Quick answer
Deferred income tax records certain future tax consequences already embedded in reported assets and liabilities. It arises when an item’s carrying amount differs from its tax base and that difference will affect taxable income as the item is recovered or settled.
Accounting income and taxable income can recognize the same event in different periods. A faster tax deduction—in Canada, often capital cost allowance (CCA) on equipment—may reduce current tax now while leaving less deduction for later; an accrued expense may reduce accounting profit now but become deductible only when paid. Deferred tax makes those future consequences visible at the reporting date.
CCA is the tax deduction for qualifying depreciable property. Its amount follows tax rules rather than the accounting depreciation schedule; it is not necessarily faster than accounting depreciation.
Tax base and future recovery or settlement
The carrying amount comes from the financial statements: it is the amount currently reported for the asset or liability. The tax base reflects how recovering the asset or settling the liability will affect future taxable income. Recovering an asset means getting value from it, often by using or selling it; settling a liability means paying or otherwise fulfilling the obligation.
For an asset, the tax base is generally the amount that will be deductible against the taxable economic benefits from recovery. For a liability, it is generally the carrying amount less amounts that will be deductible on settlement. Revenue received in advance also considers the amount that will not be taxable in a future period. Tax base is therefore not necessarily original tax cost.
A difference is temporary when future recovery or settlement changes taxable income. A taxable temporary difference generally produces future taxable amounts and a deferred tax liability. This balance is commonly shortened to DTL. A deductible temporary difference generally produces future deductions and can support a deferred tax asset (DTA), subject to recognition requirements. These balances represent future tax effects, not current bills or cash refunds. A permanent difference does not reverse in that way.
Two tax-base anchors
- Asset: if equipment has a $56,000 carrying amount but only $44,000 of future tax deductions remain, the $12,000 difference is taxable as the asset is recovered under the stated facts.
- Liability: if a $10,000 warranty liability becomes fully deductible when paid, that future $10,000 deduction leaves a nil tax base and a $10,000 deductible difference under the stated facts.
Scroll horizontally to see all columns.
| Balance | Future event | Tax-base reasoning |
|---|---|---|
| Depreciable equipment | Use or sale recovers the asset | Tax cost less deductions already claimed leaves the future deductions and, under the stated facts, the tax base. |
| Receivable whose revenue is already taxable | Customer pays | Collection creates no further taxable amount, so the tax base ordinarily equals the receivable under those facts. |
| Accrued expense deductible only when paid | Entity pays the liability | When the entire carrying amount will be deductible on payment, the liability has a nil tax base. |
| Revenue received in advance and already taxed | Entity provides the service | If settlement creates no future taxable amount, the liability can have a nil tax base. |
| Prepaid expense already deducted for tax | Entity consumes the service | No tax deduction remains, so the asset can have a nil tax base. |
Deferred tax analysis by balance
- Establish each item’s carrying amount before tax accounting.
- Determine its tax base from the applicable tax facts.
- Classify the difference as taxable, deductible, or not temporary.
- Apply the rate expected when the difference reverses, using rates that have been enacted or are sufficiently advanced through formal approval to be treated as substantively enacted where the framework requires it.
- Assess whether each deferred tax asset qualifies for recognition.
- Compare the required closing balances with the opening deferred tax balances. The movement is the period’s deferred tax effect, subject to where the underlying item was recognized.
One year with depreciation and an accrued liability
North Shore Fabrication begins 20X2 with a $1,000 deferred tax liability (DTL) on equipment and no deferred tax asset (DTA). It reports $100,000 accounting income before tax, including $12,000 book depreciation and a $10,000 warranty expense accrued but unpaid. Tax deductions are $20,000 for the equipment and none for the warranty until paid. Equipment cost was $80,000; its year-end carrying amount is $56,000 and cumulative tax deductions are $36,000. Assume IFRS applies, there are no tax instalments, the enacted rate is 25%, no exception applies, and the DTA recognition requirements are met.
