Financial Reporting · Taxation

Deferred Tax Basics and Temporary Differences Explained

Updated 11 October 2026 · Fact-checked

Deferred tax is the tax effect of temporary differences between an asset or liability's carrying amount and its tax base. Compare the two figures for each item. If taxable profit will be higher in future, recognise a deferred tax liability. If it will be lower, recognise a deferred tax asset, subject to recoverability. Multiply by the tax rate.

Understand Deferred Tax Basics and Temporary Differences

Current tax is the tax payable on this year's taxable profit. Taxable profit follows tax law, not accounting standards. So the two often differ. For example, tax law may give relief for an asset faster than the company depreciates it in its accounts.

This timing gap creates a problem. If you only charge current tax, the tax expense in profit or loss does not match the profit reported. IAS 12 solves this with the balance sheet liability method. You look at the statement of financial position, compare each asset and liability with its tax value, and provide for the tax effect of the difference.

The carrying amount is the figure in the financial statements. The tax base of an asset is the amount that will be deductible for tax against the taxable economic benefits that flow to the entity when it recovers the carrying amount. If those benefits are not taxable, the tax base equals the carrying amount. For a liability, the tax base is the carrying amount less any amount that will be deductible for tax in future. A temporary difference is the difference between the carrying amount and the tax base. It reverses over time.

A taxable temporary difference will increase future taxable profit. It gives a deferred tax liability. The classic case is an asset with a carrying amount above its tax base, such as when tax depreciation has been faster than accounting depreciation. A deductible temporary difference will reduce future taxable profit. It gives a deferred tax asset. A common case is a provision that is only deductible when paid.

The movement in the deferred tax balance in the year is taken to profit or loss. If the underlying item was recognised in other comprehensive income, such as a revaluation gain, the related deferred tax goes to OCI instead. Deferred tax is not discounted.

Key rules to remember

Temporary difference: Temporary difference = Carrying amount − Tax base; For assets, a positive result is a taxable difference (liability). A negative result is a deductible difference (asset).
Temporary difference for liabilities: Temporary difference = Tax base − Carrying amount; Use this for liabilities, so a carrying amount above the tax base gives a deductible difference. Check the sign by asking if future taxable profit rises or falls.
Deferred tax balance: Deferred tax = Temporary difference × Tax rate; Use the rate enacted or substantively enacted at the reporting date that is expected to apply when the difference reverses.
Charge for the year: Deferred tax charge/(credit) = Closing balance − Opening balance; Take it to profit or loss, unless it relates to an item recognised in OCI or equity.
Total tax expense: Income tax expense = Current tax + Deferred tax movement ± Prior-year under/over-provision; This is the figure shown in profit or loss.
Deferred tax asset recognition: Recognise a deferred tax asset to the extent it is probable that taxable profit will be available against which the deductible difference can be used; This is the IAS 12 test. Available taxable profit includes the reversal of existing taxable temporary differences. To the extent the test is not met, do not recognise the asset.

How to solve Deferred Tax Basics and Temporary Differences questions

Use this method for any deferred tax calculation. It works for assets, provisions and revalued items.

1List each asset and liability that may give rise to a difference, such as non-current assets, provisions and accrued expenses.
2Write down the carrying amount of each item at the reporting date.
3Work out the tax base of each item, using the tax rules given in the question, such as tax allowances claimed to date.
4Calculate the temporary difference. Decide whether it is taxable (future taxable profit higher) or deductible (future taxable profit lower).
5Multiply each taxable temporary difference by the tax rate to get the deferred tax liability, and each deductible difference by the tax rate to get the deferred tax asset. Offset the asset and the liability only if there is a legally enforceable right to set off current tax and they relate to the same tax authority. Otherwise show them separately.
6Compare with the opening balance. The difference is the movement for the year.
7Post the movement to profit or loss, or to OCI if the item arose there. Add it to current tax for the total tax expense.
8Present the closing balance as a non-current liability or asset.

Quickest way: Temporary difference table

When to use it: Use this in Section C or in an OT case when you have several items and limited time.

Draw three columns: carrying amount, tax base, difference.
Fill in each row, then ask one question: will future taxable profit go up or down?
Up means liability. Down means asset.
Total the differences and multiply by the rate once.
Subtract the opening balance from the closing balance to get the charge.
For a single asset, a quick check: accounting value above tax value means a liability.

