An asset that may be used to reduce any subsequent period's income tax expense.
Deferred tax assets can arise due to net loss carry-overs, which are only recorded as assets
if it is deemed more likely than not that the asset will be used in future fiscal periods.
Temporary differences Temporary differences are differences between
the carrying amount of an asset or liability recognized in the statements of financial
position and the amount attributed to that asset or liability for tax; or
deductible temporary differences, which are temporary differences that will result in
deductible amounts in determining taxable profit of future periods when the carrying
amount of the asset or liability is recovered or settled.
Illustrated example The basic principle of accounting for deferred
tax under a temporary difference approach can be illustrated using a common example
in which a company has fixed assets which qualify for tax depreciation.
The following example assumes that a company purchases an asset for $1,000 which is depreciated
for accounting purposes on a straight-line basis of five years of $200/year.
The company claims tax depreciation of 25% per year.
The applicable rate of corporate income tax is assumed to be 35%.
And then subtract the net value.
As the tax value, or tax base, is lower than the accounting value, or book value, in years
1 and 2, the company should recognize a deferred tax liability.
This also reflects the fact that the company has claimed tax depreciation in excess of
the expense for accounting depreciation recorded in its accounts, whereas in the future the
company should claim less tax depreciation in total than accounting depreciation in its
accounts.
In years 3 and 4, the tax value exceeds the accounting value, therefore the company should
recognise a deferred tax asset.
This reflects the fact that the company expects to be able to claim tax depreciation in the
future in excess of accounting depreciation.
Timing differences In many cases the deferred tax outcome will
be similar for a temporary difference or timing difference approach.
However, differences can arise such as in relation to revaluation of fixed assets qualifying
for tax depreciation, which gives rise to a deferred tax asset under a balance sheet
approach, but in general should have no impact under a timing difference approach.
Justification for deferred tax accounting Deferred tax is relevant to the matching principle.
Examples Deferred tax liabilities
Deferred tax liabilities generally arise where tax relief is provided in advance of an accounting
expense, or income is accrued but not taxed until received.
Examples of such situations include: a company claims tax depreciation at an accelerated
rate relative to accounting depreciation a company makes pension contributions for
which tax relief is provided on a paid basis, whereas accounting entries are determined
in accordance with actuarial valuations Deferred tax assets
Deferred tax assets generally arise where tax relief is provided after an expense is
deducted for accounting purposes.Examples of such situations include:
a company may accrue an accounting expense in relation to a provision such as bad debts,
but tax relief may not be obtained until the provision is utilized
a company may incur tax losses and be able to "carry forward" losses to reduce taxable
income in future years..
An asset on a company's balance sheet that may be used to reduce any subsequent period's
income tax expense.
Deferred tax assets can arise due to net loss carryovers, which are only recorded as assets
if it is deemed more likely than not that the asset will
Deferred tax in modern accounting standards Modern accounting standards typically require
that a company provides for deferred tax in accordance with either the temporary difference
or timing difference approach.
Where a deferred tax liability or asset is recognised, the liability or asset should
reduce over time as the temporary or timing difference reverses.
Under International Financial Reporting Standards, deferred tax should be accounted for using
the principles in IAS 12: Income Taxes, which is similar to SFAS 109 under US GAAP.
Both these accounting standards require a temporary difference approach.
Other accounting standards which deal with deferred tax include:
UK GAAP - Financial Reporting Standard 19: Deferred Tax
Mexican GAAP or PCGA - Boletín D-4, el impuesto sobre la renta diferido
Canadian GAAP - CICA Section 3465 Russian PBU 18 Accounting for profit tax
Derecognition of deferred tax assets and liabilities Management has an obligation to accurately
report the true state of the company, and to make judgements and estimations where necessary.
In the context of tax assets and liabilities, there must be a reasonable likelihood that
the tax difference may be realised in future years.
For example, a tax asset may appear on the company's accounts due to losses in previous
years.
In this case a deferred tax asset should be recognised if and only if the management considered
that there will be sufficient future taxable profit to utilise the tax loss.
If it becomes clear that the company does not expect to make profits in future years,
the value of the tax asset has been impaired: in the estimation of management, the likelihood
that this tax loss can be utilised in the future has significantly fallen.
In cases where the carrying value of tax assets or liabilities has changed, the company may
need to do a write down, and in certain cases involving in particular a fundamental error,
a restatement of its financial results from previous years.
Such write-downs may involve either significant income or expenditure being recorded in the
company's profit and loss for the financial year in which the write-down takes place.
See also Deferred financing costs
Tax shield Notes
^ IAS 12.5 ^ IAS 12.34
External links Summary of International Accounting Standard
12: Income Taxes - by the International Accounting Standards Board
Summary of Financial Accounting Standard 109: Income Taxes - US Financial Accounting Standard
Financial Reporting Standard 19: Deferred Tax - UK Financial Reporting Standard
Deftax - Commercial Deferred Tax Software