ACCOUNTING

STANDARDS

Presented By:
Sachin Regi &
Anagha Mohan
What are Accounting Standards?
Accounting standards are a set of principles and guidelines that govern how
financial statements are prepared, presented, and reported by organizations. They
ensure consistency, transparency, and comparability in financial reporting, which
is crucial for users such as investors, creditors, regulators, and analysts who rely
on financial information to make informed decisions.

The Need for Accounting Standards:

 The need for accounting standards arises from the complexity of financial
transactions, the diverse nature of businesses, and the global nature of trade
and investment. Without standardized accounting practices, it would be
difficult for stakeholders to understand and trust financial statements,
which could lead to inefficiencies and risk in the economy.
 Accounting standards also help to prevent fraudulent reporting and
provide a framework for auditing financial statements.
 Accounting Standard 2 (AS 2): Valuation of Inventories

Objective:
The primary objective of Accounting Standard 2 (AS 2) is to provide guidance on
the treatment of inventories in the financial statements. The standard provides a
comprehensive framework for the valuation of inventories and ensures that
inventories are reported at an appropriate value. This Standard deals with the
determination of such value, including the ascertainment of cost of inventories and
any write-down thereof to net realizable value.

Scope of AS 2:
AS 2 applies to all types of inventories except:

 Work in progress arising under construction contracts (covered by AS 7).

 Financial instruments such as shares, bonds, or other financial instruments.

It specifically covers:

 Raw materials, Work-in-progress, Finished goods, Trading goods

Key Definitions in AS 2:
1. Inventories are assets:
 held for sale in the ordinary course of business;
 in the process of production for such sale; or
 in the form of materials or supplies to be consumed in the production
process or in the rendering of services.

2. Net realizable value:

It is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make
the sale.
Measurement of Inventories
 Inventories should be valued at the lower of cost and net realizable value.

Cost of Inventories
 The cost of inventories should comprise all costs of purchase, costs of
conversion and other costs incurred in bringing the inventories to their
present location and condition.

Costs of Purchase
 The costs of purchase consist of the purchase price including duties and
taxes (other than those subsequently recoverable by the enterprise from the
taxing authorities), freight inwards and other expenditure directly
attributable to the acquisition. Trade discounts, rebates, duty drawbacks
and other similar items are deducted in determining the costs of purchase.

Costs of Conversion
 The costs of conversion of inventories include costs directly related to the
units of production, such as direct labour. They also include a systematic
allocation of fixed and variable production overheads that are incurred in
converting materials into finished goods.
 Fixed production overheads are those indirect costs of production that
remain relatively constant regardless of the volume of production.
 Variable production overheads are those indirect costs of production that
vary directly, or nearly directly, with the volume of production.
 The allocation of fixed production overheads for the purpose of their
inclusion in the costs of conversion is based on the normal capacity of the
production facilities
 Variable production overheads are assigned to each unit of production on
the basis of the actual use of the production facilities.

Other Costs
 Other costs are included in the cost of inventories only to the extent that they
are incurred in bringing the inventories to their present location and
condition.
Note:

 Interest and other borrowing costs are usually considered as not relating to
bringing the inventories to their present location and condition and are,
therefore, usually not included in the cost of inventories.

Exclusions from the Cost of Inventories

In determining the cost of inventories, it is appropriate to exclude certain costs and
recognize them as expenses in the period in which they are incurred. Examples of
such costs are:
(a) abnormal amounts of wasted materials, labour, or other production
costs;
(b) storage costs, unless those costs are necessary in the production
process prior to a further production stage
(c) administrative overheads that do not contribute to bringing the
inventories to their present location and condition; and
(d) selling and distribution costs.

Cost Formulas
 The cost of inventories of items that are not ordinarily interchangeable and
goods or services produced and segregated for specific projects should be
assigned by specific identification of their individual costs.
 Specific identification of cost means that specific costs are attributed to
identified items of inventory. However, when there are large numbers of
items of inventory which are ordinarily interchangeable, specific
identification of costs is inappropriate.
 The cost of inventories, other than those dealt with in specific identification
method should be assigned by using the first-in, first-out (FIFO), or weighted
average cost formula. The formula used should reflect the fairest possible
approximation.
Techniques for the Measurement of Cost
 Techniques for the measurement of the cost of inventories, such as the
standard cost method or the retail method, may be used for convenience if
the results approximate the actual cost. Standard costs take into account
normal levels of consumption of materials and supplies, labour, efficiency
and capacity utilization.

