Deferred tax under IAS 12 is one of the most error-prone areas in financial reporting. The formula — temporary difference × tax rate — looks simple, but the correct application demands careful professional judgment at every step.
We examine 7 common mistakes along with worked numerical examples, journal entries and practical tips to help you avoid them in your next close.
What Is Deferred Tax and Why Does It Matter?
Differences between accounting profit and taxable profit fall into two categories:
- ›Permanent differences (non-deductible fines, exempt income): Never reverse. No deferred tax arises.
- ›Temporary differences (depreciation timing, provisions, lease liabilities): Reverse in future periods. These create Deferred Tax Assets (DTA) or Liabilities (DTL).
- ›Rule: Only temporary differences that will reverse in future periods give rise to deferred tax. Including permanent differences is a fundamental misapplication.
- ✓How to distinguish temporary vs. permanent differences with numerical examples
- ✓How to apply the recoverability test for DTA recognition
- ✓How to remeasure balances when the tax rate changes
- ✓When DTA and DTL can (and cannot) be offset
- ✓Where to record deferred tax on equity transactions
- ✓How to apply the goodwill exception in business combinations
- ✓How to develop a realistic loss carryforward DTA policy
Mistake 1: Confusing Temporary and Permanent Differences
This is the most fundamental error. Not every book-tax difference creates deferred tax. Only differences that will reverse in future periods — and thereby affect future taxable profit — give rise to DTA or DTL.
❌ Wrong: Recording DTA on non-deductible fines or permanently disallowed expenses. These items will never affect taxable profit in any future period.
📌 Worked Example — Two differences — one temporary, one permanent
- Item A — Non-deductible fine: $50,000
- → Will never be deducted. Permanent difference. No DTA.
- Item B — Employee benefit provision: $200,000
- → Deducted for tax only when paid. Temporary difference.
- → DTA = $200,000 × 25% = $50,000
✅ Correct Approach — Test to apply for every difference
"Will this difference reverse in a future period and affect taxable profit?" If the answer is no, no deferred tax is recognised.
📒 Journal Entry
Dr: Deferred Tax Asset ........... 50,000
Cr: Deferred Tax Expense (Income) 50,000
💡 Practical Tip Add a "Difference Type" column to your tax reconciliation workpaper. Categorising each item forces a deliberate judgment rather than defaulting to "deferred tax on everything".
Mistake 2: Recognising DTA Without a Recoverability Test
IAS 12 para. 24 requires a DTA to be recognised only to the extent it is probable that sufficient taxable profit will be available. "Probable" means more likely than not — optimistic or unsupported projections do not qualify.
❌ Wrong: Recognising $800,000 DTA after three consecutive loss years based solely on a verbal expectation of returning to profit with no written business plan or signed contracts.
📌 Worked Example — Recoverability test in practice
- Total deductible temporary difference: $800,000
- Loss carryforward limit: 5 years
- Approved profit forecast:
- • Year +1: $100,000 taxable profit
- • Year +2: $250,000 taxable profit
- • Years +3 to +5: uncertain
- Supportable DTA = $350,000 × 25% = $87,500
- Remaining $450,000 → DTA not recognised.
✅ Correct Approach — What constitutes sufficient evidence?
Approved budgets, signed customer contracts, market analyses, and historical profitability trends. Management intent alone is not enough; evidence must be objective and verifiable.
💡 Practical Tip Review DTA balances at every reporting date. If prior-period projections did not materialise, reduce or write down the DTA immediately — do not carry forward unsupported assets.
Mistake 3: Using the Wrong Tax Rate
IAS 12 para. 47 requires deferred tax to be measured using the tax rates expected to apply in the period the difference reverses, based on rates enacted or substantively enacted at the reporting date.
❌ Wrong: Continuing to use the 25% rate when a 20% rate has been enacted effective next year before the reporting date.
📌 Worked Example — Rate change impact
- Existing DTL: $500,000 temporary difference
- At 25%: DTL = $125,000
- At 20%: DTL = $100,000
- Difference: $25,000 — recognised as tax income in P&L.
✅ Correct Approach — When a rate change is enacted
Remeasure all DTA and DTL balances immediately. The resulting adjustment is recognised in P&L, or in equity if the underlying transaction was equity-based.
📒 Journal Entry
(Rate reduction → DTL decreases → tax income):
Dr: Deferred Tax Liability ........ 25,000
Cr: Deferred Tax Expense (Income) 25,000
💡 Practical Tip Build a tax legislation monitoring step into your close calendar. Rate changes enacted mid-year must be reflected in that interim period's financial statements.
Mistake 4: Incorrectly Offsetting DTA and DTL
IAS 12 para. 74 allows offset only when (1) there is a legally enforceable right to set off current tax assets against current tax liabilities, AND (2) they relate to the same taxable entity and the same tax authority. Both conditions must be met simultaneously.
❌ Wrong: Netting a parent's DTA against a subsidiary's DTL when they are separate tax entities with no consolidated tax return.
