Dstinguish between temporary and permanent differences.Permanent differences are differences in taxable and pretax incomes that are never reversed. Tax exempt interest expense, premiums paid on life insurance of key employees, and goodwill amortization are examples of expenses on the financial statements, but they are not deductions on the tax returns. These differences are never deferred but are considered decreases or increases in the effective tax rate. If the only difference between taxable and pretax incomes were a permanent difference, then tax expense would be simply taxes payable.Temporary differences are differences in taxable and pretax incomes that will reverse in future years. That is, current lower (higher) taxes payable will be a future higher (lower) taxes payable. These differences result in deferred tax assets or liabilities. An example would be with liabilities: The temporary difference that results by using the installment sales method for taxes and the sales method for pretax income. Long-term liabilities: The long-term tax liability that results by using the declining balance depreciation for the tax returns and straight-line depreciation for the financial statements.f: Compute income tax expense, income tax payable, deferred tax assets, and deferred tax liabilities.If a change in the tax rate is enacted, then under the liability method, all deferred tax assets and liabilities are r*ued using the new tax rate. If the tax rate increases, then the increase in deferred tax liabilities increases the current tax expense. If tax rates decrease, the decrease in deferred tax liabilities will decrease the current tax expense.Example: Deferred taxes and a change in tax rates:During year one, the tax rate is 40%
 

　　Starting in year two, the tax rate will fall to 35%

　　Assume taxable income is $20,000

　　Pretax income is $30,000 (the difference occurred because DDB depreciation is used on tax returns and SL depreciation is used on the financial statements).

　　The $10,000 difference is temporary (reverses in the future)

　　The deferred tax liability is determined by the tax rate that will exist when the reversal occurs (35%).