Chapter 7: Standards Impacting Financial Statements - Test 3: answer key

Question 1 · 2 marks · Chapter 7: Standards Impacting Financial Statements · hard

Scenario. Suvarna Alloys Ltd is a domestic manufacturer of alloy steel with the financial year ending 31 March 2026. The statement of profit and loss for 2025-26 discloses a profit before tax of Rs 90,00,000. While computing the tax expense under AS 22, the following information is placed before the tax manager: (i) Depreciation charged in the statement of profit and loss is Rs 24,00,000, whereas depreciation allowable under the Income-tax Act, 1961 is Rs 36,00,000. The company follows the written down value method for tax purposes and the straight-line method for accounting. (ii) A donation of Rs 2,00,000 to a charitable trust has been debited to the statement of profit and loss; the company has not claimed and does not intend to claim any deduction for it under Section 80G. (iii) A penalty of Rs 1,00,000 imposed for delayed filing of GST returns has been debited to the statement of profit and loss; no deduction is available for the penalty. (iv) A provision for warranty of Rs 15,00,000 was created during the year, of which claims aggregating Rs 6,00,000 were actually settled and allowed as a deduction during the year; the balance is allowable only on payment. (v) Interest of Rs 2,00,000 on a term loan sanctioned by a bank has been debited on the accrual basis, but the payment was not made before the due date specified in Section 43B of the Income-tax Act, 1961. The company has no brought forward business loss or unabsorbed depreciation, has not opted for any tax holiday and the provisions of Section 115JB do not apply to it. The applicable tax rate is 30% (ignore surcharge and cess). There is adequate evidence of future profit sufficiency and there are no other differences between accounting income and taxable income.

What is the taxable income of Suvarna Alloys Ltd for the year ended 31 March 2026?

1. Rs 92,00,000 (correct answer)
2. Rs 83,00,000
3. Rs 1,16,00,000
4. Rs 90,00,000

Answer: A — Rs 92,00,000

Explanation. Taxable income = Rs 90,00,000 - Rs 12,00,000 (excess tax depreciation) + Rs 2,00,000 (donation disallowed) + Rs 1,00,000 (penalty disallowed) + Rs 9,00,000 (unpaid warranty provision, Rs 15,00,000 - Rs 6,00,000 settled) + Rs 2,00,000 (interest disallowed under Section 43B on accrual basis) = Rs 92,00,000. The donation and penalty are permanent differences; the other three are timing differences that will reverse in later years.

Where it goes wrong. Option (b) omits the unpaid warranty provision; option (c) adds back the excess tax depreciation instead of deducting it.

Authority. AS 22 para 6 (timing and permanent differences); AS 22 para 4 (taxable income)

Question 2 · 2 marks · Chapter 7: Standards Impacting Financial Statements · medium

What is the current tax liability of Suvarna Alloys Ltd for the year ended 31 March 2026?

1. Rs 24,90,000
2. Rs 27,60,000 (correct answer)
3. Rs 34,80,000
4. Rs 27,00,000

Answer: B — Rs 27,60,000

Explanation. Current tax is the amount of income tax determined to be payable in respect of the taxable income for the period, measured using the applicable tax rates and tax laws. Taxable income is Rs 92,00,000, so current tax = 30% x Rs 92,00,000 = Rs 27,60,000. This is the amount payable to the taxation authorities and is recognised irrespective of the deferred tax arising on timing differences.

Where it goes wrong. Option (d) applies 30% to the accounting profit; option (a) applies it to an incorrectly computed taxable income of Rs 83,00,000.

Authority. AS 22 para 21 (measurement of current tax); AS 22 para 4 (current tax definition)

Question 3 · 2 marks · Chapter 7: Standards Impacting Financial Statements · hard

What is the net deferred tax position of Suvarna Alloys Ltd to be recognised as at 31 March 2026?

