Chapter 3: Tax Accounting And Timing

Very Short Question Answer

Briefly state the accounting methods to be applied by different taxpayer.

The accounting methods to be applied by different taxpayers are summarized below:

Persons	Income Head	Accounting Method
Individual Sole trader/proprietor Partnership firm Company	Employment, Investment Business Business, Investment Business, Investment	Cash basis Cash or accrual basis Cash or accrual basis Accrual basis

How do you treat an amount as derived and an expense as incurred under cash basis accounting?

A person who keeps tax account on a cash basis in calculating the person’s income from employment, business or investment should:

• treat an amount as derived and include in income only when the payment is received or made available to the person.
• treat an expense as incurred and deduct in that calculation only when the payment is made.

Briefly describe accrual basis of accounting.

A person who keeps tax account on an accrual basis should treat an amount as derived and include in income when the person becomes entitled to receive the payment. The expense is treated as incurred:

• when the person is obliged to make the payment,
• the value of obligation can be determined with reasonable accuracy and
• the other payment has been received.

Briefly describe the cases, where a person can write off bad debts? Explain.

A person is allowed to write-off bad debt only in the following case:

If  the outstanding loan of a bank or financial institution has become a bad-debt in accordance with the standards prescribed by Nepal Rastra Bank. in other case, if the person after taking all reasonable steps believes that the amount could not be recovered.

Define the terms ‘Long Term Contract’ and ‘exclude contract’.

A long term contract is a contract the term of which exceeds 12 months and that is either a contract for manufacture, installation or construction or in relation to each, the performance of related services, or a contract with a deferred return that is not an excluded contract.

Short Question Answer

Briefly describe the provisions related to tax accounting in Income Tax Act, 2058.

Subject to ITA, 2058 an individual or an entity should keep records of incomes and expenses according to Generally Accepted Accounting Principles (GAAP). The Act states that the tax accounting should be based on prevailing accounting standards of the country. In the absence of such standard, any prevailing international principles specified by the Inland Revenue Department should be used.

Unless the Department prescribes otherwise by notice in writing, an individual should account, for tax purposes, on a cash basis in calculating the individual’s income from an employment or an investment and a company on an accrual basis.

If a person applies in writing for a change in the basis of accounting, the Department may approve the change if it is satisfied that the change is necessary to clearly reflect the income.

What is tax accounting method? How amounts are treated under cash basis of accounting?

The tax accounting method specifies the method of recognizing income and expenses for income tax purpose. There are two tax accounting methods:

1. Cash basis of accounting
2. Accruals basis of accounting

Under cash basis of accounting, an amount is treated as derived and included only when the payment is received. Likewise, an amount is treated as incurred and deducted from income only when the payment is made. Under cash basis of accounting, the date on which transactions are made is irrelevant. What is relevant is the date on which payment is received. An individual follows cash book of accounting while accounting income from employment and investment. Similarly, the sole trader or proprietor has a choice. He can apply either cash or accrual basis of accounting.

How long-term contract has been defined in the Act? What is the provision for recognition of income and expenses for such contract in the Act?

A contract has been classified into two broad categories:

1. Long-term contract
2. Excluded contract

A long-term contract means a contract of the following conditions:

• The term of which exceeds 12 months and that is either a contract for manufacture, installation or construction or the contract with a deferred return.
• For the purpose of calculating a person’s income for an income year, the estimated cumulative inclusions and deductions are treated as derived or incurred according to the percentage of the contract completed during the year.