CFA Level I Exam · Analysis of Income Taxes

Deferred Tax Assets and Liabilities for CFA Level I

Q: What is the difference between a deferred tax asset and a deferred tax liability?

A deferred tax liability means tax will be paid in the future on income already recognised in accounting. A deferred tax asset means tax relief will come in the future because the company has already paid more tax than its accounting profit implies.

Q: How do you calculate a deferred tax liability in CFA Level I?

Find the carrying amount and the tax base, take the difference, and multiply by the enacted tax rate. For an asset, a carrying amount above the tax base gives a DTL.

Q: Why does accelerated depreciation create a deferred tax liability?

Tax depreciation is higher early, so taxable income and tax paid are lower than the accounting figures suggest. The tax base falls below the carrying amount. The difference reverses in later years, when tax paid rises.

Q: Are deferred taxes discounted under IFRS?

No. Deferred tax assets and liabilities are measured at undiscounted amounts using the enacted tax rate expected to apply when the difference reverses.

Updated 7 October 2026 · Fact-checked

A deferred tax liability arises when taxable income is lower than accounting profit today, so more tax will be paid later. A deferred tax asset arises when taxable income is higher today, so less tax will be paid later. Measure it as the temporary difference × the enacted tax rate.

Understand Deferred Tax Assets and Liabilities

Companies keep two sets of books. One follows IFRS and gives accounting profit. The other follows tax law and gives taxable income. The two often differ in timing, not in total.

A temporary difference is the gap between an asset's or liability's carrying amount (in the financial statements) and its tax base (what the tax authority recognises). It will reverse in future periods. Tax expense on the income statement is based on accounting profit, but tax actually paid is based on taxable income. Deferred tax bridges the two.

A deferred tax liability (DTL) means the company has paid less tax than its income statement suggests, and the tax will come due later. A common cause is faster depreciation for tax than for accounting. Tax depreciation is higher early, so taxable income is lower, the tax base is lower than the carrying amount, and a DTL builds. It reverses in later years when tax depreciation falls below accounting depreciation.

A deferred tax asset (DTA) means the company has paid more tax than its income statement suggests and will get relief later. A common cause is a temporary difference such as warranty expense or bad debt expense recognised in accounting before it is deductible for tax. Unused tax losses and unused tax credits carried forward are a separate source of DTAs. They are not temporary differences between a carrying amount and a tax base. They are deductible amounts that reduce future tax. Under IFRS, a DTA is recognised only if it is probable that future taxable profit will be available to use it.

Quick rule for an asset: carrying amount > tax base gives a DTL. Carrying amount < tax base gives a DTA. For a liability it is reversed: carrying amount > tax base gives a DTA, carrying amount < tax base gives a DTL. Deferred taxes are measured at the tax rate expected to apply when the difference reverses, based on enacted rates. Under IFRS, deferred tax is not discounted.

Key formulas to remember

Deferred tax balance: Deferred tax = temporary difference × enacted tax rate; Use the rate expected to apply when the difference reverses.
Asset test: Asset: carrying amount > tax base → DTL; carrying amount < tax base → DTA; Temporary difference = |carrying amount − tax base|.
Liability test: Liability: carrying amount > tax base → DTA; carrying amount < tax base → DTL; Opposite direction to the asset test.
Income tax expense: Income tax expense = income tax payable + increase in DTL − increase in DTA; Payable is taxable income × tax rate. Use net changes in the balances. The DTA change is net of any reduction for amounts that are not recoverable. Under IFRS, the DTA carrying amount is reduced to the amount that is probable to be recovered. A separate valuation allowance is a US GAAP mechanism.
Income tax payable: Income tax payable = taxable income × tax rate; This is the cash tax for the period, before deferred items.

How to solve Deferred Tax Assets and Liabilities questions

Use this method for any question on deferred tax assets and liabilities.

1Identify the item: an asset or a liability, and what accounting or tax treatment differs.
2Find the carrying amount (financial statements) and the tax base (tax records).
3Compute the temporary difference as the gap between them.
4Decide direction using the asset or liability rule: DTL or DTA.
5Multiply by the enacted tax rate expected when the difference reverses.
6If asked for tax expense, add the change in DTL and subtract the change in DTA from tax payable.
7Check the sign and whether the difference is temporary. Permanent differences create no deferred tax.

