Temporary Difference

What is a temporary difference?

A temporary difference is a gap between book income and tax income that will reverse in a future period. The total amount recognized is the same for both book and tax purposes, but the timing differs. Depreciation is the classic example: accelerated tax depreciation creates higher deductions early and lower deductions later, while book depreciation spreads evenly. Over the asset's life, total depreciation equals the same amount under both methods.

Deferred taxes from temporary differences

When you pay less tax now due to timing, you create a deferred tax liability because you will pay more later. When you pay more now but will pay less later, you create a deferred tax asset. These balance sheet items track the future tax impact of temporary differences. They matter for accrual-basis financial reporting and can affect valuations.

Tracking temporary differences

Your accountant maintains a schedule of temporary differences, tracking when each will reverse. Large differences require disclosure in financial statement notes. When differences reverse, your cash taxes increase or decrease accordingly. Understanding this timing helps with cash forecasting and prevents surprise tax bills when deferred liabilities come due.