Deferred Tax

Intermediate

Deferred tax is income tax that will be payable or recoverable in future periods because of timing differences between when items are recognised in the accounts and when they are recognised for tax.

Accounting rules and tax rules do not always agree on timing. An expense might be recognised in the accounts in one year but deducted for tax in another. Deferred tax adjusts for these differences, so the tax expense in the income statement matches the profit reported.

A common example is depreciation. Suppose a company records accounting depreciation of 10,000 a year on a machine, but tax rules allow 20,000 in the first year. Its taxable profit is 10,000 lower than its accounting profit, so it pays less tax now. At a 25% tax rate, it saves 2,500 this year. But that saving will reverse in later years, when tax depreciation is lower than accounting depreciation. The company records a deferred tax liability of 2,500 for the tax it will pay later.

The opposite situation creates a deferred tax asset, for example when tax losses can be used to reduce future tax payments.

Deferred tax appears on the balance sheet as assets or liabilities, and changes in deferred tax form part of income tax expense. It is an area where IFRS and US GAAP share the same basic approach but differ in some details.

For worked examples and full lessons, visit notesbysara.org.