Quickest way: Direction check in ten seconds

When to use it: Use for MCQs that ask whether a DTA or DTL arises, or whether one is rising or falling.

Ask: will future taxable income be higher or lower than future accounting profit when this reverses?
If tax will be paid later on higher taxable income, it is a DTL.
If taxable income will be lower later (relief ahead), it is a DTA.
Eliminate options with the wrong direction first, then compute difference × rate.
Remember tax depreciation faster than accounting depreciation leads to a DTL.

Common mistakes in Deferred Tax Assets and Liabilities

Reversing the asset and liability rules
Students memorise one rule and apply it to both.
Fix: For assets, higher carrying amount gives a DTL. For liabilities, higher carrying amount gives a DTA. Think of future tax effect instead.
Creating deferred tax for permanent differences
Any gap between accounting profit and taxable income looks the same.
Fix: Only temporary differences reverse. Items never taxed or never deductible create no deferred tax.
Using the current tax rate when a new rate is enacted
Students default to the rate in the question's first line.
Fix: Use the enacted rate expected when the difference reverses.
Applying the rate to the wrong base
Students multiply the full carrying amount by the rate.
Fix: Multiply only the temporary difference, not the whole balance.
Adding the DTA increase to tax expense
Sign confusion between balance sheet and income statement.
Fix: An increase in a DTA reduces tax expense. An increase in a DTL raises it.

Worked examples

Example 1

A company buys equipment for $100,000. For accounting it uses straight-line depreciation over 5 years with no salvage value. For tax it deducts $40,000 in year 1. The tax rate is 30%. What deferred tax balance exists at the end of year 1?

Show the solution

Carrying amount = 100,000 − 20,000 = $80,000.
Tax base = 100,000 − 40,000 = $60,000.
Carrying amount exceeds tax base for an asset, so a DTL arises.
Temporary difference = 80,000 − 60,000 = $20,000.
DTL = 20,000 × 30% = $6,000.

Answer: A deferred tax liability of $6,000.

Example 2

A company reports pre-tax accounting profit of €500,000. It records a warranty expense of €60,000 that is deductible for tax only when paid, and no payments were made this year. The tax rate is 25%. Calculate income tax payable, deferred tax and income tax expense.

Show the solution

Taxable income = 500,000 + 60,000 = €560,000.
Income tax payable = 560,000 × 25% = €140,000.
The warranty provision is a liability with a carrying amount of €60,000 and a tax base of zero. For a liability, carrying amount above tax base gives a DTA.
DTA = 60,000 × 25% = €15,000.
Income tax expense = 140,000 − 15,000 = €125,000.
Check: 500,000 × 25% = €125,000.

Answer: Tax payable is €140,000, DTA is €15,000, and income tax expense is €125,000.

Exam tips

Most questions test direction first. Decide DTA or DTL before doing any arithmetic.
Watch for a tax rate change in the stem. Remeasure the deferred balance at the new enacted rate.
Check whether the question says IFRS. Deferred tax is not discounted, and DTAs need probable future profit.
Link this topic to unrecoverable DTAs and tax loss carryforwards. Under IFRS, a DTA is written down to the probable recoverable amount. Under US GAAP, a valuation allowance does this job. In both cases, a larger reduction signals doubts about future profits.
With three options listed smallest to largest, a quick estimate of difference × rate usually eliminates two.

Practice questions from Analysis of Income Taxes

Deferred Tax Assets and Liabilities 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 Assets and Liabilities: frequently asked questions

What is the difference between a deferred tax asset and a deferred tax liability?

A deferred tax liability means tax will be paid in the future on income already recognised in accounting. A deferred tax asset means tax relief will come in the future because the company has already paid more tax than its accounting profit implies.

How do you calculate a deferred tax liability in CFA Level I?

Find the carrying amount and the tax base, take the difference, and multiply by the enacted tax rate. For an asset, a carrying amount above the tax base gives a DTL.

Why does accelerated depreciation create a deferred tax liability?

Tax depreciation is higher early, so taxable income and tax paid are lower than the accounting figures suggest. The tax base falls below the carrying amount. The difference reverses in later years, when tax paid rises.

Are deferred taxes discounted under IFRS?

No. Deferred tax assets and liabilities are measured at undiscounted amounts using the enacted tax rate expected to apply when the difference reverses.