1. Deferred tax asset of Rs 30,000
2. Deferred tax liability of Rs 3,60,000
3. Deferred tax liability of Rs 30,000 (correct answer)
4. Deferred tax liability of Rs 6,90,000

Answer: C — Deferred tax liability of Rs 30,000

Explanation. Taxable timing difference on depreciation = Rs 12,00,000, giving a deferred tax liability of Rs 3,60,000. Deductible timing differences are the warranty provision of Rs 9,00,000 and the Section 43B interest of Rs 2,00,000, aggregating Rs 11,00,000, giving a deferred tax asset of Rs 3,30,000. Since the assets and liabilities relate to income tax levied by the same governing law and the company has a legally enforceable right of set-off, they are offset: net deferred tax liability = Rs 3,60,000 - Rs 3,30,000 = Rs 30,000. The donation and penalty create no deferred tax, being permanent differences.

Where it goes wrong. Option (b) ignores the deductible timing differences; option (d) wrongly creates deferred tax on the donation and penalty, which are permanent differences.

Authority. AS 22 para 13 (deferred tax assets and liabilities); AS 22 para 23 (offsetting); AS 22 para 21

Question 4 · 2 marks · Chapter 7: Standards Impacting Financial Statements · hard

What is the total tax expense to be included in the statement of profit and loss of Suvarna Alloys Ltd for the year ended 31 March 2026?

1. Rs 27,60,000
2. Rs 24,30,000
3. Rs 31,50,000
4. Rs 27,90,000 (correct answer)

Answer: D — Rs 27,90,000

Explanation. Tax expense = current tax + deferred tax charged (less deferred tax credited) to the statement of profit and loss. Current tax is Rs 27,60,000 and the net deferred tax liability created during the year is Rs 30,000 (the full opening balance, no deferred tax existing at the beginning of the year). Tax expense = Rs 27,60,000 + Rs 30,000 = Rs 27,90,000, which is debited to the statement of profit and loss.

Where it goes wrong. Option (a) takes only current tax; option (b) nets off a deferred tax benefit that exceeds the liability, incorrectly implying a net deferred tax credit.

Authority. AS 22 para 4 (tax expense definition); AS 22 para 19 (tax expense included in determination of net profit or loss)

Question 5 · 2 marks · Chapter 7: Standards Impacting Financial Statements · hard

Scenario. Vermillion Ceramics Ltd is engaged in the manufacture of vitrified tiles and has a financial year ending 31 March 2026. Owing to an extended shutdown for modernisation, the company reported a loss before tax of Rs 1,20,00,000 for 2025-26. The following further particulars are available: (i) A provision for doubtful debts of Rs 15,00,000 has been created and debited to the statement of profit and loss; under the Income-tax Act, 1961, the amount is allowable only when the debt is actually written off, which has not happened. (ii) A provision for gratuity of Rs 20,00,000 has been created and debited to the statement of profit and loss; no payment was made to the gratuity fund during the year and the amount is allowable under Section 43B only on actual payment. (iii) Depreciation charged in the statement of profit and loss is Rs 18,00,000, whereas depreciation allowable under the Income-tax Act, 1961 is Rs 30,00,000. (iv) As at 31 March 2026, the company has brought forward unabsorbed depreciation of Rs 60,00,000 and brought forward business losses of Rs 90,00,000 relating to earlier assessment years; no part could be set off in 2025-26 owing to the absence of business income. (v) The directors have placed on record a legally binding export order from a European buyer which, at the assured margin, will generate taxable income of approximately Rs 4,00,00,000 over the next two years; cancellation of the order will attract liquidated damages of Rs 1,00,00,000 payable by the buyer. There are no other differences between accounting income and taxable income. The applicable tax rate is 25% (ignore surcharge and cess). The company is not subject to Section 115JB.

What is the amount of the tax loss of Vermillion Ceramics Ltd for the year ended 31 March 2026?

