Income taxes and temporary differences

Learning goals

• Compare accounting carrying amount with tax base.
• Calculate simple deferred/future tax assets and liabilities using a supplied rate.
• Reconcile current tax, deferred tax, and total income-tax expense.

Prerequisite check

Accounting profit and taxable income differ because financial reporting and tax law have different objectives. A permanent difference affects their relationship but does not reverse; a temporary difference is expected to reverse in future periods.

Vocabulary

• Tax base: amount attributed to an asset or liability for tax purposes.
• Taxable temporary difference: future recovery/settlement creates taxable amounts.
• Deductible temporary difference: future recovery/settlement creates deductions.
• Deferred tax liability (DTL): future tax consequence of taxable temporary differences.
• Deferred tax asset (DTA): future benefit of deductible differences/losses, recognized subject to recoverability criteria.

Core idea

The statement-of-financial-position approach compares carrying amounts with tax bases and applies the enacted or substantively enacted rate expected at reversal, as required by the applicable framework. IAS 12 and Canadian ASPE Section 3465 differ in some scope, measurement, and presentation details. Never memorize an unstable Canadian tax rate for this lesson; use the rate supplied in the case and verify current law in tax work.

Why this treatment makes sense

Current tax payable reports this year's tax return, but financial statements also show future tax consequences embedded in recognized assets and liabilities. This aligns tax expense with accounting events rather than cash payment timing alone.

A repeatable method

1. Start with each recognized asset/liability's carrying amount.
2. Determine tax base from supplied tax rules.
3. Compute temporary difference and predict future taxable or deductible effect.
4. Apply the supplied future rate.
5. Assess DTA recognition/recovery using the stated framework.
6. Compare closing net deferred balance with opening to derive the period movement.
7. Reconcile statutory-rate tax to reported tax expense, including permanent items.

Worked example

Calgary Precision owns equipment with carrying amount $300,000 and tax base $220,000. Future recovery creates an $80,000 taxable temporary difference. The case-supplied rate is 25%, so DTL = $20,000.

It also has a recognized warranty liability of $36,000 that becomes tax-deductible only when paid; tax base is $0 under the supplied rule. The $36,000 deductible temporary difference creates a $9,000 DTA if recognition criteria are met. Net deferred tax liability is $11,000.

If opening net DTL was $7,500 and all movement belongs in profit or loss under the facts, deferred tax expense is $3,500. If current tax expense/payable is $62,000, total income-tax expense is $65,500.

Journal, ledger, and statement connection

Tax working papers bridge trial balance to tax return and temporary-difference schedule. Entries record current payable separately from deferred balances. The tax note reconciles rate, permanent differences, credits, and changes; presentation follows the framework.

Common mistakes

• Multiplying the accounting-tax difference in depreciation expense instead of comparing carrying amount and tax base.
• Treating every book-tax difference as temporary.
• Recording a DTA without evaluating whether it can be realized under the applicable criteria.
• Using today's headline tax rate when the question supplies a reversal rate.

Guided practice

Receivable carrying amount $50,000 and tax base $50,000 create no temporary difference. A $12,000 accrued expense deductible only on payment has tax base $0 under supplied facts, creating a $12,000 deductible difference and a $3,000 DTA at 25%.

Independent practice

Level 1 — asset: Carrying amount $180,000; tax base $140,000; supplied rate 24%. Calculate DTL.

Level 2 — liability: Accrued warranty $28,000, tax base $0, deductible on payment; supplied rate 24%. Calculate DTA.

Level 3 — reconcile: Current tax $48,000; opening net DTL $9,000; closing net DTL $14,500; all movement in profit. Calculate total tax expense and explain the sign.

Self-check and solutions

Level 1: Taxable temporary difference $40,000; DTL $9,600.

Level 2: Deductible temporary difference $28,000; potential DTA $6,720, subject to the framework's recognition assessment.

Level 3: Deferred tax expense $5,500 because the net liability increased; total tax expense $53,500.

Retrieval practice

1. What comparison begins deferred tax analysis?
2. Does a permanent difference reverse?
3. Which tax rate should be used here?

Answers: carrying amount versus tax base; no; the enacted/substantively enacted future rate supplied and supported under the stated framework.

Exam-style application

Complete a four-item temporary-difference table, calculate current and deferred tax, prepare entries, and write a rate-reconciliation explanation. State any DTA recoverability assumption and do not invent legislation.

Lesson summary

Income-tax accounting connects present financial-statement amounts to their future tax consequences through tax bases, reversal logic, supported rates, and transparent reconciliation.