 The retail method is often used in the retail trade for measuring inventories
of large numbers of rapidly changing items that have similar margins and for
which it is impracticable to use other costing methods. The cost of the
inventory is determined by reducing from the sales value of the inventory
the appropriate percentage gross margin.

Net Realizable Value

 The cost of inventories may not be recoverable if those inventories are
damaged, if they have become wholly or partially obsolete, or if their selling
prices have declined. The cost of inventories may also not be recoverable if
the estimated costs of completion or the estimated costs necessary to make
the sale have increased.
 The practice of writing down inventories below cost to net realizable value
is consistent with the view that assets should not be carried in excess of
amounts expected to be realized from their sale or use.
 Inventories are usually written down to net realizable value on an item-by-
item basis. In some circumstances, however, it may be appropriate to group
similar or related items
 Estimates of net realizable value are based on the most reliable evidence
available at the time the estimates are made as to the amount the inventories
are expected to realize.
 Estimates of net realizable value also take into consideration the purpose for
which the inventory is held.
 An assessment is made of net realizable value as at each balance sheet date.
Disclosure
The financial statements should disclose:

 the accounting policies adopted in measuring inventories, including the cost

formula used; and
 the total carrying amount of inventories and its classification appropriate to
the enterprise.
 Information about the carrying amounts held in different classifications of
inventories and the extent of the changes in these assets is useful to financial
statement users

Common classifications of inventories are:

(a) Raw materials and components

(b) Work-in-progress

(c) Finished goods

(d) Stock-in-trade (in respect of goods acquired for trading)

(e) Stores and spares

(f) Loose tools

(g) Others (specify nature)

Accounting Standard 10: Property, Plant and Equipment

Objectives of AS 10 (PPE)
 The primary objective of AS 10 is to prescribe the accounting treatment for
Property, Plant, and Equipment (PPE), which are tangible fixed assets
used in business operations.

 The standard ensures that:

o PPE is recognized as an asset only when future economic benefits are

probable and the cost can be measured reliably.

o PPE is initially measured at cost and subsequently adjusted for

depreciation, revaluation, and impairment.

o The financial statements provide relevant and reliable information

to the users regarding:

 The investment made in PPE

 The changes in that investment over time

 The depreciation and impairment charged

 The carrying amount of PPE

 This helps stakeholders assess:

o How much of the company’s capital is invested in long-term assets

o Whether these assets are being maintained or replaced

o The impact of these assets on the company’s profitability and

financial position

Scope of AS 10
AS 10 applies to tangible fixed assets that meet the following conditions:

 Held for use in the production or supply of goods or services:

o These are assets actively involved in the company's core operations.

  Held for rental to others:

o Assets owned by the enterprise but rented out to earn income.

 Held for administrative purposes:

o Assets that support business operations but are not directly involved
in production.

 Expected to be used for more than one accounting period:

o The asset must provide economic benefits over a long term, not just
one financial year.

What AS 10 Does Not Cover (Exclusions):

Some types of tangible assets, although physical in nature, are not covered under
AS 10:

 Biological assets related to agricultural activity:

o These are living animals or plants (like cattle, trees, crops).

o Their behaviour and value change based on biological

transformation, which requires a different accounting treatment.

 Wasting assets such as mineral rights, oil reserves, and natural resources:

o These assets are extracted or depleted over time and are governed by
other accounting practices.

Key Definitions
 Property, Plant, and Equipment (PPE): Tangible items held for use and
expected to be used during more than one period.

 Carrying Amount: The amount at which an asset is recognized after

deducting accumulated depreciation and impairment losses.

 Depreciable Amount: Cost of an asset less its residual value.

  Residual Value: Estimated amount that an entity would currently obtain
from disposal of the asset, after deducting estimated disposal costs.

 Useful Life: Period over which the asset is expected to be used or the
number of units expected to be produced.

Recognition Criteria under AS 10 – Property, Plant and Equipment

An item is recognized as Property, Plant and Equipment (PPE) and recorded as
an asset in the financial statements only when both of the following conditions
are satisfied:

1. Probable Future Economic Benefits

 It must be probable that the item will generate future economic benefits
for the enterprise.

