Financial Accounting · Accounting for Taxes on Income (AS 22)

Recognition of Deferred Tax Assets and Liabilities under AS 22

Updated 10 October 2026 · Fact-checked

Deferred tax is the tax effect of timing differences. A deferred tax liability is recognised on timing differences that will reverse into higher future tax. A deferred tax asset needs reasonable certainty of future taxable income. For unabsorbed depreciation and carried forward losses, AS 22 requires virtual certainty backed by convincing evidence.

Understand Recognition of Deferred Tax Assets and Liabilities

Accounting profit and taxable profit are often different. Some differences are timing differences: an item is counted in one period for accounting and in another period for tax. They reverse later. Deferred tax is the tax effect of these timing differences. AS 22 asks you to record this effect so that tax expense matches the accounting profit of the year.

When tax depreciation is higher than book depreciation, the tax paid now is lower, but it will be higher later when the difference reverses. This creates a deferred tax liability (DTL). The standard's own example: a fixed asset has a book value of Rs. 100 and a tax value of Rs. 60. The tax rate is 40%. The DTL is (100 - 60) × 40% = Rs. 16. In the reverse case, where expenses are charged in books now but allowed for tax later, you get a deferred tax asset (DTA).

A DTA is a future saving of tax, so it is only good if there will be taxable profit to absorb it. That is why prudence applies. Under paragraph 15, a DTA is recognised and carried forward only to the extent there is reasonable certainty that sufficient future taxable income will be available. Paragraph 16 says this certainty is normally judged from the enterprise's past record and realistic profit estimates.

Unabsorbed depreciation and carry forward of losses are also timing differences and give rise to DTAs (paragraph 8). But they are treated more strictly. Under paragraph 17, the DTA is recognised only to the extent there is virtual certainty supported by convincing evidence of sufficient future taxable income. Paragraph 18 adds that such losses are strong evidence that future taxable income may not be available. Virtual certainty cannot rest merely on forecasts like business plans. The evidence must exist at the reporting date in concrete form, for example a profitable binding export order whose cancellation would cost the defaulting party heavy damages.

Note the asymmetry. A DTL is recognised in full on timing differences. A DTA faces a certainty test: reasonable certainty in general, virtual certainty for losses and unabsorbed depreciation. Where recognised on such losses, paragraph 32 requires you to disclose the nature of the evidence supporting recognition.

Key rules to remember

Deferred tax on a timing difference: Deferred tax = Timing difference × Enacted (or substantively enacted) tax rate; Standard's example: (Rs. 100 - Rs. 60) × 40% = Rs. 16 DTL. Use the tax rate of the year as given in the question.
General DTA test (para 15): Recognise DTA only if reasonable certainty of sufficient future taxable income; Judged from past record and realistic estimates of future profits (para 16).
Losses and unabsorbed depreciation test (para 17): Recognise DTA only if virtual certainty + convincing evidence of sufficient future taxable income; Forecasts and business plans alone are not enough. Disclose the nature of evidence (para 32).
Direction of the difference: Tax depreciation > Book depreciation → DTL; Expense in books now, allowed for tax later → DTA; Both reverse in later years.
Offset of current tax (para 27): Offset only if legally enforceable right AND intention to settle net; Both conditions must be met.

How to solve Recognition of Deferred Tax Assets and Liabilities questions

Use this method for any question on recognising deferred tax assets or liabilities.

1List each difference between accounting profit and taxable profit.
2Separate timing differences from permanent differences. Only timing differences create deferred tax.
3For each timing difference, decide whether it will increase future tax (DTL) or reduce future tax (DTA).
4Multiply each timing difference by the tax rate given in the question to get the deferred tax amount.
5For each DTA, apply the certainty test. Use reasonable certainty for ordinary timing differences. Use virtual certainty with convincing evidence for unabsorbed depreciation and carried forward losses.
6Recognise the DTL in full and the DTA only to the extent the test is met. Do not recognise DTA where evidence is only a forecast.
7Pass the journal entry or show the effect in the Statement of Profit and Loss, and note the disclosure of evidence where required.

Quickest way: Two-question shortcut

When to use it: Use in MCQs and short theory questions where you must decide quickly whether to recognise deferred tax.

Ask: will the difference reverse? If no, it is permanent and there is no deferred tax.
Ask: does reversal increase or reduce future tax? Increase means DTL, recognise it. Reduce means DTA, go to the test.
For a DTA from losses or unabsorbed depreciation, look for concrete evidence at the reporting date, such as a binding sale or export order. If only projections exist, do not recognise it.

