What is a deferred tax liability? 

Tax laws in the USA give companies some flexibility in deciding how to declare transactions.

Often, you can choose to recognize income or expenses in the current business cycle or defer them to future periods.

For example, revenue from payments in quotas can originate from a single event but stretch across multiple tax cycles. 

This means there can be a mismatch between the figures your company reports for tax purposes and the actual figures in your financial statements.

You could end up owing future taxes—a Deferred Tax Liability (DTL) or accumulating future tax benefits—Deferred Tax Assets (DTAs).  

Depending on your industry or business model, either scenario could be advantageous.

But both have the potential for undesirable outcomes if not properly managed.

This article focuses on deferred tax liabilities, given that mismanaged or unexpected outflows are usually more painful than surprise credits (DTAs).  

So, let’s dig into the dynamics and causes of deferred tax liabilities and deferred tax assets, looking at how they impact your financial operations. 

What is deferred tax?

Deferred Tax Liabilities (DTL) and Deferred Tax Assets (DTA) happen when the taxable income reported to the tax authorities is different from the income reported in your official statements.

Official statements here mean documentation drafted according to official accounting standards like GAAP or IFRS.

That official figure is also known as “accounting income”. 

• Deferred tax liabilities represent future tax obligations that could disrupt financial planning if overlooked. Correctly accounting for DTLs helps avoid surprises and ensures you factor them into cash flow management.  

• Deferred tax assets, on the other hand, can cut down your future tax liabilities, which is equally important for planning and cash flow management. 

For example, if your company has been paid for goods or services that have not been delivered yet, i.e. deferred revenue, you could potentially end up with deferred tax liabilities.

This is because you might not need to pay tax on the deferred revenue in the current tax period.

There will be a timing difference between your taxable income and your accounting income. 

In other words, a DTL means your company hasn’t paid all tax due in the reported period, because tax laws allowed a payment to be deferred to a future tax period. 

How deferred tax liabilities occur

A timing difference is just one of many ways in which a DTL can be created.

Below, are some of the most common pathways leading to differences between accounting income and taxable income: 

Variable where differences can occur:	Where figure is recorded in accounting information:	Reason for discrepancy with tax rules:
Depreciation	Balance sheet—net assets  Income statement—expenses	Differences between tax and accounting depreciation schedules (e.g., accelerated depreciation for tax versus straight – line depreciation for accounting)
Liability recognition	Balance sheet—liabilities	Timing differences in when liabilities are recognized for accounting versus. tax purposes (e.g., warranty expenses, legal liabilities)
Tax expenses	Income statement—expenses	Changes in tax rates or tax laws affecting current versus deferred tax calculations.
Non – cash items	Cash flow statement—adjustments	Deductions like stock – based compensation, bad debt write – offs, or unrealized gains/losses.
Revenue recognition	Income statement—revenue	Differences in the timing of revenue recognition (e.g., cash basis versus accrual basis).
Inventory	Balance sheet—current assets	Differences in inventory valuation methods (e.g., LIFO versus FIFO) affecting cost of goods sold.

Deferred tax liability versus deferred tax asset

The opposite of a DTL is a deferred tax asset. A DTA happens when temporary differences in the reported period cause your company’s taxable income to be higher than your accounting income, leading to a reduction in future tax payments. 

For example, if expenses are recognized in your financial statements but are not yet deductible for tax purposes, you have a DTA.

One common cause is warranty expenses, which your company will record as an expense in the reporting period when you sell a product.

However, the actual repair costs will occur later. This creates a DTA, which will reduce your future taxable income when the warranty costs are incurred.  

Taxation timing differences can happen because of all kinds of nuances in the way companies operate, such as:  

• Different business models: everything from subscription-based sales to online sales and high-street sales. 

• Different areas within a business: for example, in manufacturing versus purchasing. 

What’s more, because of those nuances, a single section of your company can simultaneously register DTLs and DTAs derived from different aspects of its operations.  

For example, on the manufacturing side, rather than spreading the cost of machinery evenly over its useful life, your company can choose to register the bulk of the cost in the first few years of use.

This is known as “accelerated depreciation” and it means you’ll report an unusually large tax deduction upfront, temporarily reducing taxable income and lowering tax payments in the short term. 

However, it also means your company will claim smaller depreciation deductions in later years, meaning you’ll owe more tax in the future.

This future tax obligation is recorded as a DTL. In effect, it gives your company a temporary reprieve on the amount of tax you pay, but you still owe that sum and will have to pay it eventually.  

