Accounting for deferred taxes

Deferred tax expense is the net change in the deferred tax liabilities and assets of a business during a reporting period. The amount of deferred taxes is compiled for each tax-paying component of a business that provides a consolidated tax return.

The accounting for deferred taxes requires that a business complete the following steps:

  1. Identify the existing temporary differences and carryforwards.
  2. Determine the deferred tax liability amount for those temporary differences that are taxable, using the applicable tax rate.
  3. Determine the deferred tax asset amount for those temporary differences that are deductible, as well as any operating loss carryforwards, using the applicable tax rate.
  4. Determine the deferred tax asset amount for any carryforwards involving tax credits.
  5. Create a valuation allowance for the deferred tax assets if there is a more than 50% probability that the company will not realize some portion of these assets. Any changes to this allowance are to be recorded within income from continuing operations on the income statement. The need for a valuation allowance is especially likely if a business has a history of letting various carryforwards expire unused, or it expects to incur losses in the next few years.