Deferred taxes are amounts of taxes that are accrued but not yet paid, creating temporary differences between accounting income and taxable income. These taxes are deferred to future periods, indicating amounts that will need to be settled at a later date due to timing differences in recognizing income and expenses for accounting and tax purposes.
Types of Deferred Taxes
Deferred Tax Liabilities (DTL)
Deferred Tax Liabilities arise when taxable income is less than the accounting income due to temporary differences that will reverse in the future, resulting in additional tax payments. For example:
Deferred Tax Assets (DTA)
Deferred Tax Assets occur when taxable income exceeds accounting income due to temporary differences that will reverse in future periods, leading to tax savings. An example formula for this is:
Key Concepts
Temporary Differences
Temporary differences are discrepancies between the tax base of an asset or liability and its carrying amount in the balance sheet. These differences will result in taxable or deductible amounts in future periods when the carrying amount of the asset or liability is recovered or settled.
Accrued Taxes vs. Deferred Taxes
- Accrued Taxes: Taxes that are due but not yet paid.
- Deferred Taxes: Taxes that have their payment legally postponed to future periods, creating differences between accounting income and taxable income.
Examples of Deferred Taxes
- Depreciation Methods: A company uses straight-line depreciation for accounting purposes but accelerated depreciation for tax purposes.
- Revenue Recognition: Income is recognized when earned in accounting, but taxable when received.
- Warranty Expenses: Expenses are recognized when probable for accounting, but deductible when paid for tax purposes.
Historical Context
The concept of deferred taxes was formalized with the introduction of more sophisticated accounting standards. In the United States, the Financial Accounting Standards Board (FASB) issued Statement No. 109 in 1992, which provided comprehensive guidelines on accounting for income taxes.
Applicability in Financial Reporting
Deferred taxes are essential in preparing financial statements under generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS). They ensure that tax effects of all transactions are recognized in the periods in which they occur, allowing for accurate representation of financial positions and avoiding mismatches of revenue and expenses.
Comparisons and Related Terms
Tax Basis
The tax basis of an asset or liability is its value for tax purposes, used to calculate gains, losses, and depreciation during taxation.
Accrued Liability
An accrued liability is an expense that has been incurred but not yet paid. Unlike deferred taxes, accrued liabilities are settled in the current period.
FAQs
What causes deferred tax liabilities?
How are deferred taxes recorded?
Are deferred taxes permanent?
References
- Financial Accounting Standards Board (FASB), Statement No. 109
- International Financial Reporting Standards (IFRS)
- “Accounting for Income Taxes” by Dale R. Gerboth
Summary
Deferred taxes play a crucial role in aligning accounting and tax reporting, providing a mechanism to recognize future tax impacts of current temporary differences. Understanding deferred tax liabilities and assets helps in accurately assessing an organization’s financial health and tax obligations, ensuring compliance with accounting standards and tax regulations.