 This means the asset will help in:

o Producing goods or services,

o Reducing costs,

o Earning rental income,

o Or being used in administrative operations that support business

activities.

 The enterprise must have reasonable assurance of this benefit.

2. Cost Can Be Measured Reliably

 The cost of the asset must be measurable with reliability and accuracy.

 All expenditures directly attributable to acquiring and preparing the asset

for use must be identifiable.

 If the cost cannot be determined reliably, the asset cannot be capitalized and
should be expensed.
Why These Criteria Matter

 These criteria ensure that only assets with real, measurable value and
economic benefit are recorded.

 It prevents overstatement of assets and ensures that the balance sheet

reflects the true financial position of the enterprise.

Initial Measurement of PPE (AS 10)

When an item qualifies for recognition as PPE, it should be initially measured at
cost. This cost forms the basis for all future accounting related to the asset (e.g.,
depreciation, impairment, revaluation).

What Is Included in "Cost"?

The cost of PPE includes:

 Purchase Price

o The amount paid to acquire the asset.

o Net of any trade discounts, rebates, and taxes/duties that are

recoverable under applicable tax laws (e.g., GST credit).

 Directly Attributable Costs

o Costs necessary to bring the asset to its working condition and

location for intended use.

 Initial Estimated Costs of Dismantling or Restoring the Site

o If the company has an obligation to restore the site or dismantle the

asset in the future (e.g., leased land), such costs should also be
included in the asset's cost (at present value).

What Is Excluded from Cost?

Certain expenses are not capitalized and should be charged to the Profit and Loss
Account when incurred:

 General Administrative Overheads

 o Day-to-day operational expenses not directly related to the
construction/acquisition of the asset.

 Abnormal Costs or Losses

o Costs that arise due to inefficiency or error and are not necessary to
bring the asset to usable condition.

Subsequent Expenditure (After Initial Recognition)

Once an asset is ready for its intended use, any expenditure incurred afterward
must be evaluated carefully to determine whether it should be capitalized or
expensed.

Capitalization Criteria:
Subsequent costs should be added to the carrying amount of the asset (i.e.,
capitalized) only if:

 They increase the future economic benefits from the asset beyond the
originally assessed level, such as:

o Increasing the capacity or efficiency of the asset

o Extending the useful life of the asset

o Upgrading the asset to a new technology or improved functionality

Revenue Expenditure (Expensed to P&L):

If the cost does not meet the above criteria, it is charged to the Profit and Loss
account as an expense.

 Most repairs and maintenance fall into this category because:

o They restore the asset to its original condition, not improve it

o They are routine or regular in nature

Summary: Capitalize or Expense?

Type of Expenditure Treatment Reason

Leads to increased
Enhances future benefits Capitalize
performance/life
Regular Does not add extra economic
Expense (P&L)
repairs/maintenance benefits
Replacement of major Extends life or improves
Capitalize
component performance
Routine and not significant in
Minor part replacements Expense (P&L)
impact

Depreciation – AS 10 (PPE)
Meaning:

 Depreciation is the systematic allocation of the depreciable amount of an

asset over its useful life.

 It represents the wear and tear, obsolescence, or reduction in value of the

asset due to usage or passage of time.

Key Points:

 Depreciation begins when the asset is available for use, i.e., when it is in
the location and condition necessary for it to operate as intended by
management — not necessarily when it's actually used.

 Depreciation continues until the asset is:

o Fully depreciated, or

o Derecognized (removed from the books, either due to sale, disposal,

or no further use).
Depreciation Is Based On:
1. Cost (or Revalued Amount):

o Initial cost of acquisition (or revalued amount if revaluation model is

used).

2. Useful Life:

o The estimated period over which the asset is expected to be used by

the enterprise.

o May differ from the physical life due to technological changes, legal
limits, etc.

3. Residual Value:

o The estimated amount that the enterprise expects to recover at the

end of the asset's useful life, after deducting disposal costs.

o Depreciation is charged on cost minus residual value.

Annual Review Requirement:

 Useful life and residual value should be reviewed at least once at the end
of each financial year.

 If the estimates change:

o The depreciation expense should be adjusted prospectively (i.e.,

going forward), as per AS 5 (Accounting for Changes in Estimates).

