Introduction to Deferred Assets and Liabilities
Accounting assumes periodicity, the concept that a business's financial information can be packaged into a uniform amount of time. This amount of time is generally called a fiscal year. Though there are some specific conventions, a company can choose its own period. A typical fiscal year for large businesses is July 1 of the first year to June 30 of the next. Governmental organizations will often have fiscal years that start on October 1 so that newly elected officials have time to pass budget legislation.
The tax year, however, ends on December 31. A company may have a tax year that differs from the fiscal year it uses for financial reporting purposes. Because of the difference between the tax period and the fiscal period, a tax liability is incurred but will not be paid until a time outside of the period. Assume that Industry Corp. has a fiscal year ending on June 30 and a tax liability of $10,000. Because Industry Corp. can keep the money in a bank and earn interest, the company will not pay the taxes until the last day of the calendar year, December 31. This amount will show on the fiscal financial statements as a deferred tax liability, which is debt created as a result of the difference between financial statement income and taxable income. Though tax liabilities from out-of-period taxes are common, they are not the only situations that result in deferred tax liabilities or, as may be the case, deferred tax assets. A deferred tax asset is a current resource owned and created when the tax is paid in advance.Because tax regulations and accounting rules differ, there are circumstances where the tax base under the two systems will differ, causing a deferred tax situation. Typically, this occurs when depreciation, or the process of allocating the cost of a fixed asset to an expense account over the life of the asset, is different under the two systems. As an example of a deferred tax liability, assume that Industry Corp. owns a software program, an asset which costs $50,000 with a useful life of five years. Suppose that this asset is depreciated straight line on the income statement. In other words, the financial statements will have a depreciation expense of $10,000.