Understanding Deferred Tax: Definition, Examples, and Calculation

Deferred tax refers to the taxes that are payable in future periods as a result of transactions or events that have occurred in the current period. Deferred tax arises when there is a timing difference between the recognition of revenue or expenses for financial reporting purposes and the recognition of such items for tax purposes.

For example, if a company recognizes revenue in one period but is not allowed to deduct the related costs for tax purposes until a later period, then the company has a deferred tax liability (i.e., a tax asset) that must be paid in the future. Similarly, if a company deducts costs for tax purposes in one period but does not recognize the corresponding revenue for financial reporting purposes until a later period, then the company has a deferred tax asset (i.e., a tax payable) that must be paid in the future.

Deferred tax is calculated using the tax rates and laws that are expected to apply in the periods when the deferred tax assets or liabilities are recovered or settled. The measurement of deferred tax requires the use of estimates and judgments, and changes in these estimates can result in adjustments to the deferred tax balances.