1. What Are Deferred Taxes?
Deferred taxes arise due to temporary differences between the accounting treatment of certain items
under Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards
(IFRS), and the tax treatment of those same items under tax laws. These differences can result in
either a deferred tax asset or a deferred tax liability.
2. Types of Deferred Taxes:
• Deferred Tax Liability (DTL):
o Occurs when taxable income is lower than accounting income in the current period.
o Taxes are deferred and will be paid in the future, typically due to temporary
differences such as:
▪ Depreciation differences between tax and accounting methods.
▪ Revenue recognition differences.
o Example: If a company recognizes more depreciation for tax purposes than for
accounting purposes, it will pay less tax now but owe more in the future.
• Deferred Tax Asset (DTA):
o Occurs when taxable income is higher than accounting income in the current period.
o Taxes are prepaid and the company will receive tax benefits in the future.
o Example: If a company recognizes an expense earlier for accounting purposes than for
tax purposes, it will pay more tax now but will pay less in the future as the expense is
accounted for later under tax laws.
3. Causes of Deferred Taxes:
• Depreciation Methods: Different rules for calculating depreciation in accounting vs. taxes (e.g.,
straight-line vs. accelerated depreciation).
• Revenue Recognition: Timing differences between when revenue is recognized for accounting
purposes vs. tax purposes (e.g., installment sales).
• Accruals and Provisions: Certain expenses recognized in the financial statements before they
are deductible for tax purposes.
• Losses: Net operating losses (NOLs) can create a deferred tax asset if they are expected to
offset future taxable income.
4. Recognition of Deferred Taxes:
• Deferred tax assets and liabilities are recognized based on the temporary differences between
the carrying amounts of assets and liabilities for financial reporting purposes and their tax
bases.
• These deferred tax items are measured using the tax rates that are expected to apply when
the temporary differences reverse.
5. Measurement of Deferred Taxes:
Deferred tax items are measured using the tax rates that are expected to be in effect when the
temporary differences reverse. This involves:
• Current tax rates for expected future periods.
• Change in tax laws that could affect the measurement (e.g., tax rate changes in the future).
6. Valuation Allowance (for DTA):
• For deferred tax assets, if it is more likely than not that some portion or all of the deferred tax
asset will not be realized (i.e., if the company believes it won’t have enough future taxable
income to use it), a valuation allowance must be recognized to reduce the DTA to its realizable
value.
7. Tax Expense/Benefit in the Income Statement:
• The income tax expense (or benefit) reported in the income statement is the sum of the
current tax expense (based on taxable income for the period) and the change in deferred taxes
(due to temporary differences).
• Formula: Income Tax Expense=Current Tax Expense+Change in Deferred Taxes\text{Income Tax
Expense} = \text{Current Tax Expense} + \text{Change in Deferred
Taxes}Income Tax Expense=Current Tax Expense+Change in Deferred Taxes
8. Deferred Taxes and Financial Statement Presentation:
• Balance Sheet: Deferred tax assets and liabilities are reported separately from current assets
and liabilities.
• Income Statement: The change in deferred tax assets and liabilities is included in the tax
expense calculation.
9. Key Considerations:
• Reversibility: Temporary differences will reverse over time, so the deferred tax asset or liability
will eventually be realized.
• Impact of Tax Rate Changes: If the tax rate changes, it can affect the carrying value of both
DTAs and DTLs.
• Deferred Taxes and IFRS vs. GAAP: The general principles of recognizing and measuring
deferred taxes are similar, but th
Attach
Search
Reason
