WallStreetMojo

WallStreetMojo

WallStreetMojo

MENUMENU
  • Blog
  • Free Video Tutorials
  • Courses
  • All In One Bundle
  • Login
Home » Accounting Tutorials » Assets Tutorials » Deferred Income Tax

Deferred Income Tax

By Madhuri ThakurMadhuri Thakur | Reviewed By Dheeraj VaidyaDheeraj Vaidya, CFA, FRM

Deferred Income Tax Definition

Deferred income tax is a balance sheet item which can either be a liability or an asset as it is a difference resulting from recognition of income between the accounting records of the company and the tax law because of which the income tax payable by the company is not equal to the total expense of tax reported.

It simply refers to the tax that is overpaid or owed by the Company to the tax authorities. Deferred Income tax affects the tax outgo to the authorities for the financial year. If there is a deferred tax asset, the Company will have to pay less tax in the particular year, whereas, if there is a deferred tax liability, it will have to pay more tax.

Deferred Income Tax

Causes of Deferred Income Tax Expense

deferred tax

Deferred tax is created due to the difference in the timing of book profit and the taxable profit. Some items are deducted from the taxable profits, and others are not. Timing differences are of two types:

  • Permanent Difference: The differences which cannot be reversed in the subsequent periods and may take a long time are permanent differences.
  • Temporary Difference: The difference which can be reversed in the subsequent period and is generally created because the items are charged and taxed in different periods of time is the temporary difference.

Let us discuss the two types of Deferred Income Tax expense in detail.

You can download this Deferred Income Tax Excel Template here – Deferred Income Tax Excel Template

1) Deferred Income Tax Asset

deferred tax assets

Deferred tax asset is created when the Company has already paid the tax. The benefit of deferred tax assets is that the Company will have less tax outgo in the future subsequent years.

Popular Course in this category
Sale
All in One Financial Analyst Bundle (250+ Courses, 40+ Projects)
4.9 (1,067 ratings)
250+ Courses | 40+ Projects | 1000+ Hours | Full Lifetime Access | Certificate of Completion
View Course

Example

Consider an Electronics Company XYZ Inc., which gives a warranty on the goods and assumes that the warranty repairs cost will go around 5% of the total revenue. If the revenue for the period is $ 500,000, then the balance sheet of the Company to the shareholders and the tax department will be:

Balance Sheet for Shareholder’s

Balance Sheet for Tax Authorities

There is a tax difference of $ 6,250, which the Company has already paid but is not visible in the balance sheet. Thus, it will record a deferred tax asset of $ 6,250 for the period.

2) Deferred Income Tax Liability 

deferred tax liability

Deferred tax liability is created when the Company underpays the tax, which it will have to pay in the near future. The liability is created not due to Company defaulting on its tax liabilities but due to timing mismatch or accounting provisions, which causes less tax outgo than required by the Company.

Example

An Oil Company ABC Inc produces 10,000 barrels of oil at the cost of $ 15 per barrel in 1st year. But in the next year, the labor cost increased, and it produced the same amount of oil but with a cost of $ 20. The Company sold the oil at the end of year 2 but used different accounting treatment for financial purposes and tax purposes. It recorded the cost as $ 150,000 FIFO inventory for the financial balance sheet where it recorded the cost as $ 200,000 for tax purposes LIFO inventory. It created a temporary difference of $ 50,000, and if the tax rate is 30% would create a tax liability of $ 15,000.

Important Notes  – Deferred Income Tax

  • Deferred tax impacts the future cash flows for the Company – while deferred tax assets lower the cash outflow, deferred tax liability increases the cash outflow for the Company in the future
  • Change in deferred tax balances should be analyzed to understand the future course – if the difference is going to rise or there will be a reversal in the trend of the deferred taxes
  • Deferred taxes are prone to the type of business the Company is in. If it’s a capital-intensive business and Company purchases new assets, it will have an increasing deferred tax liability because of accelerated depreciation of the assets
  • Analysts should look for changes in deferred taxes by reading the footnotes to the financial statements, which could include information about the warranty, bad debts, write-downs, policy on capitalizing or depreciating assets, policy on amortizing financial assets, revenue recognition policy, etc.

Conclusion

Deferred tax is a balance sheet line item which is recorded because the Company owes or pay more tax to the authorities. The deferred tax represents the negative or positive amounts of tax owed by the Company. Deferred income taxes impact the future cash flow of the Company, i.e., if its an asset, the cash outflow will be less, and if it’s a liability, the future cash outflow will be more.

Recommended Articles

This article has been a guide to what is Deferred Income Tax expense and its definition. Here we discuss deferred income tax along with its calculation, causes, and practical examples. You can learn more about financing from the following articles –

  • Provision for Bad Debts
  • Marginal Tax Rate
  • Income Tax Expense
  • What is Tax Accounting?
0 Shares
Share
Tweet
Share
Primary Sidebar
Footer
COMPANY
About
Reviews
Contact
Privacy
Terms of Service
RESOURCES
Blog
Free Courses
Free Tutorials
Investment Banking Tutorials
Financial Modeling Tutorials
Excel Tutorials
Accounting Tutorials
Financial Statement Analysis
COURSES
All Courses
Financial Analyst All in One Course
Investment Banking Course
Financial Modeling Course
Private Equity Course
Venture Capital Course
Excel All in One Course

Copyright © 2021. CFA Institute Does Not Endorse, Promote, Or Warrant The Accuracy Or Quality Of WallStreetMojo. CFA® And Chartered Financial Analyst® Are Registered Trademarks Owned By CFA Institute.
Return to top

WallStreetMojo

Free Investment Banking Course

IB Excel Templates, Accounting, Valuation, Financial Modeling, Video Tutorials

* Please provide your correct email id. Login details for this Free course will be emailed to you

Book Your One Instructor : One Learner Free Class
Let’s Get Started
Please select the batch
Saturday - Sunday 9 am IST to 5 pm IST
Saturday - Sunday 9 am IST to 5 pm IST

This website or its third-party tools use cookies, which are necessary to its functioning and required to achieve the purposes illustrated in the cookie policy. By closing this banner, scrolling this page, clicking a link or continuing to browse otherwise, you agree to our Privacy Policy

Login

Forgot Password?

WallStreetMojo

Free Accounting Course

You will Learn Basics of Accounting in Just 1 Hour, Guaranteed!

* Please provide your correct email id. Login details for this Free course will be emailed to you

WallStreetMojo

Download Deferred Income Tax Excel Template

Special Offer - All in One Financial Analyst Bundle (250+ Courses, 40+ Projects) View More