In our previous discussion, accounting income was greater than taxable income in the year of origination,
resulting in a deferred tax liability. If, however, accounting income is less than taxable income, a deferred tax asset results. Once again, income tax expense is based upon accounting income, income tax payable is based upon taxable income, and the difference is debited to a deferred tax asset account.
Temporary difference no. 1 relates to income earned but not yet received, which is recognized for accounting purposes but not for tax purposes. Temporary difference no. 2 involves the opposite situation—income has been received but not earned.
The Deferred Tax Asset account represents a prepayment of taxes. For example, if accounting income is
$200, taxable income is $220, and the tax rate is 20%, then, according to GAAP, the tax should only be $40.
Nevertheless, we are forced to pay $44 because IRS has a different set of accounting rules. Thus the extra $4 we are now paying is not an expense of this period (because in this period we only earned $200 under accounting rules), but rather a prepayment of next period’s taxes.
resulting in a deferred tax liability. If, however, accounting income is less than taxable income, a deferred tax asset results. Once again, income tax expense is based upon accounting income, income tax payable is based upon taxable income, and the difference is debited to a deferred tax asset account.
Temporary difference no. 1 relates to income earned but not yet received, which is recognized for accounting purposes but not for tax purposes. Temporary difference no. 2 involves the opposite situation—income has been received but not earned.
The Deferred Tax Asset account represents a prepayment of taxes. For example, if accounting income is
$200, taxable income is $220, and the tax rate is 20%, then, according to GAAP, the tax should only be $40.
Nevertheless, we are forced to pay $44 because IRS has a different set of accounting rules. Thus the extra $4 we are now paying is not an expense of this period (because in this period we only earned $200 under accounting rules), but rather a prepayment of next period’s taxes.