Depreciation Method:
 The method used should reflect the pattern in which the asset's future
economic benefits are expected to be consumed.

 Common methods:

o Straight Line Method (SLM)

o Written Down Value (WDV) / Diminishing Balance Method

  Once selected, the method should be consistently applied unless there is a
valid reason to change.

Derecognition – AS 10 (PPE)
Derecognition means removing an asset from the books of accounts — i.e., no
longer recognizing it as PPE in the financial statements.

When Is an Asset Derecognized?

An asset should be derecognized when either of the following conditions is met:

1. Disposal of the Asset

o The asset is sold, exchanged, or scrapped.

o Control of the asset is transferred to another party.

2. No Further Economic Benefits Are Expected

o The asset is no longer expected to provide any future economic

benefits.

Accounting Treatment of Derecognition

When an asset is derecognized, the company must calculate the gain or loss on
disposal:

Gain or Loss on Derecognition

= Net Disposal Proceeds – Carrying Amount of the Asset

 Net Disposal Proceeds = Amount received from sale (after deducting

selling costs)

 Carrying Amount = Book value of the asset at the time of disposal (cost
minus accumulated depreciation and impairment)

The resulting gain or loss is recognized in the Statement of Profit and Loss for
the period in which derecognition occurs.
Important Notes:

 Derecognition applies regardless of whether the asset is replaced — the old

asset must be removed, and a new one recorded separately.

 If the asset is disposed of in exchange for another asset, the new asset is
recognized at fair value, and the old one is derecognized.

Disclosure Requirements – AS 10 (PPE)

For each class of PPE, the following details must be disclosed in the financial
statements:

 Measurement Basis

 Disclose the accounting model used:

o Cost model or

o Revaluation model

 Depreciation Methods and Useful Lives

 Specify the method of depreciation used for each asset class:

o Straight Line Method (SLM), Written Down Value (WDV), etc.

 State the useful lives or depreciation rates used.

 Gross Carrying Amount and Accumulated Depreciation

 Report the original cost (gross carrying amount).

 Show accumulated depreciation and impairment losses, if any.

 Also disclose the net carrying amount at the end of the reporting period.

 Reconciliation of Carrying Amount

 Provide a reconciliation of the opening and closing balances for each class
of PPE, showing:

o Opening balance

o Additions
 o Disposals

o Depreciation for the period

o Impairments (losses or reversals)

o Revaluations (if any)

o Closing balance

This gives a full picture of how the asset’s value changed during the year.

 Details of Revaluations (If Any)

 If assets are revalued, disclose:

o Effective date of revaluation

o Whether the revaluation was by an independent valuer

o The revaluation surplus (credited to revaluation reserve)

o The carrying amount under cost model, if revaluation had not been
applied
Accounting Standard 11 (AS 11): The Effects of Changes in
Foreign Exchange Rates

Objective:
The main objective of Accounting Standard 11 is to prescribe the accounting
treatment for transactions involving foreign exchange and to define the treatment
of foreign exchange differences in financial statements. It aims to provide a
consistent approach to the recognition, measurement, and reporting of foreign
currency transactions and the translation of foreign currency financial statements.

AS 11 is particularly important because it provides guidance on how to deal with:

1. Foreign exchange transactions,

2. Foreign currency monetary items,

3. The translation of financial statements of foreign operations,

4. The exchange rate differences arising from these activities.

Scope
This Standard should be applied:

 in accounting for transactions in foreign currencies; and

 in translating the financial statements of foreign operations.
 this Standard also deals with accounting for foreign currency transactions in
the nature of forward exchange contracts.

Key Definitions:
 Foreign Currency: A currency other than the functional currency of the
reporting entity. For example, for an Indian company, the foreign currency
would include any currency other than the Indian Rupee (INR).
  Functional Currency: The currency of the primary economic environment
in which the entity operates. For most businesses, this is the currency in
which they conduct their transactions. For example, a company located in
India with significant business transactions in USD may use INR as its
functional currency.

 Foreign Currency Monetary Items: These include items that are:

o Receivables or payables in foreign currency (e.g., loans, trade

receivables, etc.).

o Assets or liabilities to be settled in a foreign currency.

o Any other financial instrument that involves foreign currency

settlement.

