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Deferred tax explained: assets, liabilities and the direction test

The Summo Notes team9 min readUpdated August 2026
  • Carrying amount against tax base
  • Taxable or deductible
  • Never discounted
Deferred tax explained header, an accountant at a desk working through a tax reconciliation on paper beside a laptop, in a bright Australian office.

Deferred tax is the tax effect of timing differences between accounting and tax. It arises when an item's carrying amount in the accounts differs from its tax base, because that gap will reverse in a future period. Compare the two figures, work out whether the difference is taxable or deductible, then multiply by the tax rate expected when it reverses. The result is a deferred tax liability or a deferred tax asset, and it is never discounted.

On this page
  1. The whole topic in one comparison
  2. Why it exists at all
  3. The tax base
  4. The method, start to finish
  5. Reading the direction
  6. Two worked examples
  7. Permanent differences are not your problem
  8. When an asset does not count
  9. Traps that cost easy marks
  10. Your deferred tax checklist
  11. Questions people ask
  12. Keep going

The short version

  • The accounts and the tax return measure the same thing in different ways. Deferred tax is the gap between them.
  • Every question turns on one comparison: the carrying amount against the tax base.
  • For an asset, above the tax base gives a liability. For a liability, it flips.
  • Multiply the difference by the tax rate. Never discount it.
  • Differences that never reverse are permanent, and they create no deferred tax at all.
Jump to the checklist

The whole topic in one comparison

Deferred tax has a reputation it half deserves. The idea is small and the maths is one multiplication. What makes it expensive is direction. Get the comparison the wrong way round and a question you understood perfectly turns into lost marks, with no partial credit to soften it.

So the good news is that this drills well. There is one comparison, one rule for reading it, and one multiplication. Once those are automatic, most deferred tax questions become data entry.

Deferred tax is examined in both programs: inside Financial Reporting in the CPA Program subjects, and inside Financial Accounting and Reporting in the CA Program subjects.

Why it exists at all

Your accounts and your tax return are two different measurements of the same business.

The accounts ask when an item earns or costs you something. Tax asks when the law lets you deduct it or makes you include it. Those two answers often land in different years.

Depreciation is the usual example. The accounts write an asset down over its useful life. The tax rules write it off on their own schedule. Over the whole life of the asset the total is the same. In any single year it is not, and that gap has to unwind eventually.

Deferred tax records the unwinding before it happens. It is not money you owe today and nobody is going to send you a bill for it.

The tax base

Everything depends on one number that never appears in your accounts.

The carrying amount is what the item is worth in the books. The tax base is what it is worth to the tax office.

For an asset, the tax base is the amount you can still deduct in future. For a liability, it is the carrying amount less anything you will be able to deduct in future.

That second one is the definition people skip, and it is the reason the rule flips between assets and liabilities. Read it twice.

The gap between the two figures is the temporary difference. Temporary is doing real work in that phrase. The difference will reverse. If it never will, it is not a temporary difference and no deferred tax arises.

The method, start to finish

The deferred tax methodStep one, write down the carrying amount and the tax base. Step two, subtract to get the temporary difference. Step three, read the direction, which depends on whether the item is an asset or a liability. Step four, multiply the difference by the tax rate expected when it reverses.1Write both figures downCarrying amount from the accounts, tax base from the tax rules.2SubtractCarrying amount less tax base is the temporary difference.3Read the directionAsset or liability decides which way it runs. This is the step that costs marks.4Multiply by the rateUse the rate expected to apply when the difference reverses.
The four steps, in orderA high-level illustration of the method, not a substitute for the standard.

Step three is the only hard one. The other three are arithmetic.

Reading the direction

Most guides show you the asset case and stop there. That is fine until a question hands you a liability, and then the rule you memorised gives you the wrong answer.

Here is the whole thing on one grid.

The direction test for assets and liabilitiesFor an asset carried above its tax base, the difference is taxable and gives a deferred tax liability. For an asset carried below, it is deductible and gives a deferred tax asset. For a liability the results are reversed: carried above its tax base gives a deferred tax asset, carried below gives a deferred tax liability.Above its tax baseBelow its tax baseAssetTaxable differenceDeferred tax liabilityDeductible differenceDeferred tax assetLiabilityDeductible differenceDeferred tax assetTaxable differenceDeferred tax liability
Which way the difference runs, for assets and for liabilitiesA high-level illustration of the method, not a substitute for the standard.

If you only remember one thing

Ask whether the difference means more tax later or less tax later. More tax later is a liability. Less tax later is an asset. The carrying amount comparison is a shortcut to that question, which is why the shortcut flips between assets and liabilities while the question never does.

