Deferred Tax Asset Journal Entry

Journal Entries for Deferred Tax Assets

If a company has overpaid its tax or paid advance tax for a given financial period, then the excess tax paid is known as deferred tax asset and its journal entry is created when there is a difference between taxable income and accounting income.

There can be the following scenario of deferred tax asset:

  1. If book profit is lesser than taxable profit. Then deferred tax assets get created.
  2. If, as per books, there is a loss in accounts, but as per income tax rules, the company shows a profit, then the tax has to be paid and will come under deferred tax assets that can be used for future year tax payment.

Examples of Deferred Tax Asset Journal Entries

Let’s assume your company has bought an asset for $30,000, which can be depreciated in books in a straight line manner in 3 years with no salvage value. But due to some tax rules, for tax purposes, this asset can be fully depreciated in year one itself. Let’s say the tax rate is 30%, and for the next three years, EBITDA is $50,000 per year.

In year 1:

  • EBITDA = $50,000
  • Depreciation as per books = 30,000/3 = $10,000
  • Profit Before Tax as per books= 50000-10000 = $40,000
  • Tax as per books = 40000*30% = $12,000

But as per tax rule, this asset can be depreciated fully in the first years.

  • So As per tax rules Profit before tax = 50000-30000 = $20,000
  • Actual tax paid = 20,000*30% = $6,000

Because of tax and accounting rules the first year your company has shown more tax but paid the lesser tax that means it has created deferred tax liability in its book for year 1

The following journal entry must be passed in year 1 to recognize the deferred tax:

Deferred Tax Journal Entries 1

In year 2:

  • Tax as per books should be same = $12,000

But in actuals, you have depreciated the whole asset in year 1, so in the second year.

  • Actual tax paid = 50,000*30% = $15,000

As we can see in Y2 actual tax paid is more than the tax payable in books that means

  • Deferred tax asset in Y2 = 15,000 -12,000 =$3,000

The following journal entry must be passed in year 2 to recognize the deferred tax asset:

Deferred Tax Asset Journal Entries 1

Year 3 –

Same way in year 3 also:

  • Deferred tax asset = $3,000

The following journal entry must be passed in year 3 to recognize the deferred tax:

Deferred Tax Asset Journal Entries 2

Now, if you see in these three years total deferred tax liability = $6,000 and total deferred tax asset = $3,000+$3,000 = $6,000 hence in the life of the asset deferred tax asset and deferred tax liability has nullified each other.

Particulars Y1 Y2 Y3
EBITDA (a) 50,000 50,000 50,000
Depreciation as per accounting books (b) 10,000 10,000 10,000
Profit Before Tax as per accounting books (a-b) 40,000 40,000 40,000
Tax as per accounting books (30%) 12,000 12,000 12,000
Depreciation as per tax rules 30,000
Actual profit before tax 20,000 50,000 50,000
Actual tax paid (30%) 6,000 15,000 15,000
Deferred tax asset (liability) (6,000) 3,000 3,000

Microsoft Deferred Income Tax Statement

Microsoft Corp is a US multinational company headquartered in Washington. It is in the business of developing, manufacturing, and licensing software such as Microsoft Office. As per the 2018 annual report, its yearly revenue is $110.4 Bn.

Below is the screenshot of its deferred tax asset and liabilities statement. As we can see, Deferred Tax Asset has been generated mostly from “Accruals Revenue” and “Credit Carryforwards.” The main source of Deferred tax liabilities is Unearned Revenue. From 2017 to 2018, Net Deferred tax assets have been increased from -5,486 million to $828 million.

Microsoft Income Tax Statement 1

Microsoft Income Tax Statement 2

Source: https://www.microsoft.com

Amazon Deferred Tax Asset

Amazon is an American multinational based in Washington. The primary focus of Amazon is in e-commerce, cloud computing, and artificial intelligence. As per the 2018 annual report, its annual revenue is $233 Bn. Below is the screenshot of Amazon’s Deferred Tax Asset and Deferred Tax liabilities statement. The Main Sources for deferred tax assets are Loss Carryforward and Stock-Based compensation. “Depreciation and amortization” are the main source of deferred tax liabilities. From 2017 to 2018, net Deferred tax liabilities increased from $197 M to $544M.

Amazon

Source: https://ir.aboutamazon.com

Advantages

  • It is purely legal for a company to show different accounts for tax purposes and accounting purposes. So, using this deferred tax functionality, a company can pay lesser taxes when it sees the lesser profit and deferred the tax payment for the coming years when profit will increase.

Disadvantages

  • Deferred tax assets journal entry can affect company cash flows in future years. So, a company will have to use this keeping future cash in mind.
  • While studying a financial report of the company, an investor can get fooled by looking at the net income of the company while without looking effect of deferred tax assets and liabilities.
  • Though it is legal, companies may employ some illegal ways to take advantage of its features.

Conclusion

While understanding and applying deferred tax assets or liabilities, it is important for companies and investors to analyze and understand the future cash flow effect of it. Future cash flow can be affected by deferred tax assets or liabilities. If a deferred tax liability is increasing, that means it is a source of cash and vice versa. So, by analyzing this deferred tax helps in assessing where the balance is moving forward.

Recommended Articles

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