Deferred tax liabilities arise when what occurs?

• A. A tax expense is paid in cash
• B. A tax expense is reported but not paid
• C. Income tax is fully accrued
• D. No tax expense is reported

Answer: (B)

Deferred tax liabilities arise when a company recognizes a tax expense on its income statement that is not immediately payable in cash. This situation typically occurs when there are temporary differences between the accounting earnings and taxable income, leading to a situation where the tax expense is recognized before the actual cash payment is made to the tax authorities.

For instance, if a company uses accelerated depreciation methods for tax purposes but straight-line depreciation for accounting purposes, it will report higher depreciation expenses on its tax return in the early years, which will reduce taxable income. Consequently, the company will recognize a tax expense on its financial statements while deferring the actual cash payment of taxes, resulting in a deferred tax liability. This means that the company will have to pay those taxes in the future when the temporary differences reverse.

The other scenarios do not accurately describe the creation of deferred tax liabilities. When a tax expense is paid in cash, there are no deferred tax liabilities because the obligation has been settled. If income tax is fully accrued, this would typically imply that the expense has been both recognized and paid, negating the possibility of a deferred tax liability. Lastly, if no tax expense is reported, there can be no deferred tax liabilities as there is no tax effect to defer.