Here is a summary: The goal of using deferred tax assets and liabilities is to show a reasonable level of income tax expense in relation to book pre-tax income. If tax expense were booked each year based on the just the amount that is legally owed for that year, there could be large variations in income tax expense, as a percentage of pre-tax income, from year to year. This is because of the timing differences between book income and taxable income. Many of these differences reverse over time. Therefore, in order to offset these impacts and present a more meaningful tax expense number, deferred tax expense (credit) and deferred tax assets (liabilities) are recorded to account for these temporary differences. Deferred tax assets are recorded with credits to income tax expense, while deferred tax liabilities are recorded with a debit to income tax expense.
A deferred tax asset can be thought of as the following: you've recognized book expense for something that is not yet deductible for tax purposes or you've been taxed on income that is not yet recordable for book purposes. Essentially, you're paying the tax earlier than book accounting would recognize the event, so you have an asset (deferred tax asset) because you'll get a tax benefit on your tax return in the future when the item becomes deductible. When recording this asset, you're crediting expense to offset the current tax expense associated with this event. Even though you are currently taxed on the item, you want to offset this tax with a credit to deferred tax expense so that your overall tax expense is proportionate to pre-tax income.
A deferred tax liability most often arises when you claim deductions on your return that are not yet recognized for book purposes. The most common example is accelerated tax depreciation. You have a liability because you will be paying higher taxes in the future because you've depreciated the asset faster for tax than for book. Similarly, deferred tax liabilities could arise if you have income on the books that is not yet a taxable event, such as an unrealized gain. You'll have to pay tax on that gain in the future, hence recording the deferred tax liability, even though it is not currently taxable. Essentially, you're providing for tax expense on the book income, even though it's not currently taxable, to better reflect the economics of the situation.
An important point to remember is that you don't recognize deferred taxes on permanent differences. These are differences that will never reverse between book and tax. An example is non-deductible penalties. They are book expenses, but they will never be recognized as tax deductions on the return. Therefore, no deferred tax is provided on the books.
AUD: 99
FAR: 95
BEC: 89
REG: 87
AICPA Ethics: 91
Licensed Illinois CPA
.