Temporary Difference
A difference between an asset or liability's book value for financial reporting and its tax basis that will reverse over time.
What is Temporary Difference?
A temporary difference arises when the carrying amount of an asset or liability on the GAAP balance sheet differs from its tax basis under the applicable tax code, and that difference is expected to reverse in future periods. Temporary differences give rise to deferred tax assets or liabilities recognized under ASC 740 (GAAP) and IAS 12 (IFRS). A taxable temporary difference (where book value exceeds tax basis) creates a deferred tax liability—income that is recognized for GAAP now but will be taxed in the future. A deductible temporary difference (where tax basis exceeds book value) creates a deferred tax asset—a tax benefit that will be realized in the future. Common sources include accelerated tax depreciation (creating a deductible difference), warranty accruals (deductible when paid, not when accrued), and unrealized gains on investments. Temporary differences are distinct from permanent differences, which never reverse and therefore create no deferred tax balance.
Example
A company buys equipment for $1,000,000. GAAP straight-line depreciation over 5 years = $200,000/year. Tax MACRS depreciation in Year 1 = $400,000. The $200,000 excess tax deduction creates a $200,000 taxable temporary difference—GAAP book value ($800,000) exceeds tax basis ($600,000) by $200,000, resulting in a $42,000 deferred tax liability at a 21% tax rate.
Source: FASB ASC 740 — Income Taxes