At the same time, for a different asset, your company may incur an impairment or write-down that is registered in your accounting books but not immediately deductible for tax purposes.

This results in a DTA. 

After balancing all DTLs and DTAs, your financial statement will report either a net DTL, net DTA, or neither, if the amounts offset each other completely. 

Effect of deferred taxation on financial health

It’s important to note that DTLs and DTAs aren’t necessarily going to be a problem for your operation.

They can both be used strategically to plan ahead.

For example, by reducing current taxable income you can free up cash for other uses, like investments or operations. 

Here’s how DTLs can impact financial statements and overall financial stability: 

Balance sheet impact

The net deferred tax, after summing up all DTLs and DTAs, affects your equity and leverage ratios.

For example, a net DTL increases total liabilities, potentially reducing equity as a proportion of total assets.

The other side of the coin is that it raises the debt-to-equity ratio, making the company appear more leveraged. 

Cash flow implications

DTLs may indicate future cash outflows, while DTAs suggest potential future tax savings, impacting your future cash flow planning and liquidity. 

Profitability analysis

Understanding DTLs and DTAs helps you analyze profitability and tax efficiency, providing insights into your company’s long-term financial health. 

Income statement

Strategies that defer taxes can boost net income by reducing current tax expenses, which in turn increases Return On Equity (ROE) in the short term.

However, these effects are temporary, as future tax payments will reduce profitability and could shift the ratios over time.  

Of course, you must carefully manage your use of the deferred tax option to avoid accumulating an excessive net DTL position.

If future taxable income is less than expected, or if cash flow is tight, you may have difficulty meeting these tax obligations.

In other words, you need to make sure you have enough future earnings and cash reserves to cover deferred tax payments when they become due.  

Also, aggressive use of timing differences could lead to overstated net income, misleading stakeholders about your company’s true financial health.

Worse still, you could trigger audits or penalties by the tax authorities. 

Common types of deferred tax liabilities 

Our table above describes common pathways to a DTL or DTA in your financial result, but what is the effect on specific items in the balance sheet?  

For example, you’ve already seen how different ways of describing depreciation can create a DTL related to fixed assets.

Here’s how industry-specific accounting differences and other nuances show up in the other basic line items: 

Revenue  

If your company operates under the accrual method (e.g., recording revenue when a contract is signed) you may clash with tax rules that require revenue recognition only when the cash is actually received.

In this case, you will be recognizing revenue earlier for accounting purposes than for tax purposes, creating a timing difference.

An example is when customers pay in instalments or subscriptions.

The tax rules may recognize revenue upon delivery of the product, whereas accounting spreads it over the instalment period. 

Inventory  

If you prefer the First-In, First-Out (FIFO) inventory valuation method for accounting but the LIFO Last-In, First-Out (LIFO) method for tax reporting, there may be a discrepancy between the two figures.

FIFO includes older (and likely cheaper) inventory, part of which is recorded as the cost of goods sold (COGS).

Under LIFO, the newer inventory is classed as COGS, while older, cheaper inventory remains on the balance sheet.

That leads to different inventory figures, but the difference will be even greater if inventory costs rise during the period. These effects are especially common in industries like manufacturing and retail. 

Intangible assets  

This refers to non-physical assets like patents, trademarks or licenses, whose useful lives can be highly variable or even indefinite.

That means you can vary the way you allocate the cost of the asset in your statements, ranging from immediate expensing to quotas (systematic amortization).

Once again, the method may differ between official accounting standards and tax rules, leading to DTLs or DTAs.  

Accrued liabilities 

Your company may accrue bonuses or employee benefits as expenses in its financial statements based on when they are earned (e.g. in keeping with the main accounting standards), but tax rules might only allow deductions when those bonuses or benefits are actually paid.

This results in a DTA, with the company receiving a tax deduction in the future. 

Non-cash transactions 

Industries like banking, insurance, and wealth management frequently deal with complex financial instruments such as bonds, derivatives, or factoring agreements.

These instruments must be paid back at some point, each with its own specific deadline for payment.

The firms investing in them are experts in using those different timelines to adjust the way they recognize the gains, losses, or expenses stemming from each instrument.

For example, unrealized gains on derivatives or investments might be measured one way for accounting purposes and another under tax rules, creating a DTL.  

Calculating the probability of deferred tax effects 

Calculating your likely deferred taxation position for the year ahead, or even longer periods, can be useful for managing cash flow and financial planning in general. However, it is not a precise science.  

If you know your company inside out you can have a good stab at drafting business projections, but estimating future taxable income or deductions is much trickier.

It takes knowledge of external factors such as changes in tax laws, economic conditions, and market dynamics. 

