Future income-tax effects of temporary differences between financial-statement carrying amounts and tax bases.
Deferred tax is the financial-statement recognition of future income-tax effects caused mainly by temporary differences between an asset or liability’s carrying amount and its tax base. A taxable temporary difference generally creates a deferred tax liability; a deductible temporary difference can create a deferred tax asset, subject to the applicable recognition rules.
Deferred tax does not mean the entity has ignored a tax bill. It usually means financial reporting and tax rules recognize the same economic item in different periods.
For a simple temporary difference:
This formula is only the starting point. The preparer must first determine the correct tax base, whether the difference is taxable or deductible, which rate applies when the difference reverses, and whether an exception or recognition limitation applies.
| Term | Meaning |
|---|---|
| Carrying amount | Amount at which an asset or liability appears in the financial statements |
| Tax base of an asset | Amount that will be deductible for tax against future taxable economic benefits, based on applicable tax law |
| Tax base of a liability | Carrying amount less amounts expected to be deductible for tax when the liability is settled, subject to the specific tax rules |
| Temporary difference | Difference between the carrying amount and tax base that affects taxable or deductible amounts in future periods |
The sign cannot be interpreted mechanically without considering whether the item is an asset or a liability. It is safer to ask what tax consequence will arise when the asset is recovered or the liability is settled.
Assume equipment has:
Recovering the asset’s $400,000 carrying amount would produce only $300,000 of future tax deductions. The $100,000 taxable temporary difference therefore creates a deferred tax liability:
Suppose accounting profit before tax is $1,000,000 and the faster tax depreciation makes current taxable income $900,000. Ignoring every other difference:
| Component | Calculation | Amount |
|---|---|---|
| Current tax expense | $900,000 x 25% | $225,000 |
| Deferred tax expense | $100,000 x 25% | $25,000 |
| Total income tax expense | $225,000 + $25,000 | $250,000 |
The company pays less current tax because tax depreciation was faster, but recognizes a $25,000 deferred tax liability because less tax depreciation remains for future periods. As the temporary difference reverses, the liability generally decreases and the future current-tax effect emerges.
| Difference | Example | Deferred tax? |
|---|---|---|
| Temporary | Depreciation recognized at different rates for book and tax | Generally yes |
| Temporary | Provision recognized now but deductible only when paid | Potential deferred tax asset |
| Temporary | Revenue taxed before or after accounting recognition | Depends on direction of timing difference |
| Permanent | Expense never deductible under the relevant tax law | No |
| Permanent | Income permanently exempt from tax | No |
Permanent differences can affect the effective tax rate, but they do not reverse and therefore do not create deferred tax balances.
Presentation on the balance sheet does not permit unrestricted netting. Offsetting depends on the reporting framework, legal rights, tax authority, and how current tax balances are settled. Analysts should review gross balances, valuation allowances or recognition limitations, expiry information, and the note explaining major sources.
| Question | Current tax | Deferred tax |
|---|---|---|
| Main basis | Taxable profit or loss for the current or prior period | Temporary differences and qualifying carryforwards |
| Common balance | Income tax payable or receivable | Deferred tax asset or liability |
| Cash connection | Usually tied more directly to returns, installments, and settlements | Not a direct invoice or scheduled borrowing |
| Key review | Tax computation and payments | Tax bases, reversal, rates, and realizability |
The income statement’s tax expense can include both current and deferred components. Cash taxes paid can differ from both because of installments, refunds, settlements, and payment timing.
IAS 12 and FASB Topic 740 both use temporary-difference models, but their detailed recognition, measurement, presentation, and disclosure requirements are not identical. One important difference concerns deferred tax assets: IAS 12 recognizes them to the extent that sufficient future taxable profit is probable, while U.S. GAAP records a valuation allowance when available evidence indicates it is more likely than not that some or all of the asset will not be realized.
Other questions include:
These questions require entity- and jurisdiction-specific analysis rather than a generic formula.
Deferred tax can help explain why the reported effective tax rate differs from the statutory rate and why tax expense differs from cash paid. Analysts often review:
A deferred tax liability is not automatically equivalent to debt, and a deferred tax asset is not cash. Timing, likelihood of reversal, and operating assumptions matter.
Deferred tax accounting is highly dependent on tax law, facts, estimates, and the reporting framework. This page is educational and does not provide accounting, tax, legal, audit, or investment advice.