Companies calculate income under two sets of rules. Book accounting determines the earnings reported in the financial statements, while tax accounting determines taxable income and cash taxes owed to the government. Because the rules recognize certain revenue and expenses at different times, book income and taxable income may differ in a given period.
A temporary difference occurs when an item affects book income and taxable income in different periods but eventually reverses. That difference can create a deferred tax asset, or DTA, or a deferred tax liability, or DTL. A DTA represents a potential reduction in future taxes, while a DTL represents taxes expected to be paid in the future because the company pays less tax today.
The simplified formulas are DTA equals deductible temporary difference multiplied by the applicable tax rate, and DTL equals taxable temporary difference multiplied by the applicable tax rate. In practice, companies must consider jurisdiction-specific tax rates and rules.