According to Matching-concept of accounting your expenses should match with your revenue,thats why provision for Prepaid/or Outstanding liability is made in the account books.So that all the expenses and revenue of the relevant financial year are recognised in the same financial year. Similary in the case of Business and profession some incomes and treated in different way e.g, in the case of company some expenses are write in the same year but Under Income Tax they are allowed to be writen of in a period of Five year.or even disalowed in the Income Tax Or in other instance Under Indian Company Act some expenses are allowed on accrued basis but under Income Tax Act these are allowed on payment basis ,(for Example Sec 43B of Income Tax Act)Since different treatment of same item result in different Profit Or Loss for the Fy.So in order to reconcile this different A provision for Tax Liabilty is made so that the Tax Expenses of the same year is recognised in the same year:which is known as Deffered Tax Liability.
Deffred Tax Liability arise when Profit as per Income Tax Act is low where as accounting Profit is more.So in order to neutralise this Deffered Tax Liabilty is provided which is to be adjusted in the forthcoming year/years.
One thing is to be noted that Deferred Tax Liability is Recognised only for Timing Difference and not for Permanent differece.
Timing Difference means treatment of an item based on the different time for example if an item which comes under Sec 43 B is recognised in accounting year itself when it incurred irrespective of payment made but in Income Tax it is recognised only when actual payment is made,which may may be made in the next year.Hence there will arise time difference.
Permanent differene arise which can not be adjusted in any subsequent year.For example if an item is treated as revenue expenditure in Account books but which is compelety disallowed in the Income Tax Act then it is Called Permanent difference.
27th August 2009 From India