Deferred Income Taxes

Income tax allocation is the method used to accrue income taxes expense on the basis of accounting income when accounting income and taxable income differ. The account used to record the difference between income taxes expense and income taxes payable is called as Deferred Income Taxes.

Let us take an example of Envest Corporation’s income statement. Envest Corporation has income taxes expense of 144,500 dollars. Suppose, however, that Envest’s actual income taxes payable are 92,000 dollars. The following entry shows how income tax allocation would treat this situation:

In the other years, Envest’s Income taxes Payable may exceed its Income Taxes Expense. In this case, the entry is the same except that Deferred Income Taxes is debited.

The financial Accounting Standards Board has issued specific rules for recording, measuring and classifying income taxes. Deferred income taxes are recognized for the estimated future tax effects resulting fro temporary differences in the valuation of assets, liabilities, equity, revenues, expenses, gains and losses for tax and financial reporting purposes.  Temporary differences include revenues and expenses or gains and losses that are included in taxable income before or after they are included in financial income. In other words, recognition point for revenues, expenses, gains and losses is not the same for tax and financial reporting.

For example, advance payments for goods and services, such as magazine subscriptions are not recognized as income until the products are shipped. However, for tax purposes, advance payments are usually recognized as revenue when cash is received. As a result, taxes paid exceed taxes expense, which creates a deferred income taxes asset (or prepaid taxes).

Questionnaire:

• What is deferred?
• Given an example of deferred income taxes?