At the end of the accounting period, the businesses need to record a provision for income tax. The provision is recorded to fulfill the accrual concept of accounting.
Detailed understanding
Many businesses view taxation as a burdensome process. Tax calculation is a complicated process owing to the fact that many factors need to be considered in order for it to be accomplished properly. Businesses and individual taxpayers make provisions for income taxes based on the estimated amount they expect to pay this year. Provision for permanent and temporary differences is determined by adjusting the firm’s reported net income with a variety of permanent differences and temporary differences.
Once the adjusted net income is determined, the applicable tax rate is multiplied to determine the tax provision. Individuals or businesses can alter this provision to a considerable degree by engaging in tax planning to defer or eliminate tax liabilities. Therefore, depending on the taxpayer’s tax planning abilities, the size of this provision may vary quite a bit.
When it comes to taxation within an organization, Income Tax is considered one of the most important headings. Because of this, organizations need to ensure that they fully understand the functionality and how the tax must be calculated. So that compliance with all the laws and regulations is a must. Further, organizations should be fully prepared in terms of income taxes provision from an internal perspective. Accounting professionals should be prepared on this front by preparing Income Tax Provisions.
Example for income tax provision
Provision for Income Tax can be calculated using a simple technique. All you have to do is multiply the income tax rate with the income. Note that this income must be the income before tax.
Provision for Income Taxe = Income Earned before Tax * Applicable Tax Rate.
Provision for Tax =$100,000 x 35%
Provision for Tax = $35,000
Provision for Income Tax Calculation
The calculation for the provision for Income Taxe can further be explained by using an income statement approach. ABC company has Sales Revenue: $ 150,000, COGS: $75,000, Selling and Administration Expenses: $23,000, and Distribution Expenses: $12,000. The applicable tax rate is 35%.
| Particulars | Debit | Credit |
| Sales Revenue | 150,000 | |
| COGS: | 75,000 | |
| Gross Profit | 75,000 | |
| Selling and Administration Expenses | 23,000 | |
| Distribution Expenses | 12,000 | |
| Profit Before Tax | 40,000 | |
| Income Tax 35%: | 14,000 | |
| Profit After Tax | 26,000 |
Provision for Income Tax = $14,000 (40,000×35%)
Journal entry for Provision for Income Tax
| Particulars | Debit | Credit |
| Profit and Loss Account | $14,000 | |
| Provision for Income Tax | $14,000 |
The debit impact of the transaction is recording for the expense. It leads to a decrease in profit. On the other hand, the credit impact of the transaction is the creation of a credit balance (provision) in the balance sheet. This provision is to be used while recording actual tax expenses in the accounting record.
Further read, tothefinance
Over and Under Provision of Income Tax
In calculating the company’s net income, several changes are often made. And while considering all these factors, the provision for the tax is determined. Thus, there is no doubt that the income tax provision is an estimate of the tax to be paid, and the amount of tax paid may differ from the amount created in the past. For this reason, Over and Under Provision of Tax is a concept that is applied in every company.
Over Provision of Income Tax occurs when the actual tax paid is lower than what was actually anticipated or estimated. The remaining provision can be brought forward to be used in the future accounting period.
On the other hand, under the provision is when provision for the tax was not sufficient to meet the actual tax liability. Hence, the business needs to further record tax expenses.
Conclusion
At the end of the accounting period, the business needs to provide provisions for the income tax. It’s because accounting profit is subject to changes and tax calculations are not a simple and straight process. Hence, there may be over/under the provision.
An over provision is when the business has had estimated higher provision and actual to be paid is low. On the other hand, under the provision is when actual tax expense is higher than estimated and recorded in the past.