 Exchange Differences: These are the differences arising from the

conversion of foreign currency items into the functional currency of the
company, at the rates of exchange prevailing on different dates. Exchange
differences can be gains or losses depending on the changes in exchange
rates.

Recognition of Foreign Exchange Transactions:

1. Initial Recognition:

Foreign currency transactions should be recognized at the exchange rate

prevailing on the date of the transaction.

2. Subsequent Recognition:

Monetary Items: After initial recognition, any monetary items

denominated in foreign currency should be re-translated at the closing
[Link] resulting exchange differences are recognized in the profit and loss
account.

Non-Monetary Items: Non-monetary items measured in terms of historical

cost or revalued cost are not re-translated at the balance sheet date. They
continue to be carried at the exchange rate at the date of the transaction.
Exchange Differences and Their Treatment:
1. Monetary Items (Revaluation):

For monetary items, exchange differences arising from the revaluation of

foreign currency balances are recognized as income or expense in the period
in which the exchange rate changes. These exchange differences can be:

o Foreign Exchange Gains: If the functional currency

strengthens, the monetary items in foreign currency will result
in a gain.

o Foreign Exchange Losses: If the functional currency weakens,

the monetary items in foreign currency will result in a loss.

2. Non-Monetary Items (No Revaluation):

For non-monetary items like property, plant, and equipment, and

inventory, exchange differences do not affect the carrying value of the asset.
The original exchange rate (i.e., the rate on the transaction date) is used for
reporting the value in the balance sheet.

Exchange Differences on Foreign Currency Borrowings:

Foreign exchange differences arising from borrowing costs related to qualifying
assets that are constructed or produced are capitalized as part of the cost of the
asset under AS 16 (Borrowing Costs). If the borrowings are for other purposes,
exchange differences are recognized in the profit and loss account.
 Accounting Standard 16: Borrowing Costs

Objective of AS 16
The objective of AS 16 is to prescribe the accounting treatment of borrowing costs
and ensure that such costs are either capitalized (included in the cost of a qualifying
asset) or expensed, depending on the circumstances.

Scope of AS 16:
AS 16 applies to all borrowing costs, except for the following:

 Borrowing costs relating to qualifying assets measured at fair value (i.e.,

those held for trading).

 Borrowing costs of inventories that are manufactured or otherwise

produced over a short period (as per AS 2 – Valuation of Inventories).

Definitions
The following terms are used in this Standard with the meanings specified:

 Borrowing costs are interest and other costs incurred by an enterprise in

connection with the borrowing of funds.
 A qualifying asset is an asset that necessarily takes a substantial period of
time to get ready for its intended use or sale.

Borrowing costs may include:

 Interest and commitment charges on bank borrowings and other short-term

and long-term borrowings;
 Amortization of discounts or premiums relating to borrowings;
 Amortization of ancillary costs incurred in connection with the arrangement
of borrowings;
 Finance charges in respect of assets acquired under finance leases or under
other similar arrangements; and
 Exchange differences arising from foreign currency borrowings to the extent
that they are regarded as an adjustment to interest costs.
Recognition
 Borrowing costs that are directly attributable to the acquisition, construction
or production of a qualifying asset should be capitalized as part of the cost
of that asset. The amount of borrowing costs eligible for capitalization
should be determined in accordance with this Standard. Other borrowing
costs should be recognized as an expense in the period in which they are
incurred.
 Borrowing costs are capitalized as part of the cost of a qualifying asset when
it is probable that they will result in future economic benefits to the
enterprise and the costs can be measured reliably. Other borrowing costs are
recognized as an expense in the period in which they are incurred.

Capitalization of Borrowing Costs:

 AS 16 mandates that borrowing costs that are directly attributable to the
acquisition, construction, or production of a qualifying asset should be
capitalized as part of the cost of that asset.
 This means that when a company borrows funds to finance the purchase,
construction, or production of a qualifying asset, the interest expense and
other borrowing costs incurred during the construction or production phase
must be added to the cost of the asset.

When Should Borrowing Costs be Capitalized?

 Borrowing costs are capitalized only when activities necessary to prepare
the asset for its intended use or sale are actively ongoing.

 The capitalization ceases when the asset is substantially ready for use or
sale.

When Should Borrowing Costs be Expensed?

