Effects of Assets Leases on Financial ...
Introduction A lease is a contract between a lessor or owner of an... Read More
A deferred tax asset arises whenever a company’s taxable income exceeds its accounting profit. This variance results in an excess amount being paid for income taxes, which the company expects to recover in future operations.
On the other hand, a deferred tax liability arises whenever a deficit amount is paid for income taxes, and the company expects to eliminate this deficit during future operations.
Temporary differences occur whenever there is a difference between the tax base and the carrying amount of assets and liabilities on the balance sheet.
Permanent differences are differences between the tax and financial reporting of revenue or expense items that will not be reversed in the future.
The formation of deferred tax assets or liabilities from temporary differences can only occur if the differences will reverse themselves at some future date and to such an extent that the balance sheet items are expected to create future economic benefits for the company.
Temporary differences are divided into (i) taxable temporary differences and (ii) deductible temporary differences.
Taxable temporary differences are temporary differences that result in a taxable amount in the future when determining the taxable profit as the relevant balance sheet item is recovered or settled.
Taxable temporary differences result in a deferred tax liability when the carrying amount of an asset exceeds its tax base or when the tax base of liability exceeds its carrying amount.
Deductible temporary differences are temporary differences that result in a reduction or deduction of taxable income in the future when the relevant balance sheet item is recovered or settled. They result in a deferred tax asset when the tax base of an asset exceeds its carrying amount or the carrying amount of liability exceeds its tax base.
Since they are irreversible, permanent differences do not give rise to deferred tax assets or liabilities. Examples of the items that give rise to permanent differences include:
All permanent differences result in a difference between a company’s effective and statutory tax rates.
The following examples will help to highlight the implications of temporary and permanent differences.
Question 1
Canadian Syrup Inc. received a government grant of $2,000 to buy a domestically manufactured machine. The grant would result in:
- A permanent tax difference.
- A taxable temporary tax difference.
- A deductible temporary tax difference.
Solution
The correct answer is A.
The grant would result in a permanent difference because the difference is not expected to reverse in the future.
Question 2
Which of the following statements is the least accurate?
- Deferred tax assets and liabilities are recalculated at the end of each financial year.
- Deferred tax assets and liabilities are based on permanent differences, which result in a company paying an excess or deficit amount for taxes.
- A deferred tax asset or liability will not be created if there is no guarantee that future economic benefits will be derived from a temporary difference.
Solution
The correct answer is B.
Deferred tax assets and liabilities are based on temporary, not permanent, differences that result in a company paying an excess or deficit amount for taxes.
Options A and C are correct statements.