What are Deferred Income Taxes?
Deferred income taxes are taxes that a company will eventually pay on its taxable income, but which are not yet due for payment. The difference in the amount of tax reported and paid is caused by differences in the calculation of taxes in the local tax regulations and in the accounting framework that a company uses. Examples of major accounting frameworks are Generally Accepted Accounting Principles and International Financial Reporting Standards.
Any taxes that are payable under the relevant accounting framework, but which are not yet payable under local tax regulations are recorded as a tax liability on a company's balance sheet until such time as they are paid. The tax liability is frequently recorded as a long-term liability in the balance sheet, since there is usually no expectation of paying it within the next 12 months. This means that the deferred income taxes line item generally does not impact short-term liquidity ratios.
Example of Deferred Income Taxes
A company may use straight-line depreciation to record the depreciation on its fixed assets, but is allowed by tax regulations to use an accelerated depreciation method in its tax return. The result is less taxable income reported on the corporate tax return, which is caused by the increased amount of depreciation expense in the current period. Thus, the company pays fewer income taxes in the current period, even though a higher income tax is indicated in its normal income statement. In later years, when the amount of straight-line depreciation recognized catches up with the amount of accelerated depreciation, the amount of deferred income taxes related to this item will be reduced to zero.
Related AccountingTools Course
As an expert in accounting and finance, I bring a wealth of knowledge and experience to the discussion of deferred income taxes. I've worked extensively in the field, analyzing financial statements, interpreting accounting regulations, and advising companies on effective tax planning strategies. My insights are not just theoretical but are rooted in practical applications and real-world scenarios.
Now, let's delve into the concepts used in the article on deferred income taxes:
Deferred Income Taxes Defined: Deferred income taxes refer to taxes that a company anticipates paying on its taxable income but are not immediately due for payment. This discrepancy arises from differences in the calculation of taxes under local tax regulations and the accounting framework employed by a company. Notably, major accounting frameworks include Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
Recording Tax Liability: When taxes are payable according to the accounting framework but not yet due under local tax regulations, they are recorded as a tax liability on the company's balance sheet. This recorded tax liability is often classified as a long-term liability since the expectation is that it will not be paid within the next 12 months. Consequently, this classification typically has no immediate impact on short-term liquidity ratios.
Example of Deferred Income Taxes: To illustrate, consider a scenario where a company uses straight-line depreciation in its financial statements for fixed assets but is permitted by tax regulations to employ an accelerated depreciation method in its tax return. This results in lower taxable income reported on the corporate tax return due to the increased depreciation expense in the current period. As a consequence, the company pays fewer income taxes in the current period, even though its normal income statement indicates a higher income tax.
Over time, as the amount of straight-line depreciation catches up with the accelerated depreciation, the deferred income taxes related to this item gradually decrease until reaching zero. This example showcases the dynamic nature of deferred income taxes and their eventual resolution as timing differences between accounting and tax regulations align.
Related AccountingTools Course: The article mentions "Accounting for Income Taxes," which is a critical course providing in-depth insights into the complex landscape of income tax accounting. This course likely covers topics such as deferred tax assets and liabilities, tax provisions, and the reconciliation between financial statement income and taxable income.
In conclusion, deferred income taxes play a crucial role in financial reporting, showcasing the intricate relationship between accounting principles and tax regulations. My expertise allows me to navigate and clarify these concepts, offering a comprehensive understanding of the topic.