1. Rs 1,43,00,000 (correct answer)
2. Rs 1,55,00,000
3. Rs 1,31,00,000
4. Rs 1,20,00,000

Answer: A — Rs 1,43,00,000

Explanation. Taxable loss = accounting loss of Rs 1,20,00,000 + Rs 15,00,000 (doubtful debts provision disallowed) + Rs 20,00,000 (gratuity provision disallowed) - Rs 12,00,000 (excess tax depreciation) = Rs 1,43,00,000. The brought forward unabsorbed depreciation and business losses of Rs 1,50,00,000 cannot be set off in the current year as there is no business income, and they do not alter the current year's tax loss.

Where it goes wrong. Option (b) deducts the brought forward losses from the current year's tax loss; option (c) omits the excess tax depreciation.

Authority. AS 22 para 4 (taxable income/tax loss); AS 22 para 6

Question 6 · 2 marks · Chapter 7: Standards Impacting Financial Statements · hard

Based on the export order and the other evidence available, what is the net deferred tax position of Vermillion Ceramics Ltd to be recognised as at 31 March 2026?

1. Deferred tax asset of Rs 8,75,000
2. Deferred tax asset of Rs 5,75,000 (correct answer)
3. Deferred tax liability of Rs 3,00,000
4. Deferred tax asset of Rs 35,00,000

Answer: B — Deferred tax asset of Rs 5,75,000

Explanation. Deductible timing differences of Rs 35,00,000 (Rs 15,00,000 doubtful debts + Rs 20,00,000 gratuity) give a deferred tax asset of Rs 8,75,000 at 25%. The taxable timing difference on depreciation of Rs 12,00,000 gives a deferred tax liability of Rs 3,00,000. Offsetting the two yields a net deferred tax asset of Rs 5,75,000. Although the company has unabsorbed depreciation and carried forward losses, the binding export order supported by liquidated damages constitutes convincing evidence of virtual certainty of future taxable income.

Where it goes wrong. Option (a) shows the gross deferred tax asset without offsetting the deferred tax liability arising on depreciation.

Authority. AS 22 para 13; AS 22 para 15 (prudence); AS 22 para 17 (virtual certainty)

Question 7 · 2 marks · Chapter 7: Standards Impacting Financial Statements · medium

Given that Vermillion Ceramics Ltd has unabsorbed depreciation and carried forward business losses, what level of certainty must be demonstrated for recognition of the deferred tax asset?

1. Reasonable certainty that sufficient future taxable income will be available
2. Recognition in full, since the timing differences are objectively determinable
3. Virtual certainty supported by convincing evidence that sufficient future taxable income will be available (correct answer)
4. No recognition until the brought forward losses are actually set off under the Income-tax Act

Answer: C — Virtual certainty supported by convincing evidence that sufficient future taxable income will be available

Explanation. Deferred tax assets are normally recognised only to the extent that there is reasonable certainty of realisation. However, where an enterprise has unabsorbed depreciation or carry forward of losses under the tax laws, deferred tax assets are recognised only to the extent that there is virtual certainty supported by convincing evidence that sufficient future taxable income will be available. Virtual certainty must be supported by concrete evidence available at the reporting date, such as the binding export order with heavy liquidated damages.

Where it goes wrong. Option (a) states the general test of reasonable certainty, which is displaced by the stricter virtual certainty test in loss cases.

Authority. AS 22 para 15; AS 22 para 17; AS 22 para 18 (convincing evidence)

Question 8 · 2 marks · Chapter 7: Standards Impacting Financial Statements · hard

What amount should appear as the tax expense (or income) in the statement of profit and loss of Vermillion Ceramics Ltd for the year ended 31 March 2026?

1. Tax expense of Rs 5,75,000
2. Tax expense of Rs 3,00,000
3. Nil, since no tax is payable for the year
4. Tax income (credit) of Rs 5,75,000 (correct answer)

Answer: D — Tax income (credit) of Rs 5,75,000

Explanation. Current tax for the year is nil because the company has a tax loss and no taxable income. The recognition of a net deferred tax asset of Rs 5,75,000 is a deferred tax credit to the statement of profit and loss. Tax expense = current tax (nil) + deferred tax (credit Rs 5,75,000), resulting in a tax income (credit) of Rs 5,75,000 for 2025-26, which reduces the reported loss.