More tax later is a liability. Less tax later is an asset. Every direction question comes back to that.

Two worked examples

Worked example

An asset is carried at 100 and its tax base is 60.

The carrying amount is above the tax base, so the difference is 40. It is an asset, so above means taxable. That is a deferred tax liability of 40 times the tax rate.

Read what that says. The accounts have already recognised value the tax return has not been charged on. When the asset is used or sold, tax catches up. The liability books that catch-up now.

Worked example

Now a liability, carried at 100, tax base nil, because the whole amount is deductible when it is paid.

The difference is 100. It is a liability, so above means deductible. That is a deferred tax asset of 100 times the tax rate. Future tax will be lower, so the benefit is recognised now.

Same subtraction, opposite answer. The only thing that changed was whether the item was an asset or a liability.

Exam trap

Two slips cost most of the marks here. The first is discounting the balance. Deferred tax is not discounted, no matter how long the reversal takes. The second is taxing the same difference twice, once in one calculation and again in another. Fix the direction first, then reach for the calculator.

Permanent differences are not your problem

Some differences never reverse. A fine you cannot deduct, or income that is never taxable, leaves a gap between accounting profit and taxable profit that just sits there.

These are permanent differences and they produce no deferred tax. Nothing unwinds, so there is nothing to record.

The mistake is sweeping every difference between accounting and tax into one pile and running the method over the lot. Sort first. Ask whether it will ever reverse. If the answer is no, set it aside.

When an asset does not count

Liabilities get recognised whenever a taxable difference exists. Assets do not.

A deferred tax asset is only worth something if there will be future taxable profit to use it against. A benefit you can never claim is not an asset. So it is recognised only to the extent that future taxable profit is probable.

That is the judgement half of an otherwise mechanical topic, and it is where extended response and written submission questions go. The number is not enough. You need a sentence saying why the entity expects to be able to use it.

Must know
The direction testCarrying amount against tax base, which way it runs for assets and for liabilities, then multiply. Drill it until it is automatic. It is the highest return method in the whole topic.
Should know
When a deferred tax asset countsThe future taxable profit test, and how to write the reasoning rather than just the number. This is where the written marks sit.
Worth a pass
Presentation and offsettingHow the balances are shown and when they can be offset. Smaller, and cheap to learn once the method is solid.

Traps that cost easy marks

The five that catch people

Getting the direction backwards, so a liability becomes an asset. Applying the asset rule to a liability, where the shortcut inverts. Discounting the balance, which is never right. Recognising a deferred tax asset with no support for future taxable profit. And running the method over permanent differences that were never going to reverse. Every one is a process slip rather than a knowledge gap, so every one is preventable.

Your deferred tax checklist

Make the method automatic

0 of 6 done

Six short drills that turn the direction test into something you do without thinking. Progress saves in your browser.

Nice. That is the hard thinking done.

Get the second and third of those cold and most of what this topic asks is already answered.

Questions people ask

What is the difference between a deferred tax asset and a deferred tax liability?
A liability means more tax is coming later, because the accounts have recognised something the tax return has not been charged on yet. An asset means less tax is coming later, because a future deduction is already sitting there. Which one you get depends on the direction of the difference and on whether the item is an asset or a liability.
Is deferred tax ever discounted?
No. It is the temporary difference multiplied by the tax rate, full stop. Discounting it is one of the most common slips in the topic, and it is a straight loss of marks every time.
Which tax rate do I use?
The rate expected to apply when the difference reverses, not automatically the current year rate. If a change in rate has been enacted or substantively enacted, that is the one the reversal will meet.
How do I tell a permanent difference from a temporary one?
Ask whether it will ever reverse. A temporary difference unwinds in a future period. A permanent one, like a non-deductible fine, never does, so it creates no deferred tax at all.
Why do assets and liabilities work in opposite directions?
Because the tax base means something different for each. For an asset it is what you can still deduct. For a liability it is the carrying amount less what you will deduct later. Once you know that, the flip stops being arbitrary and becomes obvious.

Want the method already on a page?

Our Financial Accounting and Reporting pack puts the deferred tax and consolidation methods on a page, with a cheat sheet built for an open-book sitting, practice questions and worked solutions. Your time goes on practice, not on making notes.

See the Financial Accounting and Reporting pack

Keep going

Deferred tax is one of the anchor topics in two subjects. See where it sits in the Financial Reporting study guide and the Financial Accounting and Reporting study guide. Then read how to find the topics that carry the marks, which is the method behind why we say start here.