Common mistakes in Recognition of Deferred Tax Assets and Liabilities

Recognising a DTA on carried forward losses because the company expects future profits.
Students apply the general reasonable certainty test to every DTA.
Fix: For losses and unabsorbed depreciation, paragraph 17 needs virtual certainty supported by convincing evidence. Forecasts and business plans are not enough.
Computing deferred tax on the whole book value or on the whole expense.
Students forget deferred tax is on the difference only.
Fix: Take the difference between accounting and tax figures, then multiply by the tax rate.
Treating permanent differences as timing differences.
Any difference between book and tax profit looks alike.
Fix: Ask whether the difference reverses in later periods. If not, it creates no deferred tax.
Mixing up DTA and DTL direction.
Students memorise labels without thinking of tax paid now versus later.
Fix: Higher tax depreciation than book depreciation means less tax now and more later, so it is a DTL.
Skipping the disclosure of evidence.
Students stop once the amount is computed.
Fix: If a DTA is recognised on unabsorbed depreciation or carried forward losses, state the nature of the supporting evidence (paragraph 32).
Setting off current tax assets and liabilities automatically.
Students assume offset is allowed whenever both exist.
Fix: Offset only when there is a legally enforceable right and an intention to settle on a net basis.

Worked examples

Example 1

On the date of first applying AS 22, a fixed asset has an opening book value of Rs. 1,00,000 and a tax value of Rs. 60,000. Book depreciation uses straight line method and tax depreciation uses written down value method. The tax rate is 40% and there are no other timing differences. Compute the deferred tax to be recognised.

Show the solution

The difference arises because tax depreciation has been higher than book depreciation. It will reverse later.
So it is a timing difference that increases future tax. This is a DTL.
Timing difference = Rs. 1,00,000 - Rs. 60,000 = Rs. 40,000.
DTL = Rs. 40,000 × 40% = Rs. 16,000.

Answer: A deferred tax liability of Rs. 16,000 is recognised.

Example 2

X Ltd has a business loss of Rs. 5,00,000 for the year, which can be carried forward under tax laws. The tax rate is 30%. The company has a history of recent losses. Its management has only a business plan showing profits in the coming years. At the year end, the company has also signed a binding export order which will give taxable profit of Rs. 2,00,000, and cancellation would require heavy damages to be paid by the customer. Compute the DTA that can be recognised and state the disclosure.

Show the solution

The carried forward loss is a timing difference. Total possible DTA = Rs. 5,00,000 × 30% = Rs. 1,50,000.
Because the company has recent losses, paragraphs 17 and 18 apply. A DTA needs virtual certainty supported by convincing evidence.
The business plan is only a forecast and is not convincing evidence.
The binding export order is concrete evidence available at the reporting date. It supports taxable income of Rs. 2,00,000.
DTA recognised = Rs. 2,00,000 × 30% = Rs. 60,000.
The balance of Rs. 90,000 is not recognised.
Disclose the nature of the evidence, namely the binding export order (paragraph 32).

Answer: DTA of Rs. 60,000 is recognised. The balance of Rs. 90,000 is not recognised. The nature of the supporting evidence must be disclosed.

Exam tips

In theory questions, quote the two tests by name: reasonable certainty for ordinary DTAs and virtual certainty with convincing evidence for losses and unabsorbed depreciation.
In numericals, show the timing difference, the tax rate and the deferred tax in separate lines so you earn step marks.
Give an example of convincing evidence, such as a binding sale or export order, to score full marks on a virtual certainty question.
For MCQs, watch for options that rely on forecasts or business plans. These do not satisfy virtual certainty.
Always mention the disclosure of evidence when a DTA on losses is recognised.

Practice questions from Accounting for Taxes on Income (AS 22)

Recognition of Deferred Tax Assets and Liabilities in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Recognition of Deferred Tax Assets and Liabilities: frequently asked questions

What is virtual certainty in AS 22?

It is the extent of certainty that, for all practical purposes, can be considered certain. It must be supported by convincing evidence available at the reporting date in concrete form. It cannot rest merely on forecasts such as business plans.

Is a deferred tax asset always recognised?

No. It is recognised only to the extent of reasonable certainty of sufficient future taxable income. For unabsorbed depreciation and carried forward losses, the test is stricter and needs virtual certainty with convincing evidence.

How do you calculate deferred tax liability?

Find the timing difference between the accounting and tax figures, and multiply it by the tax rate. In the standard's example, (Rs. 100 - Rs. 60) × 40% gives a DTL of Rs. 16.

Are unabsorbed depreciation and carried forward losses timing differences?

Yes. Paragraph 8 treats them as timing differences that give rise to deferred tax assets, subject to prudence.