Where it goes wrong. Option (c) assumes that a tax loss necessarily means no tax expense or income; the deferred tax consequence must still be recognised.

Authority. AS 22 para 4 (tax expense/tax saving); AS 22 para 19

Question 9 · 2 marks · Chapter 7: Standards Impacting Financial Statements · medium

Scenario. Which of the following items gives rise to a permanent difference while computing taxable income under AS 22?

Which of the following items gives rise to a permanent difference while computing taxable income under AS 22?

1. Provision for warranty debited to the statement of profit and loss but allowable only on payment
2. Excess of depreciation allowable under the Income-tax Act, 1961 over depreciation charged in the books
3. Penalty imposed under the GST law for delayed filing of returns and debited to the statement of profit and loss (correct answer)
4. Interest accrued on a term loan but unpaid before the due date specified in Section 43B

Answer: C — Penalty imposed under the GST law for delayed filing of returns and debited to the statement of profit and loss

Explanation. A penalty for infringement of law is a disallowance that will never reverse; it originates in one period and has no corresponding allowance in any later period. It is therefore a permanent difference and creates neither a deferred tax asset nor a deferred tax liability. Warranty provisions, excess tax depreciation and Section 43B interest are timing differences, which originate in one period and reverse in one or more subsequent periods.

Where it goes wrong. Option (d) is a timing difference, not a permanent one, because the interest becomes allowable once it is actually paid within the time allowed by Section 43B.

Authority. AS 22 para 6; AS 22 para 13 (permanent differences do not result in deferred tax)

Question 10 · 2 marks · Chapter 7: Standards Impacting Financial Statements · hard

Scenario. Amrit Ltd reports depreciation as per accounting records of Rs 6,00,000 and depreciation as per income-tax records of Rs 14,00,000 for the year ended 31 March 2026. Unamortised preliminary expenses as per the tax records amount to Rs 60,000. There is adequate evidence of future profit sufficiency and the tax rate is 30%. What is the net deferred tax asset or liability to be recognised?

Amrit Ltd reports depreciation as per accounting records of Rs 6,00,000 and depreciation as per income-tax records of Rs 14,00,000 for the year ended 31 March 2026. Unamortised preliminary expenses as per the tax records amount to Rs 60,000. There is adequate evidence of future profit sufficiency and the tax rate is 30%. What is the net deferred tax asset or liability to be recognised?

1. Deferred tax liability of Rs 2,22,000 (correct answer)
2. Deferred tax liability of Rs 2,40,000
3. Deferred tax asset of Rs 18,000
4. Deferred tax liability of Rs 4,20,000

Answer: A — Deferred tax liability of Rs 2,22,000

Explanation. Excess depreciation allowed for tax purposes of Rs 8,00,000 (Rs 14,00,000 - Rs 6,00,000) is a taxable timing difference and creates a deferred tax liability of Rs 2,40,000 at 30%. Unamortised preliminary expenses allowed in earlier years for tax purposes but still unamortised in the books constitute a deductible timing difference of Rs 60,000, creating a deferred tax asset of Rs 18,000. Net position = deferred tax liability of Rs 2,22,000, being the two offset since they relate to the same governing tax law.

Where it goes wrong. Option (b) ignores the deferred tax asset on preliminary expenses; option (d) adds the two instead of setting them off.

Authority. AS 22 para 13; AS 22 para 23 (offsetting); AS 22 para 21

Question 11 · 2 marks · Chapter 7: Standards Impacting Financial Statements · hard

Scenario. Navkar Ltd has a book profit of Rs 60,00,000 under Section 115JB of the Income-tax Act, 1961, attracting tax at 15%, and a taxable income of Rs 20,00,000 under the normal provisions, attracting tax at 30%. The timing difference on depreciation for 2025-26 is Rs 15,00,000 and is expected to reverse in a year in which the company will pay tax under the normal provisions. What is the tax expense for the year ended 31 March 2026?

