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How are deferred tax assets and deferred tax liabilities derived?

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Basically, the book tax provision has 2 part - current (what you will pay this year) and deferred (what you will pay in some other period. It is determined using the financial book income. (Yes, there are some things, called "permanent" differences which are past this discussion).

Tax accounting uses different conventions and requirements to determine what "income" is TAXABLE income. So for example, while financial accounting may require a company record an expense for bad debts - using some basis, (perhaps it's past history that some percent of sales are never collected) and that reduces book income that year - tax has a different set of requirements - which says that the expense CANNOT be recoded until it is absolutely realized (an "all events" test, not just an estimate) has been met.

So while over the years, the amount of bad debt (reducing income) may be very, very similar - when it happens is different. So, while the book provision, using book income, records a total tax expense that year which incorporates the booked estimate of bad debt, since tax will not report that expense until a later period and will pay the tax on that income until the tax expense is recorded, the total provision (current + deferred) carries that until tax "catches up" to books (in this case.)

These differences can go either way, and therefore produce a deferred tax asset (something you paid tax on - recognized as income for tax before book, or a deferred tax liability (where say books allowed an expense before tax (as in the above)).

The net position (having a deferred asset or liability) is what is commonly shown on financial statements, although depending on the level of presentation, there may be one line for each - with detail of at least the major items causing the differences, someplace else in the statements.
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