A difference of when a revenue (or gain)/expense (or loss) is included in financial income and when it is included in taxable income is referred to as a temporary difference. A temporary difference originates in one or two periods and reverses in a subsequent period. Temporary differences will result in taxable or deductible amounts in future periods. A future taxable amount means future taxable income will be increased relative to pretax accounting income, whereas a future deductible amount means taxable income will be decreased relative to accounting income, when that temporary difference reverses. Deferred tax liabilities are recognized for all taxable temporary differences. Deferred tax assets are recognized for all deductible temporary differences (and operating loss carryforwards). Listed below are 7 causes of temporary differences. For each temporary difference, follow the example 1 to 1) write the journal entry and highlight balance sheet account, 2) highlight or circle the items in the shaded parts of the statement.

1. Accrual of loss contingency (e.g., 1,000); tax-deductible when paid.

finance accounting	tax reporting
loss 1000, liability - loss contingency 1000 in later years when paid liability - loss contingency 1000 cash 1000	no entry in later years when paid loss 1000 cash 1000

2. Newspaper subscriptions (e.g, 1,000; taxable when cash is received, recognized for financial reporting when the performance obligation is satisfied. Journal entry and related balance sheet account:

financial accounting	tax reporting
in later years when the performance obligation is satisfied	in later years when performance is satisfied

3. Prepaid rent (e.g., 1,000); tax-deductible when paid. Journal entry and related balance sheet account:

financial accounting	tax reporting
when time passes in future year	when time passes in future year

A revenue (or gain)/expense (or loss) is recognized in the income statement before/after it is reported in the tax return. This temporary difference results in a future taxable/deductible amount. Therefore, a deferred tax liability/asset needs to be recognized in the current period.

4. Warranty expense(e.g. 1,000); estimated for financial reporting when products are sold; deducted for tax purposes when paid. FYI, the accrued interest expense has similar effect. Journal entry and related balance sheet account:

financial accounting	tax reporting
in future years when warranty was fulfilled	in future years when warranty was fufilled

A revenue (or gain)/expense (or loss) is recognized in the income statement before/after it is reported in the tax return. This temporary difference results in a future taxable/deductible amount. Therefore, a deferred tax liability/asset needs to be recognized in the current period.

5. Advance rent receipts (e.g., 1,000) on an operating lease (as the lessor); taxable when received. Journal entry and related balance sheet account in the year the temporary difference arises;

financial accounting	tax reporting
in later year when time passes	in later years when time passes

A revenue (or gain)/expense (or loss) is recognized in the income statement before/after it is reported in the tax return. This temporary difference results in a future taxable/deductible amount. Therefore, a deferred tax liability/asset needs to be recognized in the current period.

6. Straight-line depreciation for financial reporting; accelerated depreciation for tax purposes. Assume purchase at 10,000, straight line for financial reporting over five years. For tax return, $5,000 depreciation deduction is allowed for the first year. Journal entry and related balance sheet account in the year the temporary difference arises:

financial accounting
equipment cash depreciation expense accumulated depreciation book value of equipment by the end of first year: 10,000 (___) $ greater/less than the book value under tax basis	equipment cash depreciation expense accumulated depreciation book value (tax basis) of equipment by the end of first year: 10,000 (___) $

revenue (or gain)/expense (or loss) is recognized in the income statement slower/quicker than it is reported in the tax return. This temporary difference results in a future taxable/deductible amount. Therefore, a deferred tax liability/asset needs to be recognized in the current period.