Navkar Ltd has a book profit of Rs 60,00,000 under Section 115JB of the Income-tax Act, 1961, attracting tax at 15%, and a taxable income of Rs 20,00,000 under the normal provisions, attracting tax at 30%. The timing difference on depreciation for 2025-26 is Rs 15,00,000 and is expected to reverse in a year in which the company will pay tax under the normal provisions. What is the tax expense for the year ended 31 March 2026?

1. Rs 9,00,000
2. Rs 6,00,000
3. Rs 11,25,000
4. Rs 13,50,000 (correct answer)

Answer: D — Rs 13,50,000

Explanation. Tax under Section 115JB is a current tax for the period; here the MAT liability of Rs 9,00,000 (15% of Rs 60,00,000) exceeds the normal tax of Rs 6,00,000 (30% of Rs 20,00,000), so current tax is Rs 9,00,000. Deferred tax on timing differences must be measured at the regular tax rate and not at the MAT rate: Rs 15,00,000 x 30% = Rs 4,50,000. Tax expense = Rs 9,00,000 + Rs 4,50,000 = Rs 13,50,000.

Where it goes wrong. Option (c) measures deferred tax at the MAT rate of 15%, which the standard expressly prohibits; option (a) ignores deferred tax altogether.

Authority. AS 22, Accounting for Taxes on Income in the context of Section 115JB of the Income-tax Act, 1961

Question 12 · 2 marks · Chapter 7: Standards Impacting Financial Statements · medium

Scenario. At 31 March 2025, Dhruv Ltd carried a deferred tax asset of Rs 5,00,000. While reviewing the carrying amount at 31 March 2026, the company concluded that, on the evidence then available, only Rs 3,00,000 would be realisable against future taxable income. In 2026-27, fresh evidence established that a further Rs 1,00,000 had become realisable. How should these events be accounted for?

At 31 March 2025, Dhruv Ltd carried a deferred tax asset of Rs 5,00,000. While reviewing the carrying amount at 31 March 2026, the company concluded that, on the evidence then available, only Rs 3,00,000 would be realisable against future taxable income. In 2026-27, fresh evidence established that a further Rs 1,00,000 had become realisable. How should these events be accounted for?

1. Write down Rs 5,00,000 in 2025-26 and recognise no amount thereafter
2. Write down Rs 2,00,000 in 2025-26, and reverse Rs 1,00,000 in 2026-27 when realisability is established (correct answer)
3. Write down Rs 2,00,000 in 2025-26 and reverse the whole Rs 2,00,000 in 2026-27
4. Make no adjustment in 2025-26 as the asset was recognised in an earlier year

Answer: B — Write down Rs 2,00,000 in 2025-26, and reverse Rs 1,00,000 in 2026-27 when realisability is established

Explanation. The carrying amount of a deferred tax asset is reviewed at each balance sheet date and written down to the extent that it is no longer reasonably certain (or virtually certain, as the case may be) that sufficient future taxable income will be available against which the asset can be realised. At 31 March 2026 the asset is written down by Rs 2,00,000 (Rs 5,00,000 - Rs 3,00,000), charged to the statement of profit and loss. The write-down is later reversed to the extent the asset becomes realisable, which is the Rs 1,00,000 established in 2026-27.

Where it goes wrong. Option (c) reverses the entire write-down of Rs 2,00,000 although only Rs 1,00,000 has again become realisable.

Authority. AS 22 para 29 (review of deferred tax assets); AS 22 para 28 (re-assessment of unrecognised deferred tax assets)

Question 13 · 2 marks · Chapter 7: Standards Impacting Financial Statements · hard

Scenario. Rishabh Ltd has recognised a deferred tax liability of Rs 12,00,000 that is expected to reverse after six years. The management proposes to measure it at its present value using a discount rate of 10% (present value factor for six years being 0.564), which would reduce it to Rs 6,76,800. How should the deferred tax liability be measured under AS 22?

