Deferred Tax in simpler terms
                     Deferred Tax in simpler terms 
 
As per IAS 12, a Deferred Tax Liability is the income tax that will be 
due in the future because of taxable temporary differences. 
To fully grasp this definition, we need to understand what temporary 
differences mean. 
Temporary differences refer to the difference between an asset's carrying 
amount (CA) in the financial statement and its tax base (TB), which is 
the amount attributed to that asset or liability for tax purposes. 
In financial statements, Non-Current Assets (NCA) are subjected to 
depreciation, while for tax purposes, NCA are subjected to tax 
deductions, also known as capital allowance. 
The difference between the two depreciations results in a temporary 
difference between the carrying amount and the tax base. 
To illustrate further, let's consider an example of a Non-Current Asset 
worth $1000 that was purchased at T0, which is depreciated on a 
straight-line basis over two years, with an annual depreciation of $500. 
The tax depreciation granted by the tax authority is T1 - $750 and T2 - 
$250. 
The carrying amount of the asset at T1 is $500, while the tax base is 
$250. The temporary difference at T1 is $250 (500-250). 
How does this example result in future tax payment? 
Entities pay income tax on their taxable profits, which are calculated by 
adding back depreciation and deducting tax depreciation from the 
accounting profit and loss. 
  
In the above example, the tax depreciation ($750) is greater than 
depreciation ($500) in T1. The entity has received early tax relief, and as 
a result, the payment of tax is deferred. However, this tax difference is 
temporary as tax will be paid in the future. 
In year 2, when the tax depreciation ($250) is less than the depreciation 
charged ($500), the entity is liable to pay additional tax. 
In accordance with the accrual and matching principle, revenue or 
expenses are recorded when a transaction occurs rather than when the 
payment is received or made. The matching principle also requires that 
revenue and expenses should be recognized in the same period. 
Therefore, a Deferred Tax Liability is recorded, equal to the expected 
tax payable in the future. 
Assuming a tax rate of 20%, the deferred tax liability recognized at T1 
will be 20% x 250 = $50. 
Please feel free to contact Cheylesmore Chartered Accountants for help 
sorting this out for you.