Common mistakes in Deferred Tax Basics and Temporary Differences

Applying the tax rate to the accounting profit difference instead of the balance sheet difference.
Students mix up the old income statement approach with the balance sheet liability method.
Fix: Always start from carrying amount and tax base at the reporting date, not from the year's depreciation figures.
Confusing the sign: treating a carrying amount above the tax base as an asset.
It feels like a bigger asset is good news.
Fix: Ask whether future taxable income will rise. If the carrying amount of an asset is higher than its tax base, you will pay more tax later, so it is a liability.
Charging the full closing deferred tax balance to profit or loss.
Students forget there is an opening balance.
Fix: Charge only the movement. Closing balance less opening balance.
Putting deferred tax on a revaluation surplus through profit or loss.
Students treat all tax movements the same way.
Fix: Follow the item. If the gain went to OCI, the related deferred tax goes to OCI too.
Recognising a deferred tax asset without checking recoverability.
The calculation looks the same as for a liability.
Fix: Check that it is probable that taxable profit will be available to use the deductible difference. This can include the reversal of existing taxable temporary differences. If the question says the company is loss-making with no prospects and no such differences, do not recognise the asset.
Discounting the deferred tax balance.
Students link long reversal periods with present values.
Fix: IAS 12 prohibits discounting deferred tax. Use the undiscounted figure.

Worked examples

Example 1

At 31 December 20X1, Delta Co has plant with a carrying amount of $400,000. The tax written-down value of the plant is $310,000. The tax rate is 25%. There was no deferred tax at the start of the year. Calculate the deferred tax liability and the charge for the year.

Show the solution

Temporary difference = carrying amount − tax base = 400,000 − 310,000 = $90,000.
The carrying amount of the asset exceeds its tax base, so this is a taxable temporary difference.
Deferred tax liability = 90,000 × 25% = $22,500.
Opening balance is nil, so the movement = 22,500 − 0 = $22,500.

Answer: Closing deferred tax liability is $22,500. Charge $22,500 to profit or loss, as an increase in the tax expense.

Example 2

At 31 December 20X2, Echo Co has a provision for warranty costs of $60,000 in its accounts. Warranty costs are only deductible for tax when paid. Echo also has plant with a carrying amount of $500,000 and a tax base of $420,000. The tax rate is 20%. Opening net deferred tax liability was $10,000. Future taxable profits are expected. Calculate the closing net deferred tax liability and the charge for the year.

Show the solution

Plant: temporary difference = 500,000 − 420,000 = $80,000 taxable. Deferred tax = 80,000 × 20% = $16,000 liability.
Provision: the tax base of the liability = carrying amount 60,000 − amount deductible in future 60,000 = nil.
Temporary difference = tax base − carrying amount = 0 − 60,000 = $(60,000), a deductible difference.
Deferred tax asset = 60,000 × 20% = $12,000. Future profits are expected, so it is recognised.
Net closing liability = 16,000 − 12,000 = $4,000.
Movement = closing 4,000 − opening 10,000 = $(6,000), a credit.

Answer: Closing net deferred tax liability is $4,000. The year's movement is a credit of $6,000, which reduces the tax expense in profit or loss.

Exam tips

Read the question for the tax base. It is often given as the tax written-down value, or you must compute it from allowances claimed.
In OT questions, decide liability or asset by asking whether future taxable profit goes up or down. Then calculate.
In Section C, show the table of carrying amount, tax base and difference. Marks are given for each step even if one figure is wrong.
State whether the movement goes to profit or loss or to OCI. Revaluations are a favourite trap.
Use the tax rate given in the question and the rate for the year the difference reverses, if stated.

Practice questions from Taxation

Deferred Tax Basics and Temporary Differences in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Deferred Tax Basics and Temporary Differences: frequently asked questions

What is the difference between current tax and deferred tax?

Current tax is the tax payable or recoverable on the taxable profit of the period. Deferred tax is the tax effect of temporary differences that will reverse in future periods. Both are added together to give the tax expense in profit or loss.

What is a temporary difference in deferred tax?

It is the difference between the carrying amount of an asset or liability and its tax base. It is called temporary because it reverses over time. Taxable differences create liabilities and deductible differences create assets.

How do you calculate a deferred tax liability under IAS 12?

Find the carrying amount and tax base of each item and work out the taxable temporary difference. Multiply the total by the tax rate. The movement from the opening balance is the charge to profit or loss, unless the item is in OCI.

Is deferred tax discounted?

No. IAS 12 does not allow deferred tax assets and liabilities to be discounted. You calculate them at the undiscounted amount using the applicable tax rate.