how deferred tax liability works
the deferred tax liability on a company balance sheet represents a future tax payment that the company is obligated to pay in the future 2it is calculated as the company s anticipated tax rate times the difference between its taxable income and accounting earnings before taxes deferred tax liability is the amount of taxes a company has underpaid which will be made up in the future this doesn t mean that the company hasn t fulfilled its tax obligations rather it recognizes a payment that is not yet due for example a company that earned net income for the year knows it will have to pay corporate income taxes because the tax liability applies to the current year it must reflect an expense for the same period 3 but the tax will not actually be paid until the next calendar year in order to rectify the accrual cash timing difference tax is recorded as a deferred tax liability examples of deferred tax liabilitya common source of deferred tax liability is the difference in depreciation expense treatment by tax laws and accounting rules the depreciation expense for long lived assets for financial statement purposes is typically calculated using a straight line method while tax regulations allow companies to use an accelerated depreciation method since the straight line method produces lower depreciation when compared to that of the under accelerated method a company s accounting income is temporarily higher than its taxable income the company recognizes the deferred tax liability on the differential between its accounting earnings before taxes and taxable income as the company continues depreciating its assets the difference between straight line depreciation and accelerated depreciation narrows and the amount of deferred tax liability is gradually removed through a series of offsetting accounting entries another common source of deferred tax liability is an installment sale this is the revenue recognized when a company sells its products on credit to be paid off in equal amounts in the future 2under accounting rules the company is allowed to recognize full income from the installment sale of general merchandise while tax laws require companies to recognize the income when installment payments are made 4this creates a temporary positive difference between the company s accounting earnings and taxable income as well as a deferred tax liability 2