A deferred liabilities It is the money that a company receives from a customer as an advance payment for a product or service. It is included in the balance sheet as a liability until the good or service is delivered.
This is because the company would have to pay the money back if it did not keep its end of the deal as agreed. Therefore, it is an obligation for which it is not required to be canceled until a later period..
If the deferral is for more than one year, then the liability is classified on the company's balance sheet as a long-term liability. A deferred liability is also called deferred credit or deferred income..
Deferred tax liabilities are created when the amount of income tax expense is greater than the tax payable. This can happen when losses or expenses are tax deductible, before being recognized in the income statement..
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Long-term deferred liabilities are liabilities that do not mature within the current accounting period..
They are recorded as a liability on the balance sheet, along with the other long-term debt obligations, until they are paid. They are reported as a loss in the income statement.
Corresponds to income received in advance, such as commissions, interests, fees, leases, transportation, technical services, haulage and freight, pensions and tuition, goods in transit already sold, administration fees, and others..
It should be noted that in the event of a contingency of not being able to deliver the good or provide the service, the company must keep money available for a possible reimbursement.
Under certain circumstances, companies that carry out installment sales may record the profit obtained from the sales as deferred gross profit, and execute the proportional portion of the gross profit in realizable profit for the period only when recovering the portfolio being sold..
A deferred tax liability records the fact that the company will have to pay more income taxes in the future, due to a transaction that took place during the current period, such as an installment sale receivable..
It is a tax that must be paid for the current period, but has not yet been paid. The deferral is due to the time difference between when the tax is recorded and when it is actually paid.
In general, accounting rules differ from the tax laws of a country. This results in a difference in the income tax expense recognized in the income statement and the actual amount of the tax owed to the tax authorities..
The profit of a company before taxes indicated in the income statement may be greater than the taxable profit on the tax return. Due to this difference, deferred tax liabilities are created.
The deferred tax liability is created when the income or expense is recognized in the income statement, before it is subject to the payment of taxes..
For example, a company that made net profits for the year knows that it will have to pay taxes on those corporate profits. Because the tax liability applies for the current year, an expense for the same period must also be reflected..
However, the tax will not be paid until the next calendar year. To rectify the time difference between what is recorded and the actual payment, the tax is recorded as a deferred tax liability.
A common source of deferred tax liabilities is an installment sale, which is the income recognized when a business sells its products on credit to be paid in equal amounts in the future..
Under accounting rules, the company is allowed to recognize total income from the installment sale of merchandise in general, while tax laws require the company to recognize income as installment payments are made..
This creates a temporary positive difference between the company's accounting profit and taxable profit, as well as a deferred tax liability..
Another source of creating deferred tax liabilities is the difference in the treatment of depreciation expenses by tax laws and by accounting standards..
This happens when a company uses an accelerated depreciation method for tax filing and uses straight-line depreciation in the income statement..
Depreciation expense for assets, for financial statement purposes, is usually calculated using the straight-line method, while tax regulations allow the use of the accelerated depreciation method..
Since the straight-line method produces less depreciation compared to the accelerated method, a company's accounting profit is temporarily higher than its taxable profit..
The company recognizes the differential between the accounting profit before tax and the taxable profit, through the use of the deferred tax liability.
As the company continues to depreciate its assets, the difference between straight-line depreciation and accelerated depreciation is reduced. The amount of the deferred tax liability is gradually eliminated through a series of offsetting accounting entries..
Below is the income statement of ABC Company for financial reporting purposes. The income and expense numbers have not been changed to highlight the concept of deferred tax liability..
The asset to be depreciated is assumed to be worth $ 1,000, with a useful life of three years. It is depreciated using the straight-line depreciation method:
- Year 1: $ 333.
- Year 2: $ 333.
- Year 3: $ 334.
It should be noted that the tax expense is $ 350 for the three years, highlighted in yellow.
Now suppose that, for tax reporting purposes, the business uses an accelerated depreciation method. The depreciation profile looks like this:
- Year 1: $ 500.
- Year 2: $ 500.
- Year 3: $ 0.
It is noted that the tax to pay for year 1 is $ 300, year 2 is $ 300 and year 3 is $ 450.
When two different types of depreciation are used, for financial reporting and for tax purposes, this will result in the creation of a deferred liability..
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