Rishabh Ltd has recognised a deferred tax liability of Rs 12,00,000 that is expected to reverse after six years. The management proposes to measure it at its present value using a discount rate of 10% (present value factor for six years being 0.564), which would reduce it to Rs 6,76,800. How should the deferred tax liability be measured under AS 22?

1. At Rs 12,00,000, since deferred tax assets and liabilities are not to be discounted (correct answer)
2. At Rs 6,76,800, the present value of the tax that will be paid on reversal
3. At Rs 10,80,000, after allowing a tax shield on the notional interest
4. At Rs 5,64,000, applying the present value factor to the tax effect at the enacted rate

Answer: A — At Rs 12,00,000, since deferred tax assets and liabilities are not to be discounted

Explanation. AS 22 requires deferred tax assets and liabilities to be measured at the tax rates and tax laws expected to apply, and expressly provides that they should not be discounted to their present value. Although the liability will reverse only after six years, the measurement must remain the full tax effect of the timing difference. Hence the deferred tax liability continues at Rs 12,00,000.

Where it goes wrong. Options (b) and (d) apply present value techniques, which are expressly prohibited for deferred tax measurement.

Authority. AS 22 para 22 (deferred tax assets and liabilities should not be discounted)

Question 14 · 2 marks · Chapter 7: Standards Impacting Financial Statements · hard

Scenario. A timing difference of Rs 20,00,000 originates in the year ended 31 March 2026, when the applicable tax rate was 30%. The financial statements were approved on 20 June 2026. A Finance Act reducing the corporate tax rate to 25% was enacted on 15 May 2026. How should the resulting deferred tax be measured?

A timing difference of Rs 20,00,000 originates in the year ended 31 March 2026, when the applicable tax rate was 30%. The financial statements were approved on 20 June 2026. A Finance Act reducing the corporate tax rate to 25% was enacted on 15 May 2026. How should the resulting deferred tax be measured?

1. Deferred tax asset of Rs 5,00,000
2. Deferred tax liability of Rs 5,00,000
3. Deferred tax liability of Rs 6,00,000 (correct answer)
4. Deferred tax liability of Rs 5,50,000

Answer: C — Deferred tax liability of Rs 6,00,000

Explanation. Deferred tax assets and liabilities are measured using the tax rates and tax laws that have been enacted or substantively enacted by the balance sheet date. The reduction to 25% was enacted on 15 May 2026, i.e. after 31 March 2026, so the rate enacted at the balance sheet date of 30% applies. The timing difference is taxable in nature, giving a deferred tax liability of Rs 20,00,000 x 30% = Rs 6,00,000.

Where it goes wrong. Option (b) measures at the newly enacted rate by reference to the date of approval of the financial statements rather than the balance sheet date.

Authority. AS 22 para 21 (measurement of deferred tax using tax rates enacted by the balance sheet date)

Question 15 · 2 marks · Chapter 7: Standards Impacting Financial Statements · hard

Scenario. Pallavi Ltd debited Rs 8,00,000 of GST liability for March 2026 to its statement of profit and loss on the accrual basis. The amount was paid on 25 April 2026, well before the due date for filing the return specified in Section 43B of the Income-tax Act, 1961. What deferred tax should be recognised in respect of this item for the year ended 31 March 2026?

Pallavi Ltd debited Rs 8,00,000 of GST liability for March 2026 to its statement of profit and loss on the accrual basis. The amount was paid on 25 April 2026, well before the due date for filing the return specified in Section 43B of the Income-tax Act, 1961. What deferred tax should be recognised in respect of this item for the year ended 31 March 2026?

1. Deferred tax asset of Rs 2,40,000
2. Deferred tax asset of Rs 2,00,000
3. Deferred tax liability of Rs 2,40,000
4. No deferred tax, as no timing difference arises (correct answer)

Answer: D — No deferred tax, as no timing difference arises

Explanation. Section 43B allows an accrual-basis deduction where the statutory liability is actually paid on or before the due date for filing the return under the relevant law. As the GST of Rs 8,00,000 was paid before that due date, it is allowed in the year of accrual itself, notwithstanding that the payment was made after the balance sheet date. There is therefore no difference between accounting and taxable income and no deferred tax arises.