📌 Worked Example — Offset test
- Parent (Entity A): DTA = $300,000
- Subsidiary (Entity B): DTL = $200,000
- → Separate legal entities, different tax returns.
- → Cannot offset. Present gross on the balance sheet.
✅ Correct Approach — When is offset correct?
Same legal entity (or consolidated tax group filing a single return) and same tax authority. In consolidated statements: also verify that reversal periods overlap.
💡 Practical Tip Document the offset test annually. Group structures and tax laws change — what was permissible last year may not be this year.
Mistake 5: Omitting Deferred Tax on Equity Transactions
IAS 12 para. 61A: if a transaction is recognised directly in equity, the related deferred tax effect is also recognised directly in equity — not in profit or loss.
❌ Wrong: Recognising a $1,000,000 revaluation surplus in OCI but recording the related $250,000 DTL as a tax expense in P&L.
📌 Worked Example — Land revaluation — correct treatment
- Revaluation surplus: $1,000,000 → recorded in OCI
- DTL = $1,000,000 × 25% = $250,000 → must go to OCI too
✅ Correct Approach — The matching principle for deferred tax
Deferred tax follows the underlying transaction. Analyse every OCI item separately and ensure its deferred tax effect lands in the same statement.
📒 Journal Entry
Dr: OCI — Revaluation Surplus ...... 250,000
Cr: Deferred Tax Liability .......... 250,000
💡 Practical Tip List all OCI items (hedging, foreign currency translation, pension remeasurements) and compute deferred tax for each separately at year-end.
Mistake 6: Misapplying the Goodwill Exception in Business Combinations
IFRS 3 business combinations require fair value of identifiable assets and liabilities, which often differ from their tax bases — creating temporary differences. However, IAS 12 para. 15(a) prohibits recognising a DTL on the initial recognition of goodwill itself.
❌ Wrong: Either recognising DTL on the goodwill line itself, or failing to recognise DTL on the temporary differences in identifiable assets.
📌 Worked Example — Business combination deferred tax analysis
- Acquisition price: $5,000,000
- Fair value of net identifiable assets: $4,000,000
- Goodwill: $1,000,000 → No DTL (exception applies)
- Building: FV $2,000,000 | Tax base $1,500,000
- → DTL = $500,000 × 25% = $125,000 ✓
- Brand: FV $800,000 | Tax base $0
- → DTL = $800,000 × 25% = $200,000 ✓
✅ Correct Approach — Correct approach in a combination
For every identifiable asset and liability, compare fair value to tax base and recognise deferred tax on the difference. Do not recognise DTL on goodwill itself at initial recognition.
💡 Practical Tip During the 12-month measurement period under IFRS 3, update identifiable asset valuations as new information becomes available — deferred tax balances must be updated in parallel.
Mistake 7: Unrealistic DTA on Loss Carryforwards
Consecutive loss years are strong negative evidence under IAS 12 para. 35 that sufficient taxable profit will not be available. Loss carryforward periods are legally limited — in Turkey, the limit is 5 years. Overstating DTA distorts the balance sheet and may signal going concern issues.
❌ Wrong: After 4 loss years, recognising $2,000,000 DTA based on an undocumented sector-recovery assumption with no supporting business plan.
📌 Worked Example — Carryforward limit and realistic DTA
- Cumulative losses: $4,000,000 (Years 1–4)
- Years remaining to use: 1 (5-year limit)
- Approved forecast — Year 5: $500,000 taxable profit
- Supportable DTA = $500,000 × 25% = $125,000
- Remaining $3,500,000 → DTA not recognised (will expire)
✅ Correct Approach — 3-step realistic DTA policy
1) Track each year's loss and remaining carryforward window. 2) Recognise DTA only up to the amount supported by written, approved forecasts. 3) Review and update every reporting period — write down if projections are not met.
💡 Practical Tip Maintain a loss carryforward schedule showing each year's loss, remaining years, and probable utilisation. This is one of the first documents auditors will request.
Period-End Control Checklist
- ✓ Temporary vs. permanent test performed for every difference?
- ✓ DTA supported by probable taxable profit projections?
- ✓ Tax rate corresponds to the reversal period?
- ✓ All DTA/DTL balances remeasured after any rate change?
- ✓ Both legal right AND same tax authority conditions met before offsetting?
- ✓ Equity-related deferred tax effects recorded in equity (not P&L)?
- ✓ Goodwill exception applied; identifiable asset/liability differences measured separately?
- ✓ Loss carryforward period and realistic profit projections reviewed?
Conclusion: Always Ask "Will This Difference Actually Reverse?"
Deferred tax is technically a simple formula, but every step requires professional judgment. The most common root cause of errors is skipping the question: "Is this difference temporary or permanent?"
Running the period-end checklist above with your team before each close will materially improve both your audit experience and the quality of your financial statements.
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This article is for general information only and is not a substitute for transaction-specific accounting or tax advice.