deferred tax assets and liabilities
/ deferred = dih-FURD; often shortened to DTA and DTL /
Suppose this year you skip a chore but agree you will have to do it later, or you do an extra chore now so you can skip one next week. You have created a kind of IOU with the future — either you owe time later, or you have earned time off. Temporary differences between book and tax accounting create exactly this kind of IOU with the tax authority, and accountants put it on the balance sheet as deferred tax.
A deferred tax liability is a future tax bill you have postponed: because of a temporary difference, you paid less tax now than your book profit suggests, but you will pay it back in later years. A deferred tax asset is the opposite — a future tax saving you have earned: you paid more tax now than your book profit suggests, so future tax will be reduced. For example, if tax depreciation runs ahead of book depreciation, the company pays less tax today and records a deferred tax liability of, say, 30,000 (the future tax on that 30,000 timing gap, or its tax rate times the difference). When the gap reverses years later, the liability is paid down and disappears.
These accounts let the income statement show a tax expense that matches the book profit, even though the cash actually paid to the government differs. A deferred tax asset only counts if the company expects to have future profits to use the saving against; if not, accountants reduce it with a valuation allowance, an honest admission that a paper benefit may never be realized. Deferred taxes can be large and confusing, but the idea is simple: they record taxes whose timing has been shifted, not taxes that have vanished.
A firm uses faster tax depreciation, so this year its taxable income is 40,000 lower than its book income. At a 25 percent tax rate, it pays 10,000 less tax now and records a deferred tax liability of 10,000, to be settled in later years as the difference reverses.
A deferred tax liability is a postponed tax bill; a deferred tax asset is a prepaid tax saving.
A deferred tax asset is not guaranteed cash — it only has value if the company earns future profits to use it against; otherwise it may be written down to zero with a valuation allowance.