What is Deferred Tax Assets?
A 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.
These are created because of the timing difference between the book profit and the taxable profit. It is because there are some items which are allowed to be deducted and other not deducted from the taxable profits.
Deferred Tax Asset Examples
Let us discuss some of the reasons with examples given below:
# 1 – Business Loss
The simplest method by which these tax assets are created is when the business incurs a loss. The loss of the Company can be carried forward and set off against the profits of the subsequent years, thus reducing tax liability. Hence, such a loss is an asset or deferred tax assets to be precise for the Company.
#2 – Differences in the Depreciation Method in Accounting and Tax Purpose
Due to differences in the methods used for depreciation in accounting and tax purposes, this tax asset can be created. There are two methods of depreciation – straight line method and the double depreciation method. In the double depreciation method, the depreciation expenses more in the initial periods, and if this method is used for accounting purposes where a straight-line method is used for tax purposes, the Company will pay more tax than shown in its books. Thus, it will record deferred tax assets in the balance sheet.
#3 – Differences in Depreciation Rate in Accounting and Tax Purpose
Not only the depreciation method but the depreciation rate could cause an occurrence of this tax asset. For example, if a depreciation rate of 20% is used for tax purposes while a rate of 15% is used for accounting purposes, it will create a difference in actual tax paid and tax on the Income statement. Thus, the Company will record deferred tax assets (DTA) in the balance sheet.
Suppose taxable income is $ 5000. Thus as per this, the tax will be $ 750 on the income statement and $ 1000 paid to the tax authorities. Hence, there will be a DTA of (1000 – 750 = $ 250) due to the difference in depreciation rates.
In the above two examples, i.e., deferred tax assets are arising due to depreciation and carry forward losses. This asset is recorded only if it can materialize in future incomes. The Company checks and prepares a projection of future income statements and balance sheets. And if the Company feels that it can be used, it is only then recorded on DTA in the balance sheet. If, in a certain period, the Company feels that this asset cannot materialize in the future with certainty, it will write off any such entry in the balance sheet.
#4 – Expenses
Deferred tax assets can also form when expenses are recognized in the income statement before they are recognized in the tax statement and to tax authorities. For example, some legal expenses are not considered as the expense and thus not deducted immediately in tax statement; however, they are shown as the expense in the income statement.
Thus, for income statement
Thus, for tax statement
There is a difference in tax payable as in the income statement and the tax statement. Thus, there is a DTA of (1050 -900) = $ 150, which will be shown in the balance sheet.
#5 – Revenues
Sometimes revenue is recognized in one period for tax purposes and in a different period for accounting purposes. If the revenue is recognized for tax purposes before it is done in accounting, the Company will pay tax on such high revenue and thus creating this tax asset.
#6 – Warranties
Warranties are one of the most common examples.
Let us say an electrical goods Company has a revenue of $5 million and it has expenses of $3 million, thus a profit of $2 million. However, the expenses are bifurcated as $2.5 million for the cost of goods sold, general expenses, etc., and $0.5 million for future warranties and returns.
The tax authorities do not consider future warranties and returns as an expense. It is because this expense has not been incurred but only accounted for. Therefore, the Company cannot deduct such an expense while calculating taxes; thus, pay tax on $0.5 million as well. Therefore, this amount will be part of the deferred tax assets in the balance sheet.
#7 – Bad Debts
Another example of Deferred tax assets is Bad Debt. Let’s assume that a company has a book profit of $10,000 for a financial year, including a provision of $500 as bad debt. However, for the purpose of taxes, this bad debt is not considered until it has been written off. Thus, the Company will have to pay tax on $10,500 and hence creating this tax asset.
If the tax rate is 30%, the Company will make a deferred tax asset journal entry in its book for $150.
Deferred tax assets in the balance sheet line item on the non-current assets, which are recorded whenever the Company pays more tax. The amount under this asset is then utilized to reduce future tax liability. It can be caused due to many reasons because there are certain items allowed/disallowed in the tax income statement than in the accounting income statement. The difference in the deferred tax calculation of book profits and tax profits may lead to the recording of deferred tax assets.
To summarize: This is created whenever the book profit is lower than the taxable profit, which causes the Company to pay a higher tax now and lesser tax in the future.
Deferred Tax Assets Video
This article has been a guide to Deferred Tax Assets. Here we discuss the Top 7 examples & calculation of Deferred tax assets, including business loss, warranties, bad debts, expenses, depreciation method, and depreciation rates, etc. You can learn more about accounting from the following articles –