A company calculates its income twice, under two genuinely different rulebooks, for two genuinely different purposes: accounting income, calculated under standard financial accounting rules and reported to investors and other stakeholders, and taxable income, calculated under a country's specific tax code and used to determine what the company actually owes in tax. These two figures routinely disagree, sometimes considerably, because the two rulebooks recognise certain revenues and expenses at genuinely different times, and deferred tax exists specifically as an accounting concept to track and record the resulting gap.
Timing differences, not disagreement about the underlying facts
The gap between accounting income and taxable income doesn't usually reflect any real disagreement about a company's underlying financial facts — both figures are ultimately built from the same actual revenues and expenses; they simply recognise some of those items at different points in time under the two different sets of rules. A common example is depreciation, spreading a long-lived asset's cost over its useful life: accounting rules and tax rules can specify a genuinely different depreciation schedule for the exact same asset, meaning a company's accounting income and its taxable income for a given specific year can differ meaningfully, purely because of when each rulebook allows that same underlying cost to be recognised, not because of any actual disagreement about the asset's real cost.
Deferred tax records that a future tax bill is coming, even if it isn't due yet
When taxable income is temporarily lower than accounting income in a given year, due to one of these timing differences, a company generally pays less actual tax that year than its reported accounting income alone might otherwise suggest — but that timing difference is expected to reverse in some future year, at which point taxable income will be temporarily higher instead, and more tax will become due at that later point to make up the difference. Deferred tax is the accounting entry that specifically records this expected future tax obligation now, in the period the timing difference actually arises, rather than waiting to record it only once the future tax bill it corresponds to actually comes due — giving readers of a company's financial statements a fuller, more accurate picture of tax obligations the company genuinely expects to face later, not just the specific amount it happens to be paying to tax authorities in the current year alone.
What we're still unsure about
The basic distinction between accounting income and taxable income, and deferred tax's role in tracking the resulting timing differences, are well-established, standardised accounting principles used consistently across most jurisdictions with modern financial reporting standards. What's more genuinely a matter of ongoing debate among accounting standard-setters and tax policymakers is how transparently and consistently deferred tax obligations should actually be presented and explained in a company's financial statements, given how complex and jurisdiction-specific the underlying timing differences generating them can genuinely be — accounting standards bodies continue to refine deferred tax reporting requirements, without full, universal agreement across different countries' own specific accounting and tax systems on exactly how the resulting disclosures should be structured and presented.
This sits inside Taxation Fundamentals, one of seven topics in Accounting, one of four domains in Business, one of seventeen subjects the app can quiz you on.