- Introduction to Income Tax
- Deferred Tax Liabilities and Assets
- Tax Base of Assets and Liabilities
- Example of a Deferred Tax Liability
- Permanent and Temporary Differences Between Taxable Income and Accounting Profits
- Valuation Allowance for Deferred Tax Assets
- Disclosures for Deferred Tax Items
- IT Accounting under IFRS and US GAAP
Permanent and Temporary Differences Between Taxable Income and Accounting Profits
A permanent difference between taxable income and accounting profits results when a revenue (gain) or expense (loss) enters book income but never recognized in taxable income or vice versa. The difference is permanent as it does not reverse in the future. Thus, book and tax will never equalize.
These differences do not result in the creation of a deferred tax. Instead of creating a deferred tax asset or liability, the permanent difference results in a difference between the company’s effective tax rate and the statutory tax rate.
Effective tax rate = Income tax expense/Pre-tax income
Some examples of permanent differences are: Fines and Penalties, Meals and Entertainment, Political Contributions, Officers Life Insurance, and Tax-exempt Interest.
A temporary difference results when a revenue (gain) or expense (loss) enters book income in one period but affects taxable income in a different (earlier or later) period. A temporary difference is expected to reverse in the future and therefore results in the creation of a DTL or DTA. The following are some examples of temporary differences and DTL/DTA created.
| Event | Book Income | Tax Income | Def. Tax Asset | Def. Tax Liability |
| Installment Sales | Revenue Today | Income Later | Yes | |
| Product Warranties | Expense Today | Deduction Later | Yes | |
| Bad Debt Expense | Expense Today | Deduction Later | Yes | |
| Rent Rec’d in Advance | Revenue Later | Income Today | Yes | |
| Depreciation Expense | Straight-Line | Accelerated | Yes | |
| Prepaid Expenses | Expense Later | Deduction Today | Yes | |
| Impairment | Expense Today | Deduction Later | Yes |
Note that a Deferred Tax Liability is created when Future Taxable Income > Future Book Income. A Deferred Tax Asset is created when Future Taxable Income < Future Book Income.
The following table summarizes how differences in carrying amount and tax base result in creation of DTL and DTA.
| Balance Sheet Item | Carrying Amount Vs. Tax Base | Result |
| Asset | Carrying Amount > Tax Base | Deferred tax liability |
| Asset | Carrying Amount < Tax Base | Deferred tax asset |
| Liability | Carrying Amount > Tax Base | Deferred tax asset |
| Liability | Carrying Amount < Tax Base | Deferred tax liability |
Temporary differences can be of two types:
- Taxable temporary differences: These differences result in future taxable income.
- Deductible temporary differences: These differences result in future tax deductions.
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