Key Takeaways
- A temporary difference exists whenever an asset's or liability's carrying amount differs from its tax base, even if no tax is currently payable.
- Taxable temporary differences produce deferred tax liabilities; deductible temporary differences produce deferred tax assets (subject to the probability test).
- IAS 12.24 requires a deferred tax asset to be recognised only to the extent that it is probable (typically interpreted as above 50%) that taxable profit will be available against which the deductible difference can be used.
- Temporary differences reverse over the life of the asset or liability, unlike permanent differences, which never reverse.
What is Temporary Difference?
IAS 12.5 defines a temporary difference as the gap between an asset's or liability's carrying amount and its tax base. The tax base of an asset is the amount that will be deductible for tax purposes against future taxable economic benefits (IAS 12.7). The tax base of a liability is its carrying amount minus any amount that will be deductible for tax in future periods (IAS 12.8).
When the carrying amount of an asset exceeds its tax base, the difference is taxable: recovering the asset will generate taxable income in excess of the tax-deductible amount. IAS 12.15 requires an entity to recognise a deferred tax liability for all taxable temporary differences, with limited exceptions (goodwill on initial recognition, for instance). In the opposite direction, when the tax base exceeds the carrying amount, the difference is deductible. IAS 12.24 permits recognition of a deferred tax asset only when probable future taxable profit exists to absorb it.
The measurement rate is prescribed by IAS 12.47: deferred tax is measured at the tax rates expected to apply when the temporary difference reverses, using rates enacted or substantively enacted by the reporting date. For the auditor, ISA 540.13(a) requires evaluation of whether the entity's method for the accounting estimate is appropriate. That means testing the projected taxable profit forecasts supporting deferred tax assets and verifying the tax rate applied to each category of temporary difference.
Worked example: Bergstrom Skog AB
Client: Swedish forestry and paper company, FY2025, revenue EUR 75M, IFRS reporter. Bergstrom acquires a paper-drying line on 1 January 2025 for EUR 2,400,000. For accounting purposes, the asset is depreciated straight-line over 10 years (EUR 240,000 per year). Swedish tax law permits accelerated depreciation at 30% of the declining balance in year one.
Step 1 — Determine the carrying amount and tax base at 31 December 2025
The accounting carrying amount after one year of straight-line depreciation is EUR 2,400,000 minus EUR 240,000, giving EUR 2,160,000. The tax depreciation in year one is 30% of EUR 2,400,000, giving EUR 720,000. The tax base is EUR 2,400,000 minus EUR 720,000, producing EUR 1,680,000.
Documentation note: record the carrying amount per the fixed-asset register and the tax base per the corporate tax computation. Cross-reference the tax depreciation rate to the applicable provision of Swedish income tax law (Inkomstskattelagen Chapter 18).
Step 2 — Identify the temporary difference and its direction
The carrying amount (EUR 2,160,000) exceeds the tax base (EUR 1,680,000) by EUR 480,000. This is a taxable temporary difference because recovering the asset at its carrying amount will produce future taxable income in excess of the remaining tax-deductible amount.
Documentation note: record the nature of the difference (taxable), the amount (EUR 480,000), and the reason (accelerated tax depreciation creates a front-loaded deduction that reverses in later years). Reference IAS 12.15–18.
Step 3 — Recognise the deferred tax liability
Sweden's corporate income tax rate is 20.6%. The deferred tax liability is EUR 480,000 multiplied by 20.6%, giving EUR 98,880. IAS 12.47 requires the rate to be enacted or substantively enacted at the reporting date. The 20.6% rate has been in force since 2019 with no announced changes.
Documentation note: record the tax rate applied, the source (Inkomstskattelagen 65:10), the resulting deferred tax liability of EUR 98,880, and the journal entry (debit tax expense, credit deferred tax liability). Attach the enacted rate confirmation.
