Textbook Problem

Deferred Tax Assets and Liabilities

A friend says to you, “I don’t understand how taxable temporary differences can be ‘liabilities’ and how deductible temporary differences can be ‘assets.’ It seems to me that these temporary differences relate only to the future and that accounting is based on ‘historical cost.’ In addition, the government frequently changes the tax laws, so no one knows what the future tax laws will be.”

Required:

Prepare a written response for your friend that explains why deferred tax assets and deferred tax liabilities are recognized and reported on a corporation’s balance sheet. Include a discussion of a valuation allowance.