TAX ACCOUNTING

METHOD OF ACCOUNTING

Section 32(1) of the Income Tax Ordinance, 2001, deals with the accounting method. According to this section, income chargeable to tax shall be computed in accordance with the method of accounting regularly employed by such person.

DIFFERENT TYPES OF ACCOUNTING METHODS [Section 32(2)]

There are only two methods of accounting, “cash basis” and “accrual basis”, which are generally in use. Accrual basis system of accounting is used by the company to maintain its accounts and compute income under the head “income from business” while other person may account for such income on a cash or accrual basis. The taxability of profits in relation to a method of accounting is discussed below:

Cash Basis Accounting

Cash basis of accounting means such method of accounting under which a person’s income is chargeable to tax under the head “income from business” if it fulfils the following conditions:

(a) Income is actually received.

(b) Expenditure is actually incurred.

(c) Record is actually kept.

(d) Entries are actually made.

Accrual Basis Accounting

Accrual basis of accounting means such method of accounting under which a person’s income is chargeable to tax under the head “income from

business” if it fulfils the following conditions:

(a) Income is due to the person.

(6) Expenditure incurred is payable by the person.

(c) Net profit or loss is calculated after taking into account all the income and expenditure relating to period irrespective of the fact
whether income is not actually received or expenditure is not actually paid during the year.

Notes

1. An amount shall be due to a person when the person becomes entitled to receive it even if the time for discharge of the entitlement is postponed or the amount is payable by installment. Section 34(2)

2. An amount shall be payable by a person when all the events that determine liability have occurred and the amount of the liability can be determined with reasonable accuracy, but not before economic performance occurs. Section 34(3)

3. Economic performance shall occur:

(a) In the case of the acquisition of services of assets, at the time the services or assets are provided;

(b) In the case of the use of assets, at the time the Dfa Ho assets are used; and

(c) in any other case, at the time payment is made in full satisfaction of the liability.