 If the borrowing costs do not meet the criteria for capitalization, they should
be recognized as an expense in the period in which they are incurred.
 For example, if the borrowing costs are for a project that does not involve
the creation of a qualifying asset (e.g., short-term financing), those costs
should be expensed in the period they are incurred.

Criteria for Capitalization:

To capitalize borrowing costs, all of the following conditions must be met:

1. Expenditure on the asset: The company must incur expenditure on the asset
(either directly or indirectly).

2. Borrowing activity: The borrowing must be specifically for the purpose of

acquiring, constructing, or producing the asset.

3. Involvement of borrowing costs: The borrowing costs must be directly

attributable to the asset and must arise during the period of construction or
production.

Capitalization Process:
1. Commencement of Capitalization:

 Capitalization of borrowing costs begins when:

 Expenditure is being incurred on the asset.

 Borrowing costs are being incurred.

 Activities necessary to prepare the asset for its intended use or

sale are in progress.

2. Suspension of Capitalization:

 Capitalization is suspended during periods when active development

is interrupted (such as when construction is halted for extended
periods).

3. Ceasing Capitalization:

 Capitalization of borrowing costs stops when the asset is substantially

ready for its intended use or sale.
Disclosure
The financial statements should disclose:

 the accounting policy adopted for borrowing costs; and

 the amount of borrowing costs capitalized during the period.
Accounting Standard 22 (AS 22), titled “Accounting for
Taxes on Income”

Key Concepts and Definitions

Accounting Income:

 It is the net profit or loss for a period, before deducting income tax expense,
as shown in the Profit and Loss Account.

 Determined based on the accounting policies and standards applicable

(e.g., Companies Act and Indian GAAP).

 This is the figure used for preparing financial statements and is reported to
shareholders and stakeholders.

 Example: A company earns ₹10,00,000 as per its Profit and Loss Account,
after deducting all expenses except income tax. This is its accounting
income.

Taxable Income:

 It is the income computed in accordance with the provisions of the Income

Tax Act, 1961.

 It considers various allowances, disallowances, incentives, and deductions

that may differ from accounting standards.

 Taxable income forms the basis on which current income tax liability is
calculated.

Current Tax:

 The amount of income tax payable in respect of taxable income for a

particular financial year.

 It is computed by applying the tax rate in force for the assessment year to
the taxable income.
  This is recognized as a liability in the financial statements when the income
is earned.

Deferred Tax:

 Refers to the tax effect of timing differences.

 Timing differences are those differences between accounting income and

taxable income that originate in one period and reverse in another.

 Deferred tax is recognized in the books to account for the future tax
consequences of these differences.

 Deferred tax can result in:

o Deferred Tax Asset (DTA): Future tax benefit.

o Deferred Tax Liability (DTL): Future tax obligation.

Types of Differences
1. Timing Differences:

 These are differences between accounting income and taxable income that:

o Arise in one accounting period, and

o Reverse (cancel out) in one or more future periods.

 Timing differences lead to deferred tax assets or liabilities because the

related tax effects occur in different periods.

 These differences are temporary in nature and eventually even out over
time.

2. Permanent Differences:

 These are differences between accounting income and taxable income that:

o Arise in one period, and

o Do not reverse in any future period.

 These differences are permanent in nature and are ignored when calculating
deferred taxes.
 They affect the effective tax rate, but not the deferred tax calculations.

Deferred Tax Liabilities (DTL)

 Definition: A Deferred Tax Liability arises when accounting income is
higher than taxable income due to timing differences.

 This means the company is paying less tax now, but will have to pay more
tax in the future as the timing difference reverses.

 DTL represents a future tax obligation.

 It is recognized in the books as a liability because it will result in additional

tax payments later.

o Common situations leading to DTL:

 Depreciation: When depreciation as per the Income Tax Act is higher than
depreciation as per accounting standards, taxable income is reduced
temporarily.

 Revenue recognition: Income recognized earlier for accounting purposes

but taxed later.

Deferred Tax Asset (DTA)

 Definition: A Deferred Tax Asset arises when accounting income is lower
than taxable income due to timing differences.

 This means the company is paying more tax now, but will save tax in the
future when the timing difference reverses.

 DTA represents a future tax benefit.

 It is recognized as an asset, but only when there is reasonable certainty of

earning sufficient taxable income in future.

