Crash Course in Accounting and Financial Statement Analysis, Second Edition

Deferred Taxes

The income tax expense that a company records on its income statement in accordance with Generally Accepted Accounting Principles (GAAP) does not always equal the taxes a company actually owes to the IRS.

	Debit	Credit
COGS (SE)[1]	5
Inventories (A)		5

^[1] Sometimes companies disclose large write-downs separately on the income statement; other times they include them in COGS.

For the purposes of reporting financial statements to the public (via the SEC), companies prepare their financial statements in accordance with U.S. GAAP. Companies trading in exchanges outside the United States may report in accordance with the GAAP of their respective countries. Under GAAP, tax expense is calculated based on the GAAP pretax income.

Source: Used with permission. Microsoft 2005 Annual Report.

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However, in addition to reporting these financial statements, companies must also prepare financial statements to the IRS for filing tax returns. The differences (Exhibit 6.4) between GAAP tax expense and IRS taxes payable are recorded as deferred tax assets and liabilities.

Exhibit 6.4. How Do GAAP and IRS Taxes Differ?

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Advanced Discussion: Deferred Tax Asset

A deferred tax asset is created when taxes payable to the IRS are higher than those recorded ...