Deferred Income Tax

Deferred income tax refers to the taxes that will have to be paid by the company at the end of the fiscal year but has not yet been paid. A deferred income tax item recognises that the company will in the future pay more tax because of a transaction that took place during the current period.

For example, let’s say a pizza comapny receives an order for 1,000 pizzas at a party that will be held next quarter. The sale price of each pizza is Rs.200 and the cost of revenue per pizza is Rs.75. The person who ordered the pizza pays an advance of Rs.50,000 for 250 pizzas. This is the revenue that the company has already received without providing service. The profit on each pizza is Rs.125 (200 – 75). So the advance profit earned is Rs.31,250 (250 * 125). Suppose the tax rate is 25%, then the company owes the government Rs 7,813 (31,250 * 25%). This is the tax amount that has not yet been paid but will have to be paid once the order is fulfilled and revenue is recognised, and will be recorded as deferred income tax.