What is deferred tax liability and what is its purpose?

Deferred Tax Liability (DTL) is reported on a firm's balance sheet and represents the net difference between the taxes that are paid in the current accounting period and the taxes that will be paid in the next accounting period. The liability occurs when the accounting income is greater than the taxable income.

For an example, a company is allowed to defer taxes on a percentage of its income and report this amount as a DTL on its balance sheet. When the tax is due, there will be an equal amount reduction in the DTL item and the cash and cash equivalents account on the balance sheet. In other words the DTL means an accrued tax on the books because book expenses did not match tax deductions for a particular year.

On a balance sheet, a tax that a company will owe on its income, but that has not yet been assessed. Because of differences between tax regulations and the GAAP, income may be recognized on a balance sheet for accounting purposes, but not for tax purposes. However, that income will eventually be recognized for tax purposes and income tax will then be assessed. This tax is called deferred income tax, and is recorded as a liability on the balance sheet.