Where it goes wrong. Options (a) and (b) assume that payment after the balance sheet date automatically creates a timing difference, ignoring the Section 43B due-date concession.

Authority. AS 22 para 6 (timing differences); Section 43B of the Income-tax Act, 1961

Question 16 · 2 marks · Chapter 7: Standards Impacting Financial Statements · hard

Scenario. Kshipra Ltd enjoys a tax holiday under Section 10B of the Income-tax Act, 1961. During 2025-26, timing differences of Rs 1,00,00,000 originate, of which differences aggregating Rs 30,00,000 are expected to reverse during the tax holiday period. The applicable tax rate is 30%. What amount of deferred tax liability should be recognised in 2025-26?

Kshipra Ltd enjoys a tax holiday under Section 10B of the Income-tax Act, 1961. During 2025-26, timing differences of Rs 1,00,00,000 originate, of which differences aggregating Rs 30,00,000 are expected to reverse during the tax holiday period. The applicable tax rate is 30%. What amount of deferred tax liability should be recognised in 2025-26?

1. Rs 30,00,000
2. Rs 21,00,000 (correct answer)
3. Rs 9,00,000
4. Rs 0

Answer: B — Rs 21,00,000

Explanation. Deferred tax in respect of timing differences which originate during the tax holiday period and reverse during that period is not recognised to the extent deduction from total income is allowed during the holiday. Deferred tax on timing differences which reverse after the holiday is recognised in the year in which they originate. Of Rs 1,00,00,000, Rs 30,00,000 reverses within the holiday and is ignored; the balance of Rs 70,00,000 gives a deferred tax liability of Rs 70,00,000 x 30% = Rs 21,00,000.

Where it goes wrong. Option (c) recognises deferred tax only on the portion reversing during the holiday, which is the precise opposite of the statutory treatment.

Authority. AS 22, Accounting for Taxes on Income in the situations of Tax Holiday under Sections 10A and 10B of the Income-tax Act, 1961

Question 17 · 2 marks · Chapter 7: Standards Impacting Financial Statements · medium

Scenario. The statement of profit and loss of Tejas Ltd for 2025-26 includes exempt agricultural income of Rs 5,00,000 and a penalty of Rs 2,00,000 that is wholly disallowed for tax purposes. Which of these gives rise to deferred tax under AS 22?

The statement of profit and loss of Tejas Ltd for 2025-26 includes exempt agricultural income of Rs 5,00,000 and a penalty of Rs 2,00,000 that is wholly disallowed for tax purposes. Which of these gives rise to deferred tax under AS 22?

1. No deferred tax arises on either item, since both are permanent differences (correct answer)
2. Only the exempt agricultural income
3. Only the penalty disallowed for tax purposes
4. Both, since both cause a difference between accounting income and taxable income

Answer: A — No deferred tax arises on either item, since both are permanent differences

Explanation. Exempt agricultural income is never taxable in any period, and a penalty disallowed under the tax law is never allowable in any later period. Both originate in one period and do not reverse subsequently; they are permanent differences and do not result in deferred tax assets or liabilities, although they alter the effective tax rate and hence the current tax. Only timing differences, which reverse in later periods, give rise to deferred tax.

Where it goes wrong. Option (d) assumes that every divergence between accounting and taxable income results in deferred tax, overlooking the permanent/timing distinction.

