Deferred tax is an accounting concept that recognizes the difference between the tax expense reported in a company's financial statements and the actual taxes payable to the tax authorities. It arises due to timing differences in recognizing revenue and expenses for financial reporting purposes versus tax purposes. This article aims to simplify the concept of deferred tax and explain its presentation in financial statements.
Deferred tax arises from temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and their tax bases. These differences can be either taxable temporary differences or deductible temporary differences.
Taxable temporary differences result in higher taxable income in future periods when the carrying amount of an asset or liability exceeds its tax base. On the other hand, deductible temporary differences lead to lower taxable income in future periods when the tax base exceeds the carrying amount.
The key idea behind deferred tax is that these temporary differences will reverse over time and result in either future tax payments or tax benefits. Therefore, recognizing deferred tax allows for more accurate reporting of a company's financial performance and position.
Deferred tax is presented as a separate line item in the balance sheet and income statement of a company's financial statements. It is classified as a non-current asset or liability, depending on whether it represents a future tax benefit or obligation.
On the balance sheet, deferred tax assets and deferred tax liabilities are presented separately. A deferred tax asset represents a future tax benefit resulting from deductible temporary differences or unused tax losses or credits. It is classified as a non-current asset because it is expected to be realized beyond one year.
Conversely, a deferred tax liability represents a future tax obligation resulting from taxable temporary differences. It is also classified as a non-current liability because it is expected to be settled beyond one year.
Deferred tax is also reflected in the income statement. The tax expense reported in the income statement includes both the current tax expense, which is the actual tax payable based on the current year's taxable income, and the deferred tax expense or benefit.
The deferred tax expense or benefit is determined by considering the changes in deferred tax assets and liabilities during the year. If there is an increase in deferred tax assets or a decrease in deferred tax liabilities, it results in a deferred tax benefit that reduces the overall tax expense. Conversely, if there is a decrease in deferred tax assets or an increase in deferred tax liabilities, it leads to a deferred tax expense that increases the overall tax expense.
In conclusion, deferred tax is a concept that recognizes timing differences between financial reporting and tax reporting. It ensures that a company's financial statements accurately reflect the future tax consequences of these temporary differences. By presenting deferred tax as a separate line item in the balance sheet and income statement, stakeholders can gain insights into a company's tax obligations and benefits. Understanding the concept of deferred tax and its presentation in financial statements is essential for investors, analysts, and other users of financial information.