Common situations leading to DTA:

  Provisions: Expenses like provision for doubtful debts, leave encashment,
or gratuity that are allowed for tax only when actually incurred.

 Prepaid expenses: Recognized for tax but not yet charged in books.

Recognition Criteria
1. Deferred Tax Liability (DTL):

 DTL must be recognized for all taxable timing differences.

 No conditions are imposed for its recognition.

 The logic is that if you are deferring tax now (due to lower taxable income),
you will definitely pay it later, hence a liability should be recognized.

2. Deferred Tax Asset (DTA):

 DTA should be recognized only if there is reasonable certainty that there

will be sufficient future taxable income to realize the asset.

 This means the company should expect to have enough profits in the future
against which these tax benefits can be used.

 It is based on the prudence concept — avoid overstating assets unless

realization is probable.

Reassessment of Deferred Tax Assets and Liabilities

 Deferred Tax Assets (DTA) and Deferred Tax Liabilities (DTL) are not
static; they must be reviewed and reassessed at every balance sheet date.

 This ensures that the amounts of DTA and DTL shown in the financial
statements reflect the latest expectations about the timing and extent of
reversals of the underlying differences.
Reassessment of DTA:
 DTA should be re-evaluated to confirm whether the condition of
reasonable certainty (or virtual certainty, in the case of losses or
unabsorbed depreciation) still holds true.

 If the company no longer expects sufficient taxable income in the future:

o The DTA should be reduced or written off, fully or partially.

 If there is new evidence indicating improved future profitability:

o DTA may be recognized or increased.

Reassessment of DTL:
 DTL should also be re-assessed to reflect any changes in timing differences
or in tax rates.

 If the timing differences have reversed or are expected to reverse earlier or

later than expected, the amount of DTL should be adjusted accordingly.

Tax Rate Changes:

 If the applicable tax rate changes (due to changes in tax laws), the
DTA/DTL must be recalculated using the new rate.

 The difference caused by the change in tax rate should be adjusted in the
profit and loss account of the current period.

Disclosure:
 If there is a material change in the DTA/DTL due to reassessment, it should
be disclosed separately in the notes to accounts.

 The reasons for changes, particularly in assumptions or evidence used for

recognition, should be stated clearly.
Presentation in Financial Statements
1. Classification:

 Deferred Tax Assets (DTA) and Deferred Tax Liabilities (DTL) must be
presented as non-current items in the balance sheet.

 This is because timing differences typically reverse over a long period — not
within the operating cycle or one year.

 They should not be clubbed with current tax assets or liabilities.

2. Separate Disclosure:

 DTA and DTL should be disclosed separately under the appropriate

headings:

o DTA under “Non-Current Assets”

o DTL under “Non-Current Liabilities”

 This helps users of financial statements understand the nature and long-
term tax implications of the entity’s operations.

3. Offsetting (Netting Off):

 Offsetting of DTA and DTL is permitted, but only if both of the following
conditions are met:

o They arise under the same governing taxation laws (e.g., the same
Income Tax Act).

o They pertain to the same taxable entity (i.e., same company or

business unit).

 If these conditions are not satisfied, the DTA and DTL must be presented
separately.

4. Notes to Accounts:

 The notes to financial statements should include:

o Break-up of the major components of DTA and DTL.

 o Nature of the timing differences giving rise to these amounts.

o Movement in DTA/DTL balances during the year (opening balance,

additions, reversals, closing balance).

Disclosure Requirements
1. Nature of Timing Differences:

 The financial statements should disclose the nature of the timing

differences that have resulted in the recognition of:

o Deferred Tax Assets (DTA)

o Deferred Tax Liabilities (DTL)

 This helps users understand why these tax items arise and how they might
reverse in the future.

2. Amount of DTA and DTL:

 The total amount of DTA and DTL recognized in the financial statements
should be clearly stated.

 If DTA and DTL are not offset, they should be shown separately under the
appropriate heads (non-current assets and liabilities).

 If offsetting is done (as per the allowed criteria), then net amount should be
shown, with appropriate explanation in the notes.

3. Movement in DTA/DTL During the Year:

 If the change in DTA or DTL is material, the movement during the year
should be disclosed in the notes.

 This includes:

o Opening balance of DTA/DTL

o Additions during the year (new timing differences)

o Reversals during the year (old timing differences reversing)

o Closing balance