Authority. AS 22 para 6; AS 22 para 13 (permanent differences do not result in deferred tax)

Question 18 · 2 marks · Chapter 7: Standards Impacting Financial Statements · medium

Scenario. Under AS 22, an enterprise should offset deferred tax assets and deferred tax liabilities only where:

Under AS 22, an enterprise should offset deferred tax assets and deferred tax liabilities only where:

1. It has a legally enforceable right to set off the recognised amounts
2. The assets and liabilities relate to taxes on income levied by the same governing taxation laws
3. When the legally enforceable set-off right and same taxation laws criteria are simultaneously satisfied (correct answer)
4. The deferred tax assets and liabilities are expected to reverse in the same accounting period

Answer: C — When the legally enforceable set-off right and same taxation laws criteria are simultaneously satisfied

Explanation. AS 22 permits offsetting of deferred tax assets and liabilities only where the enterprise has a legally enforceable right to set off assets against liabilities representing current tax and the deferred tax assets and liabilities relate to taxes on income levied by the same governing taxation laws. Both conditions must be satisfied cumulatively; satisfaction of one alone does not permit net presentation.

Where it goes wrong. Options (a) and (b) each state only one limb of a two-part cumulative test, and option (d) introduces a timing condition not found in the standard.

Authority. AS 22 para 23 (offsetting of deferred tax assets and liabilities)

Question 19 · 2 marks · Chapter 7: Standards Impacting Financial Statements · medium

Scenario. At each balance sheet date, an enterprise re-assesses deferred tax assets that were not recognised in earlier years. How should a previously unrecognised deferred tax asset be dealt with when realisation becomes probable?

At each balance sheet date, an enterprise re-assesses deferred tax assets that were not recognised in earlier years. How should a previously unrecognised deferred tax asset be dealt with when realisation becomes probable?

1. It should continue to be left unrecognised, as the timing difference has already reversed
2. It should be recognised by restating the opening retained earnings as a prior period item
3. It should be recognised only when the related timing difference is actually realised in cash
4. It should be recognised in the statement of profit and loss to the extent it has become reasonably certain, or virtually certain, that sufficient future taxable income will be available (correct answer)

Answer: D — It should be recognised in the statement of profit and loss to the extent it has become reasonably certain, or virtually certain, that sufficient future taxable income will be available

Explanation. At each balance sheet date an enterprise re-assesses unrecognised deferred tax assets and recognises previously unrecognised deferred tax assets to the extent that it has become reasonably certain, or virtually certain where there is unabsorbed depreciation or carry forward of losses, that sufficient future taxable income will be available against which they can be realised. The recognition is made in the statement of profit and loss of the period in which the re-assessment is made, not as a prior period adjustment.

Where it goes wrong. Option (b) treats the recognition as a correction of a prior period error, whereas it is a change in estimate recognised in the current period.

Authority. AS 22 para 28 (re-assessment of unrecognised deferred tax assets); AS 22 para 15

Question 20 · 2 marks · Chapter 7: Standards Impacting Financial Statements · medium

Scenario. Which of the following would constitute convincing evidence of virtual certainty for recognising a deferred tax asset by an enterprise having unabsorbed depreciation and carried forward losses?

Which of the following would constitute convincing evidence of virtual certainty for recognising a deferred tax asset by an enterprise having unabsorbed depreciation and carried forward losses?

1. A projection of future profits submitted to a credit agency for obtaining loans and accepted by that agency
2. A profitable binding export order, cancellation of which will result in the defaulting party paying heavy damages (correct answer)
3. The management's business plan forecasting a turnaround, approved by the board of directors
4. An improving trend in the profits reported by comparable enterprises in the same industry

Answer: B — A profitable binding export order, cancellation of which will result in the defaulting party paying heavy damages

Explanation. Virtual certainty must be supported by convincing evidence available at the reporting date in a concrete form. A profitable binding export order whose cancellation attracts heavy damages from the defaulting party is such evidence. A projection of future profits submitted even to an outside agency such as a credit agency cannot, in isolation, be considered convincing evidence, and neither can internal business plans nor industry trends, which are a matter of perception rather than fact.

Where it goes wrong. Option (a) is expressly identified in AS 22 as insufficient, since projections alone do not constitute convincing evidence of virtual certainty.

Authority. AS 22 para 18 (virtual certainty supported by convincing evidence)