for doubtful debts
| Account | Dr (₹) | Cr (₹) |
|---|---|---|
| Deferred Tax Asset (Balance Sheet) | 25,000 | |
| To Deferred Tax Income / Credit to P&L | 25,000 | |
| (Being deferred tax asset created on provision for doubtful debts disallowed under Sec 36(1)(vii) @ 25%) | ||
P&L net impact = Dr ₹62,500 − Cr ₹25,000 = Net deferred tax expense ₹37,500 charged to current year P&L. Balance sheet shows DTL ₹62,500 and DTA ₹25,000 (gross) or Net DTL ₹37,500 after netting.
Year 2 — Movement, not full reversal
Roll forward to 31 March 2027. Assume:
- Book depreciation Year 2: ₹5,00,000 (SLM)
- Tax depreciation Year 2: ₹6,37,500 (15% on opening WDV of ₹42,50,000)
- Cumulative book WDV: ₹40,00,000; cumulative tax WDV: ₹36,12,500
- Cumulative timing difference: ₹3,87,500
- Required DTL at year-end: ₹3,87,500 × 25% = ₹96,875
- Opening DTL: ₹62,500. Required incremental DTL: ₹34,375
- Provision for doubtful debts: reduced to ₹70,000 (some balance written off, some recovered). Cumulative timing difference: ₹70,000. Required DTA = ₹17,500. Opening DTA: ₹25,000. Reversal needed: ₹7,500
Entry 3 — Incremental DTL for the year
| Account | Dr (₹) | Cr (₹) |
|---|---|---|
| Deferred Tax Expense (P&L) | 34,375 | |
| To Deferred Tax Liability | 34,375 | |
| (Being incremental DTL on Year 2 depreciation timing difference) | ||
Entry 4 — Partial reversal of DTA on doubtful debts
| Account | Dr (₹) | Cr (₹) |
|---|---|---|
| Deferred Tax Expense (P&L) | 7,500 | |
| To Deferred Tax Asset | 7,500 | |
| (Being reversal of DTA on provisions partially recovered / written off during the year) | ||
Year 8 — Late-life reversal of original DTL
Several years on, tax depreciation under WDV falls below book SLM depreciation. The DTL starts unwinding. By the time the asset is fully depreciated in books (Year 10), the cumulative tax depreciation = cumulative book depreciation = ₹50,00,000, and the timing difference returns to zero. The DTL is fully reversed:
| Account | Dr (₹) | Cr (₹) |
|---|---|---|
| Deferred Tax Liability | (remaining balance) | |
| To Deferred Tax Income / Credit to P&L | (remaining balance) | |
| (Being full reversal of DTL as book and tax WDV converge at end of asset's useful life) | ||
The cumulative deferred tax charge to P&L across the asset's entire life is exactly zero. Year-on-year it smooths the tax-cost reflection of the asset over its book life rather than its tax life. This is the whole point of deferred tax accounting.
Special entry — Ind AS 12 only — deferred tax through OCI
Under Ind AS 12, deferred tax follows the underlying item. If a fair value gain on an FVOCI investment is recognised in Other Comprehensive Income (not P&L), the related deferred tax is also recognised in OCI, not P&L:
| Account | Dr | Cr |
|---|---|---|
| Deferred Tax Expense — OCI | X | |
| To Deferred Tax Liability | X | |
| (Being deferred tax on FVOCI fair value gain, recognised through OCI to match the underlying) | ||
This is one of the cleanest ways to spot whether a company is on Ind AS or Indian GAAP — only Ind AS files will show deferred tax movements through OCI in the SOCIE.
Audit-file disclosures — what the notes must contain
Deferred tax is not just a number on the balance sheet. The notes to financial statements must disclose:
Under AS 22
- Break-up of DTA and DTL by major component (depreciation, provisions, carry-forward losses, etc.)
