Deferred Tax Liability

Deferred Tax Liability

What is deferred tax liability?

Deferred tax liability is a tax which is assessed or due for the current period but which has not yet been paid. The deferral arises from the timing difference between the time the tax is accrued and the time the tax is paid. A deferred tax liability records the fact that the company will pay more income tax in the future due to a transaction that took place during the current period, such as an installment sale receivable.

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Deferred tax liability

Functioning of the deferred tax liability

Because US tax laws and accounting rules differ, a company’s pre-tax profit on the income statement may be greater than its taxable income on a tax return, resulting in deferred tax liabilities on the balance sheet. of the society. The deferred tax liability represents a future tax payment that a company should make in the future to the appropriate tax authorities, and is calculated as the company’s anticipated tax rate multiplied by the difference between its profit taxable and its accounting profit before taxes.

Simplify deferred tax liabilities

A simple way to define the deferred tax liability is the amount of taxes that a business has “underpaid” – which will (possibly) be compounded in the future. To say that it has underpaid does not necessarily mean that it has not fulfilled its tax obligations, but rather to recognize that the obligation is paid according to a different schedule.

For example, a business that has earned net income for the year knows that it will have to pay corporate income tax. Since the tax obligation applies to the current year, it must also reflect an expenditure for the same period. However, the tax will not actually be paid until the next calendar year. In order to correct the temporary cumulative / cash difference, the tax should be recorded as a deferred tax liability.

Examples of sources of deferred tax liabilities

A current source of deferred tax liabilities is the difference in treatment of depreciation charges by tax laws and accounting rules. Depreciation of long-lived assets for financial statement purposes is generally calculated using a straight-line method, while tax regulations allow companies to use an accelerated depreciation method. Since the straight-line method produces lower depreciation than that of the under-accelerated method, the accounting result of a business is temporarily higher than its taxable result.

The company recognizes the deferred tax liability on the difference between its accounting profit before tax and its taxable profit. As the company continues to depreciate its assets, the difference between straight-line depreciation and accelerated depreciation narrows, and the amount of deferred tax liabilities is gradually eliminated through a series of compensatory accounting entries.

Another common source of deferred tax liabilities is installment sales, which is the income recognized when a business sells its products on credit to be paid in equal amounts in the future. Under accounting rules, the company is authorized to record total income from the installment sale of general merchandise, while tax laws require companies to recognize income when payments are made. This creates a temporary positive difference between the accounting result and the taxable income of the business, as well as a deferred tax liability.

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