Due to accrual accounting, there are different methods for recording net income before taxes resulting in a deferred tax. Deferred taxes can greatly affect a company's net income and book value. Specifically, deferred taxes represent the difference between taxes assessed from net income and pretax income (income before taxes). Over time, deferred taxes tend to balance out.
Understand the difference between a deferred tax asset and a deferred tax liability. A deferred tax asset arises because taxes have been paid (or losses have been carried forward). Deferred tax liabilities are tax payments that have made it to the income statement, but have not flowed through to the cash flow statement.That is, no cash has changed accounts.
Review the causes of deferred taxes. Deferred taxes usually originate on the income statement. Accelerated depreciation (which speeds up expenses, and lowers tax payments) is one common cause. In general, any asset with a higher book value (as carried in the books) than tax basis will have a deferred tax liability. If the carrying value is less than the tax basis, it will result in a deferred asset.
Work through an example. The accounting income for Company XYZ is £71 and the tax expense is 20% of the accounting income. The tax expense is £14 (£71*.20). Income tax payable is the amount the IRS demands a corporation pay (the company has not been paid yet).
Calculate the deferred tax. The difference between the $110 gross income and the £57 in taxable income is £14. This amount is a deferred tax liability.
Change to a deferred tax asset. Had the amount been paid (carry forward) prior to taxes being due to the IRS, the amount would be considered a tax asset.