Reserve/Provision for Taxation/Dividends

In problem solving, there are certain assumptions we make with regard to the reserve/provision for taxation/dividend accounts.

Opening Balance becomes a determined liability

The opening credit balance in the Reserve for Taxation/Dividend is an amount that has been created by charging/appropriating the previous period profits.

It represents

An existing liability, when the account is assumed to be a current liability
A provision for a future liability (one which has not been determined), when the account is assumed to be a non-current liability.
In this case, the liability would become an existing liability as and when the tax/dividend due is determined.
In the absence of information to the contrary, we make the following assumptions,
- By the end of the current period the liability has been determined and is equal to opening balance in these accounts.

Determined liability is cleared by paying out

In the absence of information to the contrary, we make the following assumptions,

The liability which has been pre determined or has been determined in the current period is paid out in the current period.

Closing balance represents/relates to reserve created during the current period

In the absence of information to the contrary, we make the following assumptions,

The total closing balance in the reserve for Taxation/Dividend accounts is on account of the provision created during the current period.

Example

Balance Sheet of M/s ___ as on ___
Liabilities	31^st March		Assets	31^st March
Liabilities	2009	2010	Assets	2009	2010
Reserve for Taxation	1,24,000	1,32,000	...	...	...

Where only the information relating to the opening and closing balances is known, we assume that the opening balance becomes a determined liability by the end of the accounting period and is therefore paid out by the end of the accounting period.

Dr	Reserve for Taxation a/c				Cr
Date	Particulars	Amount	Date	Particulars	Amount
../../09 31/03/10	To ... To Balance c/d	1,24,000 1,32,000	01/04/09 31/03/10	By Balance b/d By P/L Appropriation a/c (?)	1,24,000 1,32,000
		2,56,000			2,56,000
			01/04/10	By Balance b/d	1,32,000

Assumptions

The opening balance of 1,24,000 is paid out during the current period.
The balancing represents the provision made by charging profits during the current period or by appropriating profits at the end of the accounting period.

The basis for such assumptions

This assumption is based on a rational approach.

Reserve for Taxation

The opening balance of Provision for Taxation account represents the amount set aside by charging/appropriating the previous period profits. When charged to profits, it represents a determined liability and when appropriated from profits it represents profits set aside to cover taxes that would be determined in the subsequent accounting period.

Where it represents a provision for future liability, it would be rational to assume that the tax liability that has been provided for towards the end of the previous period would be determined by the end of the current period i.e. within a years time. Once the tax liability becomes a determined liability, it being a statutory obligation, becomes payable within a short time. For this reason, we assume the liability to have been paid out by the end of the year.

However, where there is a specific information/indication regarding the amount paid as tax during the current period, only that should be considered. Where the actual tax liability assessed is more/less than the amount provided for during the previous period, the amount paid may be more/less than the opening balance in the reserve/provision account.

Where the opening balance, the closing balance and the amount provided for during (at the end of) the current period are known, we find out the amount paid out as the balancing figure.

Provision for Dividends

The opening balance in the Provision for Dividends account represents the amount set aside by charging/appropriating the previous period profits. When charged to profits, it represents a determined liability and when appropriated from profits it represents profits set aside to cover liability on account of dividends payable which would be determined in the subsequent accounting period.

Where it represents a provision for future liability, it would be rational to assume that the tax liability that has been provided for towards the end of the previous period would be determined by the end of the current period i.e. within a years time. Once the dividend has been declared, the provision becomes an existing liability on account of the statutory obligation to payout dividends within a period of 30 days of their declaration. For this reason, we assume the liability to have been paid out by the end of the year.

However, where there is a specific information/indication regarding the amount paid as dividend during the current period, only that should be considered. Where the actual dividend liability determined is more/less than the amount provided for during the previous period, the amount paid may be more/less than the opening balance in the reserve/provision account.