The decision as to whether a deferred tax item is a deferred tax asset or deferred tax liability can be a tricky one to make. So let's look at an example to help us out. Here we've got a company and it has accounting depreciation expense of 100 in a year. As it's a depreciation expense, this will appear on its income statements. However, the tax authority only allows a deduction of 50, and that will go on the tax authority's tax calculation. So how do we reconcile those two figures? Well, on the left hand side of this table, we've got the tax authority calculations, and on the right hand side, we've got the accounting calculations which will impact the company's income statements. So the first line item is the tax authority allowable deduction is 50. This is lower than the accounting expense of 100. Okay, so if they've got a lower expense, we move on to the next line. It means the tax authority's profit before tax will be greater than the accounting profit before tax. If the tax authority's expense is lower, it will make the higher profit. So if my tax authority profit before tax is higher, that means my tax authority tax to be paid will also be higher. Higher profit equals higher taxes.

So let's imagine that the accounting tax expense just for argument's sake, equals 5, and the tax authority tax to be paid was 7. What's the impact on my cash taxes? Well, the tax authority tax to be paid is what actually gets paid. It's a cash flow. So the impact on my cash taxes is bad. I expected to pay 5. I'm actually paying 7. Oh dear. So my cash taxes versus my tax expense, you have to pay more in real cash. If I'm paying more, that means it feels like I'm overpaying, and that creates a deferred tax asset. I'll overpay or pay more today, but the benefit of that is that I'll get to pay less in the future, and that creates an asset which will give me future economic benefit. A deferred tax liability would be the opposite way around. That would be where I actually pay less today than I expected from my accounting tax expense. Because I pay less, that means I know I'll have to pay more in the future, so that creates a liability, a future obligation.