What are Deferred Taxes?

Deferred taxes refer to the postponement of income taxes to future periods due to differences in the recognition of income or expenses between financial accounting and tax accounting. These differences create temporary variations in the timing of when certain transactions affect taxable income versus when they impact reported financial results.

Deferred Tax Assets

A deferred tax asset represents potential future tax benefits resulting from temporary differences that will likely lead to lower taxable income in the future.

Example: If a company expenses legal fees for financial reporting purposes, but must capitalize and depreciate those legal fees for tax purposes, it may have a deferred tax asset because it can deduct more depreciation for tax purposes initially.

Deferred Tax Liabilities

A deferred tax liability represents potential future tax obligations resulting from temporary differences that will likely lead to higher taxable income in the future.

Example: If a company recognizes revenue for financial reporting purposes before it’s taxable, it may have a deferred tax liability as it will pay taxes on that revenue in the future.

Journal Entries for Deferred Tax Liability

Deferred tax assets and liabilities are crucial components of a company’s financial reporting, reflecting differences in the timing of recognizing income or expenses for accounting and tax purposes. Journal entries for deferred tax assets and liabilities play a pivotal role in accurately representing a company’s financial health and tax planning strategies.

Temporary Difference Creation

When there’s a temporary difference leading to a future taxable amount.

Account
Income tax expense$150,000
Deferred tax liability$150,000

Tax Payment in the Future

When the temporary difference reverses, and the company expects to pay more in taxes.

Account
Deferred tax liability$150,000
Taxes payable$150,000

Journal Entries for Deferred Tax Asset

Temporary Difference Creation

When there’s a temporary difference leading to a future deductible amount.

Account
Deferred tax asset$150,000
Income tax expense (recovery)$150,000

Tax Deduction in the Future

When the temporary difference reverses, and the company expects to deduct more on taxes.

Account
Taxes payable (recoverable)$150,000
Deferred tax asset$150,000

These journal entries capture the recognition and utilization of deferred tax assets and liabilities over time.

Author

Mark is a Chartered Professional Accountant (CPA) in Canada, and has worked in the accounting field for over 25 years with a variety of companies including small to large privately held and public companies. Mark now runs his own accounting firm and is dedicated to helping individuals and small business owners. Mark enjoys coaching and mentoring small business owners on how to best handle their business finances.