Current and deferred tax: timing is not permanence

Learning goals

• Bridge accounting profit, taxable income and tax expense.
• Calculate tax rates and analyze recoverability of deferred-tax balances.

Draft · approximately 80 minutes, excluding further revision.

Separate four different quantities

Accounting profit follows reporting standards; taxable income follows the relevant tax law. Current tax payable, cash tax paid and total tax expense can differ because of payment timing, prior-year settlements and deferred tax. A temporary difference reverses through future taxable or deductible amounts; a permanent difference does not reverse merely as time passes.

Tax depreciation faster than book depreciation can lower current tax while creating a future taxable difference. A nondeductible fine is a simple permanent-difference example and generally creates no deferred-tax asset merely from that disallowance. Work from carrying values and tax bases rather than guessing the sign from a profit headline.

Determine direction and recoverability

For a simple asset, carrying amount above tax base often creates a deferred-tax liability; a deductible temporary difference can create a deferred-tax asset subject to recognition conditions and exceptions. Under IAS 12 assess probable future taxable profit for deductible amounts. US GAAP uses a valuation-allowance mechanism when realization is not more likely than not. The two frameworks should not be described as identical procedures.

Use the applicable tax rate expected on reversal, respecting enacted versus substantively enacted requirements of the framework. A rate change can remeasure balances and affect tax expense without immediate cash. Review expiry, jurisdiction, loss history and reversal schedules. Some deferred-tax liabilities may persist with continued reinvestment; that is an analytical scenario, not permission to delete the recognized liability.

Read the rate reconciliation and cash bridge

Define effective tax rate as income-tax expense divided by pretax accounting profit for the relevant scope. A statutory rate is a legislated benchmark; a cash tax rate needs an explicit denominator, here cash tax paid/pretax accounting profit. Geographic mix, permanent differences, credits and one-time remeasurements can explain differences. A low effective rate is not automatically sustainable.

Reconcile current and deferred components, tax payments, uncertain tax positions and deferred assets or liabilities in the notes. A large deferred-tax asset coupled with recurring losses deserves forecast sensitivity, not an automatic assumption of full recovery. Avoid calculating a meaningful-looking rate when pretax profit is near zero or negative without explaining the distortion.

An effective-rate bridge with a permanent difference

Synthetic pretax accounting profit 100 includes a 10 fine that is never deductible. Tax depreciation exceeds book depreciation 20; the stipulated rate is 25%.Taxable income=100+10−20=90, current tax 22.5, and a taxable temporary difference creates DTL 5. If all movements affect profit or loss, total expense 27.5 and effective rate 27.5%.The 2.5 percentage-point difference from the 25%benchmark arises from the nondeductible fine; the depreciation timing difference alone does not raise total tax expense in this simple case.

If current tax 22.5 is paid this year, the defined cash tax rate is 22.5%, not the 27.5%effective rate. Inspect foreign mix, credits, uncertain positions and nonrecurring remeasurements in a real reconciliation. Separate tax-law assumptions from accounting-rate calculations rather than importing this fictional rate into a real filing.

A deductible liability creates a recovery question

A warranty provision 12 has no current tax deduction in the fictional jurisdiction; deduction occurs only when paid. Its tax base under the stated assumptions is zero and the deductible temporary difference 12 can support DTA 3 at 25%, subject to the framework’s recognition test. If no adequate future taxable profit is supported, the numerical potential 3 is not automatically a recognized realizable asset.

A tax note must reconcile stocks, expense and cash

Suppose opening DTL is 8, closing DTL 10, opening DTA 4 and closing DTA 7. Assuming all movements are recognized in profit or loss, no acquisitions, foreign exchange or equity/OCI entries, deferred tax expense=(10−8)−(7−4)=−1: a deferred tax benefit 1. If current tax expense is 22, total tax expense is 21. The DTA increase reduces expense in this fact pattern; mechanically adding every balance change would get the sign wrong.

Tax payable is a balance-sheet stock. With payable opening 6, current expense 22 and closing payable 9, cash tax paid is 19 if no other movements exist:6+22−19=9. Cash tax is therefore distinct from both current expense 22 and total expense 21. For real companies, inspect refunds, prior-year assessments, foreign tax and recognition exceptions before using this simplified bridge. No fictional tax rate here is a statement about a real jurisdiction.

Formula and assumptions

Tax expense=current tax+deferred tax expense; ETR=tax expense/pretax profit; simple DTL=taxable temporary difference×applicable rate

A timing-only tax bridge

1. Book pretax profit 100. Tax depreciation exceeds book depreciation by 20; no permanent differences. Taxable income 80, tax rate 25%, current tax 20. Assume current tax is paid.
2. A taxable temporary difference 20 produces DTL 5. Total tax expense=20+5=25, effective rate 25%; defined cash tax rate 20%.
3. For the same difference 20, a qualifying future rate 30% would measure DTL 6 rather than 5; the 1 increase can affect deferred expense under the stated profit-or-loss assumptions.

Errors to catch

• Recognizing a deferred asset for a permanent nondeductible item.
• Treating tax expense as identical to cash paid.

Original knowledge check

Answer every question before checking. Review explanations after submitting; retry starts a new attempt.

Sources and coverage status

These original lessons are drafts. Public outlines are used to check scope; the official learning-outcome text and proprietary question banks are not reproduced here. Follow the source for exam-year requirements and updates.

• Reference · www.ifrs.org
• Reference · www.fasb.org
• Reference · www.ifrs.org