IAS 12 Deferred Tax Explained: Temporary Differences in Plain Terms

Why deferred tax exists

Tax laws and accounting standards often recognise the same income or expense in different years. A common example is depreciation: tax rules may allow faster deductions than the depreciation recorded in the financial statements. Over the life of the asset the totals match, but the timing differs.

Deferred tax accounts for the future tax consequences of those timing differences, so that the tax expense in the income statement relates to the profit reported in the same period.

The balance sheet approach

IAS 12 Income Taxes asks a simple question for each asset and liability: what is its carrying amount in the accounts, and what is its tax base?

Tax base of an asset: the amount that will be deductible for tax purposes against future taxable economic benefits.
Tax base of a liability: its carrying amount less any amount that will be deductible for tax in future periods.

The difference between the two is a temporary difference.

Situation	Type of difference	Result
Asset carrying amount > tax base	Taxable temporary difference	Deferred tax liability
Asset carrying amount < tax base	Deductible temporary difference	Deferred tax asset
Liability carrying amount > tax base	Deductible temporary difference	Deferred tax asset
Liability carrying amount < tax base	Taxable temporary difference	Deferred tax liability

Deferred tax is measured at the tax rates expected to apply when the difference reverses, based on rates enacted or substantively enacted at the reporting date. It is not discounted.

Worked example: accelerated tax depreciation

A company buys equipment for $100,000.

Accounting depreciation: straight-line over 5 years, $20,000 per year.
Tax depreciation in year 1: $40,000.
Tax rate: 25%.

At the end of year 1:

	Amount
Carrying amount (100,000 − 20,000)	80,000
Tax base (100,000 − 40,000)	60,000
Taxable temporary difference	20,000
Deferred tax liability at 25%	5,000

Account	Debit	Credit
Deferred tax expense	5,000
Deferred tax liability		5,000

The company has paid less tax this year than its accounting profit would suggest. The deferred tax liability represents the extra tax it will pay in later years, when accounting depreciation exceeds the remaining tax deductions and the difference reverses.

Common sources of deferred tax

Source	Typical result
Accelerated tax depreciation	Deferred tax liability
Provisions (for example, warranties) deductible only when paid	Deferred tax asset
Unused tax losses carried forward	Deferred tax asset
Revaluation of property under IAS 16	Deferred tax liability (recognised in other comprehensive income)
Fair value adjustments in a business combination	Deferred tax liability or asset (adjusts goodwill)

Recognising deferred tax assets

Under IAS 12, a deferred tax asset is recognised only to the extent that it is probable that taxable profit will be available against which the deductible temporary differences or losses can be used. Entities with a history of recent losses need convincing evidence of future profits.

Under ASC 740, all deferred tax assets are recognised first, and then a valuation allowance reduces them if it is more likely than not (above 50%) that some portion will not be realised. The end result can be similar, but the presentation and the threshold language differ.

Key IAS 12 vs ASC 740 differences

Area	IAS 12	ASC 740
Deferred tax asset recognition	Recognise to the extent probable	Recognise in full, less valuation allowance
Tax rate used	Enacted or substantively enacted	Enacted only
Balance sheet classification	Non-current	Non-current
Initial recognition exemption	Exists (with exceptions for transactions giving rise to equal and offsetting differences)	No equivalent general exemption
Uncertain tax positions	IFRIC 23: most likely amount or expected value	Two-step: more-likely-than-not threshold, then measurement

Practical checklist

List every asset and liability with a carrying amount different from its tax base.
Classify each difference as taxable or deductible.
Apply the tax rate expected when each difference reverses.
Assess recoverability of deferred tax assets.
Recognise movements in profit or loss, other comprehensive income or equity, following the item that created them.

Application scenarios

Scenario 1: Startup with tax losses carried forward

Situation. A technology startup has unused tax losses of $400,000. The tax rate is 25%, so the potential deferred tax asset is $100,000. The company has made losses for three years, but signed customer contracts support taxable profit of about $120,000 over the next two years. There are no taxable temporary differences to offset.

Analysis.

	IAS 12	ASC 740
Approach	Recognise only the portion where future taxable profit is probable	Recognise the full asset, then reduce it with a valuation allowance
Deferred tax asset recognised	$30,000 ($120,000 × 25%)	$100,000 gross
Valuation allowance	Not applicable	$70,000
Net amount on balance sheet	$30,000	$30,000

A recent history of losses is strong negative evidence under both frameworks, so recognition is limited to what convincing evidence supports.

Scenario 2: Warranty provision

Situation. A manufacturer records a warranty provision of $60,000. Tax rules allow a deduction only when warranty claims are actually paid. The tax rate is 25%.

Analysis. The provision's carrying amount is $60,000, and its tax base is nil (carrying amount less the amount deductible in future). That creates a deductible temporary difference of $60,000 and a deferred tax asset of $15,000, provided future taxable profit is probable.

Account	Debit	Credit
Deferred tax asset	15,000
Deferred tax income (profit or loss)		15,000

Summary

Deferred tax looks complex, but the logic is consistent: compare book values with tax values, multiply the difference by the expected tax rate, and test whether any asset is recoverable. Most errors come from missing a temporary difference or from recognising deferred tax assets without enough evidence of future taxable profit.

This article is for general educational purposes and reflects the author's understanding of the standards at the date shown. Always refer to the authoritative text of the standards and seek professional advice for specific situations.