Often profits per the financial statements and profits on which tax is payable are quite different from each other. There are two reasons for this:
- The depreciation figure in the profit and loss account may be different by a wide margin from the tax authorities’ figure for ‘capital allowances’ (the way tax authorities’ calculate allowances for depreciation).
Capital allowances are calculated by rules which usually vary at some point from methods used by companies to calculate depreciation provisions.
2. Another reason is, some items of expense charged in the profit and loss account are not allowed by tax authorities as expenses.
These situations give rise to timing differences. Timing differences are the intervals between when revenues and expenses are reported in financial statements and when they are reported for income tax purposes.
In the first situation mentioned above the differences between capital allowances for the accounting period and the depreciation figure in the profit and loss account eventually become equal after some years.
An example: An asset that costs $5,000 has a useful life of three years and an estimated value of $2,560., the uses straight line. Tax authorities’ capital allowances are 20 per cent reducing balance.
Calculations and other details are given in the accompanying free-to-download spreadsheet.