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.
Thank You
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