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 assetDeferred Tax AssetA deferred tax asset is an asset to the Company that usually arises when either the Company has overpaid taxes or paid advance tax. Such taxes are recorded as an asset on the balance sheet and are eventually paid back to the Company or deducted from future taxes. 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:
- If book profit is lesser than taxable profit. Then deferred tax assets get created.
- 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 valueSalvage ValueSalvage value or scrap value is the estimated value of an asset after its useful life is over. For example, if a company's machinery has a 5-year life and is only valued $5000 at the end of that time, the salvage value is $5000.. 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 TaxProfit Before TaxProfit before tax (PBT) is a line item in a company's income statement that measures profits earned after accounting for operating expenses like COGS, SG&A, depreciation & amortization, and non-operating expenses. It gives the overall profitability and performance of the company before making payments in corporate taxes. 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 fullyAsset Can Be Depreciated FullyFully depreciated assets are the assets that can no longer be depreciated for accounting or tax purposes. It implies that the entire depreciation has been provided in the accumulated depreciation account. These assets continue to be a part of the balance sheet unless they are sold or destroyed. 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 rulesAccounting RulesAccounting rules are guidelines to follow for registering daily transactions in the entity book through the double-entry system. Here, every transaction must have at least 2 accounts (same amount), with one being debited & the other being credited. 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
- Deferred tax liability in year 1 = 12000-6000 = $6,000
The following journal entry must be passed in year 1 to recognize the deferred taxDeferred TaxDeferred Tax is the effect that occurs in a firm as a result of timing differences between the date when taxes are actually paid to tax authorities by the company and the date when such tax is accrued. Simply put, it is the difference in taxes that arises when taxes due in one of the accounting period are either not paid or overpaid.:
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:
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:
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.
|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 companyMultinational CompanyA multinational company (MNC) refers to that business entity whose headquarter is in one country, and its branches or subsidiaries extend across the globe in two or more nations. The MNCs aim at maximum revenue generation by spreading business worldwide. 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 RevenueUnearned RevenueUnearned revenue is the advance payment received by the firm for goods or services that have yet to be delivered. In other words, it comprises the amount received for the goods delivery that will take place at a future date.. From 2017 to 2018, Net Deferred tax assets have been increased from -5,486 million to $828 million.
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 reportAnnual ReportAn annual report is a document that a corporation publishes for its internal and external stakeholders to describe the company's performance, financial information, and disclosures related to its operations. Over time, these reports have become legal and regulatory requirements., 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 CarryforwardLoss CarryforwardTax Loss Carry forward is a provision which permits an individual to take forward or carry over the tax loss to the next year to set off the future profit. Any taxpayer can claim it to lower the tax payments in the future. and Stock-Based compensationStock-Based CompensationStock-based compensation also called share-based compensation refers to the rewards given by the company to its employees by way of giving them the equity ownership rights in the company with the motive of aligning the interest of the management, shareholders and the employees of the company.. “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.
- 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.
- Deferred tax assets journal entry can affect company cash flowsCompany Cash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. in future years. So, a company will have to use this keeping future cash in mind.
- While studying a financial report of the companyFinancial Report Of The CompanyFinancial Reporting is the process of disclosing all the relevant financial information of a business for a particular accounting period. These reports are used by the stakeholders (investors, creditors/ bankers, public, regulatory agencies, and government) to make investing and other relevant decisions. , 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.
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.
This has been a guide to the Deferred Tax Asset Journal Entry. Here we discuss how to recognize deferred tax assets along with examples and journal entries. You can learn more about accounting from the following articles –