DEFERRED TAX

Deferred tax is an accounting concept, meaning a future tax liability or asset,

resulting from temporary differences between book (accounting) value of
assets and liabilities and their tax value, or timing differences between the
recognition of gains and losses in financial statements and their recognition
in a tax computation.

DEFERRED TAX ASSET

An asset that is used to reduce the amount of tax that a company will have to
pay in a later tax period. It is often associated with a loss carryover, and is
used as a future write-off if the next tax period is expected to produce
positive earnings. The asset is kept on the balance sheet. For example, a
deferred tax asset of $100,000 from the previous year could be applied to
before-tax income of $250,000 this year, resulting in taxable income of
$150,000 ($250,000 - $100,000).

What Does Deferred Tax Asset Mean?

An asset on a company's balance sheet that may be used to reduce any
subsequent period's income tax expense. Deferred tax assets can arise due to
net loss carryovers, which are only recorded as assets if it is deemed more
likely than not that the asset will be used in future fiscal periods.

It must be determined that there is more than a 50% probability that the
company will have positive accounting income in the next fiscal
period before the deferred tax asset can be applied.
If, for example, a company has a deferred tax asset of $25,000 on its balance
sheet, and then the company earns $75,000 in before-tax accounting income,
accounting tax expense will be applied to $50,000 ($75,000 - $25,000),
instead of $75,000.
 DEFERRED TAX LIABILITY

What Does Deferred Tax Liability Mean?

An account on a company's balance sheet that is a result of temporary
differences between the company's accounting and tax carrying values,
the anticipated and enacted income tax rate, and estimated taxes payable for
the current year. This liability may or may not be realized during any given
year, which makes the deferred status appropriate.

Because there are differences between what a company can deduct for tax
and accounting purposes, there will be a difference between a company's
taxable income and income before tax. A deferred tax liability records the
fact that the company will, in the future, pay more income tax because of a
transaction that took place during the current period, such as an installment
sale receivable.

In simple words:

Deffered tax liability means currently you are paying less

amount of tax as per IT but in future you have to pay more
so for this timing difference we have to create a deffered
tax liability in our books of accounts accoding to the
virtual certainty that in future company will earn
sufficient proft to recover it.
for deffererd tax liability the entry will be
Profit & loss a\c dr
To Deffered tax liability
 ILLUSTRATED EXAMPLE
The basic principle of accounting for deferred tax under a temporary
difference approach can be illustrated using a common example in which a
company has fixed assets which qualify for tax depreciation.

The following example assumes that a company purchases an asset for

$1,000 which is depreciated for accounting purposes on a straight-line basis
of five years. The company claims tax depreciation of 25% per year on a
declining balance basis. The applicable rate of corporate income tax is
assumed to be 35%.

Purchase Year 1 Year 2 Year 3 Year 4

Accounting value $1,000 $800 $600 $400 $200

Tax value $1,000 $750 $563 $422 $316

Taxable/(deductible) temporary
$0 $50 $37 $(22) $(116)
difference

Deferred tax liability/(asset) at 35% $0 $18 $13 $(8) $(41)

As the tax value (tax base) is lower than the accounting value (net book
value) in years 1 and 2, the company should recognise a deferred tax
liability. This also reflects the fact that the company has claimed tax
depreciation in excess of the expense for accounting depreciation recorded
in its accounts, whereas in the future the company should claim less tax
depreciation in total than accounting depreciation in its accounts.

In years 3 and 4, the tax value exceeds the accounting value, therefore the
company should recognise a deferred tax asset (subject to it having sufficient
forecast profits so that it is able to utilise future tax deductions). This reflects
the fact that the company expects to be able to claim tax depreciation in the
future in excess of accounting depreciation.
 EXAMPLES
Deferred tax liabilities

Deferred tax liabilities generally arise where tax relief is provided in

advance of an accounting expense, or income is accrued but not taxed until
received. Examples of such situations include:

• a company claims tax depreciation at an accelerated rate relative to

accounting depreciation
• a company makes pension contributions for which tax relief is
provided on a paid basis, whereas accounting entries are determined
in accordance with actuarial valuations

Deferred tax assets

Deferred tax assets generally arise where tax relief is provided after an
expense is deducted for accounting purposes.Examples of such situations
include:

• a company may accrue an accounting expense in relation to a

provision such as bad debts, but tax relief may not be obtained until
the provision is utilised
• a company may incur tax losses and be able to "carry forward" losses
to reduce taxable income in future years