- The basis of recognition of DTA on carry-forward losses (the prudence statement)
- The applicable tax rate used and any change from the prior year
Under Ind AS 12 (more detailed)
- All of the above, plus:
- Reconciliation between accounting profit × statutory tax rate and the actual tax expense (the "effective tax rate reconciliation") — this is where permanent differences become visible to the reader
- Movement of DTA and DTL during the year (opening balance, items recognised in P&L, items recognised in OCI, items recognised in equity, closing balance)
- Unrecognised DTAs and the reason they were not recognised
- Tax effects of distributions to shareholders
- Temporary differences associated with investments in subsidiaries / associates not recognised, and why
The mistakes that show up at audit
One: forgetting to apply the prudence test on DTAs. A loss-making company computes a notional DTA on its carry-forward losses and recognises it without a board-approved business plan supporting recovery. The auditor either qualifies the opinion or writes the DTA off. Either is avoidable with a one-page prudence memo in the audit file.
Two: using the wrong tax rate. The Indian corporate tax landscape has Sec 115BAA (22% + surcharge for domestic companies opting out of incentives), Sec 115BAB (15% for new manufacturing), and the standard rate. The deferred tax rate must be the rate expected to apply when the timing difference reverses, not the current year's rate if the company is mid-transition. Most reversals are in future years; if your company is moving to 115BAA next year, the deferred tax computed today should use the 22% rate, not 30%.
Three: confusing permanent and temporary differences. The classic error is treating CSR expenditure as a timing difference (it isn't — it's permanently disallowed under Section 37) or treating Section 80G donations as temporary (they aren't — the excess over qualifying limit is permanently disallowed). Both lead to overstated DTAs that the auditor will reverse.
Four: not reassessing DTAs at each reporting date. AS 22 paragraph 18 and Ind AS 12 paragraph 56 both require reassessment. A DTA recognised in year one becomes a stale balance if the company hasn't returned to profitability by year three. The audit-file documentation must be refreshed every year — same template, different facts.
Five: forgetting to update the rate when the tax law changes. When Section 115BAA was introduced in September 2019 and again when the Income-tax Act 2025 brought rate consolidations, companies that opted into the new regime needed to remeasure their opening DTA/DTL at the new rate. The catch-up entry hits the P&L in the year of remeasurement. Companies that didn't remeasure carried a wrong number on their balance sheet until the next audit caught it.
Six: gross vs net presentation confusion. Under both AS 22 and Ind AS 12, presentation is net of DTA and DTL when the legal right of set-off is present (typically yes for a single Indian company). But disclosure in the notes is gross — by component. Audit files often confuse the two and either over-net or under-disclose.
The honest takeaway
Deferred tax is not optional and it is not complicated — but it is specific. Every line item on the P&L and every asset and liability on the balance sheet has to be examined once, classified as permanent or temporary, and — if temporary — multiplied by the right tax rate and journaled in the right direction.
The decisions that compound are made at the working-paper stage, not the audit-finalisation stage. Get the classification right (permanent vs temporary), apply the prudence test rigorously to DTAs (especially on carry-forward losses), use the tax rate that will apply when the timing difference reverses (not always the current year's rate), and reassess every year. Six months of disciplined audit-file work at year-end avoids ten years of carrying a wrong number forward.
Or to put it the way the audit partner will: the cost of getting deferred tax right is the same as the cost of getting it wrong — it's the same hour of work, just done with the right reference data. The compounding is asymmetric. Do it right.
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Schedule consultationDisclaimer: This article reflects the position under AS 22 (Accounting for Taxes on Income) and Ind AS 12 (Income Taxes) as applicable in India as of June 2026, and the Income Tax Act 1961 / 2025 provisions as in force at the date of publication. Specific deferred tax computations are fact-dependent — the applicable tax rate, prudence assessment for DTAs, and treatment of fair value items vary by company. Consult a qualified Chartered Accountant before relying on this for a transaction or a year-end close.