Step 4 — Consider reversal over time
Over the remaining nine years, the accounting depreciation charge will continue at EUR 240,000 per year while the declining-balance tax deduction shrinks each year. The taxable temporary difference peaked in year one and will gradually reverse, reducing the deferred tax liability to zero when the asset is fully depreciated for both purposes.
Documentation note: include a reversal schedule showing the expected temporary difference at each year end, the projected deferred tax liability balance, and the year in which full reversal occurs. Reference IAS 12.51(b) for disclosure of the reversal schedule.
Conclusion: the deferred tax liability of EUR 98,880 arising from the EUR 480,000 taxable temporary difference on the paper-drying line is defensible because the carrying amount, tax base, applicable rate, and reversal profile are each traceable to underlying records.
Why it matters in practice
Teams frequently fail to identify temporary differences on non-depreciable assets, particularly land held at a revalued amount. IAS 12.20 requires a deferred tax liability on land revaluations even though the land is not depreciated, because disposal will trigger a taxable gain. Omitting this difference understates the deferred tax liability by the tax rate multiplied by the full revaluation surplus.
Deferred tax assets from deductible temporary differences are often recognised without adequate evidence of probable future taxable profit. IAS 12.27–29 require the entity to consider the same entity and the same tax authority when assessing whether sufficient taxable profit will exist. ISA 540.13(b) requires the auditor to evaluate whether the data supporting that probability assessment (budgets, forecasts, tax planning opportunities) are appropriate. Accepting management's assertion of future profitability without testing the forecast against historical accuracy does not meet this standard.
Temporary difference vs. permanent difference
| Dimension | Temporary difference (IAS 12) | Permanent difference |
|---|---|---|
| Definition | Difference between carrying amount and tax base that will reverse over time | Difference between accounting and taxable income that will never reverse |
| Deferred tax effect | Gives rise to a deferred tax asset or liability | Creates no deferred tax; affects only current tax |
| Common examples | Accelerated tax depreciation, revaluation surpluses, provisions deductible on payment | Non-deductible fines, tax-exempt dividend income, entertainment expenses disallowed by statute |
| IAS 12 treatment | Explicitly defined and governed by IAS 12.5, .15, .24 | Not defined in IAS 12; the term is used in practice but the standard addresses these through the tax base mechanism |
| Reversal | Reverses when the asset is recovered or the liability is settled | Never reverses; the gap between accounting and taxable amounts persists indefinitely |
The distinction matters because only temporary differences generate deferred tax balances. When practitioners misclassify a permanent difference as temporary (or vice versa), the deferred tax line is misstated and the effective tax rate reconciliation required by IAS 12.81(c) will not tie back to the statutory rate.
Related terms
Frequently asked questions
How do I document a temporary difference in the audit file?
For each material temporary difference, record the carrying amount, the tax base, the direction (taxable or deductible), the applicable tax rate, and the resulting deferred tax amount. IAS 12.81(g) requires the entity to disclose the amount of deductible temporary differences for which no deferred tax asset has been recognised. The audit file should contain the schedule that supports this disclosure and the evidence behind management's probability assessment for recognised assets.
Does a temporary difference arise on initial recognition of an asset?
IAS 12.15(b) and IAS 12.24(a) include an initial recognition exemption: no deferred tax is recognised for a temporary difference arising on initial recognition of an asset or liability in a transaction that is not a business combination and affects neither accounting profit nor taxable profit at the time. The 2023 amendment (Pillar Two and initial recognition exception update) narrowed this exemption for transactions that give rise to equal taxable and deductible temporary differences (such as leases and decommissioning obligations), requiring deferred tax to be recognised separately for each.
When does a temporary difference reverse?
A temporary difference reverses when the carrying amount of the asset or liability is recovered or settled, causing the previously deferred tax to become current. IAS 12.51(b) requires disclosure of the amount and, if determinable, the timing of reversal. For depreciable assets, reversal follows the depreciation schedule. For liabilities such as provisions, reversal occurs when the obligation is settled and the entity claims the tax deduction.