Accounting profit and tax profit are two different concepts and both are determined using different basis. This is the major reason which creates differences between tax and accounting profits. Mostly companies / businesses have different accounting profit and tax profit just due to use of different depreciation rates for tax and financial reporting.
Third Schedule Income tax Ordinance, 2001 describes the tax depreciation rates for different types of assets.
For accounting purpose we have to assess the useful lives of the assets and their appreciable amounts (cost less residual value, if any). Depreciation rate would be the rate which will charge of the appreciable amount to profit and loss account spanning over the useful life so determined.
Use of different rate of depreciation for tax and accounting purposes rises the issue of differed taxation,this issue is addressed well in tax accounting . Tax and Accounting Depreciation has direct impact on the income of any organization.
Use of tax depreciation rate ,while making financial statements, is highly recommended to avoid the lengthy process of keeping record and separate schedules of fixed asset under accounting and tax rate of depreciation.
Tax depreciation is provided on fixed assets after providing for initial allowance. Initial allowance is provided only for the first year of operation on certain fixed assets that have been prescribed in Section 23 of the Income Tax Ordinance, 2001 as eligible depreciable assets. First year of operation means the first year in which asset has been used for business or the tax year in which commercial production has been started.
After providing initial allowance depreciation will also be charged under section 22 of the ITO 2001. Depreciation rates and initial allowance rates are given in Part I and Part II of Third Schedule to the ITO 2001 respectively.