Derive taxable income and current tax
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| Calculation | Amount |
|---|---|
| Accounting income before tax | $100,000 |
| Add book depreciation | $12,000 |
| Deduct tax depreciation | ($20,000) |
| Add warranty expense not yet deductible | $10,000 |
| Taxable income | $102,000 |
| Current tax at 25% | $25,500 |
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| Account | Debit | Credit |
|---|---|---|
| Current Income Tax Expense | 25,500 | |
| Income Tax Payable | 25,500 |
Derive the closing tax bases
Equipment has $44,000 of deductions remaining: $80,000 tax cost less $36,000 claimed. Its tax base therefore follows from the deductions still available as the $56,000 carrying amount is recovered.
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| Item | Carrying amount | Tax base | Difference | Closing deferred tax |
|---|---|---|---|---|
| Equipment | $56,000 asset | $44,000 | $12,000 taxable | $3,000 DTL |
| Warranty accrual | $10,000 liability | $0 | $10,000 deductible | $2,500 DTA |
| Arithmetic difference, not a reporting offset | — | — | — | $500 more DTL than DTA |
The equipment DTL increases from $1,000 to $3,000, creating $2,000 deferred tax expense. The new warranty deduction creates a $2,500 DTA and recovery. The combined deferred movement is therefore a $500 recovery. Here, recovery means a reduction of tax expense; it is not a $500 cash receipt.
Scroll horizontally to see all columns.
| Account | Debit | Credit |
|---|---|---|
| Equipment | ||
| Deferred Tax Expense | 2,000 | |
| Deferred Tax Liability | 2,000 | |
| Warranty | ||
| Deferred Tax Asset | 2,500 | |
| Deferred Tax Recovery | 2,500 | |
Scroll horizontally to see all columns.
| Component | Amount |
|---|---|
| Current income tax expense | $25,500 |
| Net deferred tax recovery | ($500) |
| Total income tax expense | $25,000 |
| Profit after tax | $75,000 |
Financial-statement effect
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| Statement | Account | Effect | Timing |
|---|---|---|---|
| Income statement | Income tax expense | $25,500 current expense less $500 net deferred recovery gives $25,000 | 20X2 |
| Balance sheet | Tax balances | $25,500 payable, $3,000 DTL, and $2,500 DTA before any permitted offsetting | Year-end |
| Cash flow statement | Deferred tax | The deferred entries move no cash | 20X2 |
- Income statement
- AccountIncome tax expense
- Effect$25,500 current expense less $500 net deferred recovery gives $25,000
- Timing20X2
- Balance sheet
- AccountTax balances
- Effect$25,500 payable, $3,000 DTL, and $2,500 DTA before any permitted offsetting
- TimingYear-end
- Cash flow statement
- AccountDeferred tax
- EffectThe deferred entries move no cash
- Timing20X2
Opening balance, new differences, reversals, and rate changes
Calculate the required closing deferred tax asset and liability balances separately, using each temporary difference and the applicable rate at the reporting date. Compare each required closing balance with its opening balance. New differences, reversals, and rate changes explain the movement; the direction depends on whether the amount is an asset or a liability.
When the warranty claims are paid and the deduction is received, the liability and deductible temporary difference disappear, and the related deferred tax asset reverses. A change in the applicable tax rate can also remeasure a deferred tax balance before reversal.
Recognition and presentation of tax effects
A deductible difference, unused tax loss, or unused tax credit does not automatically produce a recognized asset. Forecasts, reversal patterns, expiry dates, and tax-planning facts can affect whether the benefit qualifies for recognition. Reassessment can change the asset as evidence changes.
Most tax effects enter profit or loss because the underlying transactions did. When an underlying item is recognized in other comprehensive income or directly in equity under the applicable requirements, the related tax effect generally follows that location.
IFRS and ASPE recognition differences
Under IFRS, IAS 12 governs deferred-tax recognition and its exceptions. Goodwill, business combinations, investments, offsetting, and the location of the underlying transaction can affect whether and where tax is recorded.
ASPE Section 3465 permits the taxes-payable method, which recognizes no future-tax balances, or the future-income-taxes method. Under the latter, future tax assets are recognized only to the amount more likely than not to be realized. Future-tax balances are not discounted and are non-current on a classified balance sheet. Section-specific exceptions still apply.
Distinction between current and deferred tax
Total tax expense combines current and deferred components, but their balance-sheet accounts and cash consequences remain distinct. Notes commonly reconcile tax expense to accounting profit and explain significant differences and rate effects.