On the other hand, accounting and forecasting standards are designed to ensure accurate estimation of DTLs, reducing the risk of unexpectedly large tax payments in the future.  

For DTAs, the main risk lies in overstating them when there is uncertainty about how much tax benefit will result from them.

A tax benefit is only possible if you generate enough taxable income for the DTA to make a difference.

However, if you’re not sure of passing that threshold, or the likelihood of future taxable income is uncertain, you have the option of applying a “valuation allowance”, whereby your company evaluates how much of the DTA is likely to prevail.

As a result, the reported value of the DTA is often reduced to reflect the portion more likely to be utilized. 

It’s up to your company’s management team to determine the valuation allowance, but ultimately, it needs to comply with accounting standards such as U.S. GAAP (ASC 740) or IFRS (IAS 12).

Auditors and regulators review the assumptions used in calculating the allowance, cross-referencing against historical earnings, projections of taxable income, and the expected expiration date of the DTA. 

Deferred tax calculation: Basic considerations 

Calculating deferred tax liabilities requires a methodical, step-by-step approach to identifying temporary differences, applying the appropriate tax rates, and determining the future tax consequences of those differences. 

For example, going back to the idea of measuring asset value, if the methodology for calculating depreciation in your books differs from that used for tax purposes, you need to take care in setting the expected tax rates that govern those calculations.

You will be using estimated tax rates, involving an element of judgment and forecasting. 

Taxation software helps to automate key parts of the calculation, but it’s still a good idea to work with qualified tax advisors if your business involves complex scenarios, such as international tax regulations or industry-specific issues. 

Accounting for deferred taxation in financial statements 

Deferred tax liabilities and assets are regular features in your financial statements.

Here’s how and where these items are typically reflected in the main reports: 

Balance sheet

DTLs and DTAs are reported primarily on the balance sheet, typically under non-current liabilities and non-current assets, respectively. 

Income statement

The impact of deferred taxes is reflected in the income tax expense section of your income statement, which includes both current and deferred tax components. 

Disclosure requirements

In the notes to your financial statement, you must disclose significant details about your deferred tax position, including the nature of the temporary differences and any valuation allowances applied. 

For example, a typical multinational tech firm will give an overview of deferred tax assets and liabilities in the balance sheet section of its 10-K filing.

These figures usually appear under the “non-current assets” and “non-current liabilities” headings.  

The full details of DTLs and DTAs will appear in the tax section.

Here, the company may explain that gross deferred tax assets stem from things like stock-based compensation, warranty reserves, and R&D tax credits.

This section also discloses whether the DTA figure was adjusted by a valuation allowance. 

Typical explanations for gross deferred tax liabilities include differences in depreciation methods for property, plant, and equipment, plus undistributed earnings from foreign subsidiaries.  

The difference between these two gross figures gives a net deferred asset position, which may be positive (net DTA) or negative (net DTL). 

Deferred tax accounting rules 

Accounting for deferred taxes is governed by standards such as International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP), which give you the necessary guidelines on recognition, measurement, and disclosure of your tax-relevant information. 

Arguably, the core rule to abide by is to calculate deferred tax liabilities and assets using the enacted tax rates expected to apply when the temporary differences reverse.

This is the most accurate way to correct the difference over time. 

Beyond that, some of the most important GAAP and IFRS guidelines are: 

Recognition of DTAs

You can declare a DTA only if there is “greater than 50% probability” that you will generate sufficient future taxable income to justify utilizing the asset.

If not, a valuation allowance is required to reflect the realizable value. 

Uncertain tax positions

Under GAAP (ASC 740), your company must evaluate tax positions that might be questioned by the tax authorities.

If you judge that the tax service will view your tax position as uncertain, you must recognize a liability for the potential tax owed.

IFRS (IFRIC 23) follows a similar principle, requiring disclosure and adjustment of DTLs and DTAs for any uncertain tax treatments. 

Disclosure requirements

Both GAAP and IFRS require detailed disclosures about DTLs and DTAs, including:  

The types of temporary accounting differences expected.  

Changes in deferred balances during the tax reporting period. 

The tax rates you used in the calculation.  

Evidence supporting DTAs when it is uncertain that your taxable income will justify them (IFRS only). 

Final thoughts 

Deferred tax liabilities are an important accounting concept and play a role in helping you balance immediate cash flow benefits with future tax obligations.  

By using world-class tax accounting software such as the Sage Intacct suite, you can plan for DTLs and DTAs, accurately registering timing differences between your accounting practices and local tax regulations.