A deferred tax asset is an accounting term that refers to a situation where a company has paid more taxes than what is currently required. The excess taxes paid are considered an asset on the company’s balance sheet.
A deferred tax asset is a component of a company’s balance sheet that reduces future taxable income. A line-item asset like this may be identified when a firm overpays its taxes. However, this excess money will be refunded to the company as tax relief. Hence this overpayment becomes an asset for the company.
Table of Contents
What is Deferred Tax Asset?
A deferred tax is an asset to the company that usually arises when 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. It refers to the future tax liability incurred during the current accounting period that will eventually be paid in future periods.
A deferred tax is defined as an asset for a business that generally occurs when the business has overpaid taxes or paid taxes in advance. Such payments are recorded as assets on the balance sheet and subsequently reimbursed to the business or deducted from future tax obligations. All in all, a deferred tax asset represents a tax overpayment that can be carried forward to future tax periods to get redeemed in the future.
Understanding Deferred Tax Assets
When taxes are paid or carried forward but haven’t yet been recognized on the company’s income statement, a deferred tax asset is generated. The deferred tax asset can be carried on the balance sheet until it’s used to offset future taxes.
A deferred tax asset is an accounting term that refers to a situation where a company has paid more taxes than what is currently required. The excess taxes paid are considered an asset on the company’s balance sheet. This allows the company to reduce its taxable income in future periods.
Importance of Deferred Tax Assets
- The advantage of overpaid taxes may be utilized by setting up a deferred tax asset.
- Gives assurance to the organization that overpaid taxes can be utilized in the future.
- Offers assurance to the organization that overpaid taxes might be utilized in the future.
- As DTA arises only through the temporary difference, the liability will remain unaffected.
- Assists in reducing future tax liabilities.
Deferred Tax Asset vs. Liability
A deferred tax asset is the opposite of deferred tax liability. A deferred tax liability arises when a company has underpaid its taxes. The difference between the taxes owed and the taxes paid is considered a liability on the company’s balance sheet. This allows the company to increase its taxable income in future periods.
Deferred tax assets and liabilities are created when there are temporary differences between the carrying amount of an asset or liability in the financial statements and its tax base.
Deferred tax assets are recorded when it is probable that future taxable profits will be available against which the temporary differences can be utilized. Similarly, deferred tax liabilities are recorded when it is probable that future taxable profits will not be available to realize the temporary differences.
Deferred taxes vs Income taxes
When it comes to taxes, deferred taxes and income taxes are two different types of tax liabilities. Income taxes are the liability you have for the taxes you owe on your current year’s income. Deferred taxes, on the other hand, are taxes that have been deferred to a future year.
Deferred Tax Assets on the Balance Sheet
A deferred tax asset is reported on the balance sheet as a long-term asset. This is because the asset will be used to offset future taxes. The deferred tax asset is the reported net of any deferred tax liabilities.
The deferred tax asset is an important part of a company’s financial statements. It allows investors to see how much the company has overpaid in taxes and how it will reduce its taxable income in future periods.
What causes a deferred tax asset?
A deferred tax asset can be caused by a variety of things, but the most common is when a company has overpaid its taxes. Other causes can include carryforwards of losses or credits, and timing differences between when revenue is earned and when expenses are incurred.
How is a deferred tax asset calculated?
The deferred tax asset is calculated by taking the difference between the taxes paid and the taxes owed. This difference is then multiplied by the tax rate. Some of the steps involved in the calculation of DTA are-
- Making a list of all the assets and liabilities
- Then calculating the tax bases
- Figuring out temporary differences
- Calculating the tax liability rate
- Figuring out the tax assets
How do deferred tax assets work?
Deferred tax assets work by reducing a company’s taxable income in future periods. This allows the company to save money on its taxes. The deferred tax asset is reported on the balance sheet as a long-term asset.
Benefits of a deferred tax asset
A deferred tax asset allows a company to reduce its taxable income in future periods. This can be a significant benefit for a company, as it can lower its tax bill.
A deferred tax asset can also be used to offset deferred tax liabilities. This can help a company to improve its financial position and reduce its taxes owed.
Examples of Deferred Tax Assets
Some examples of deferred tax assets include:
1. Carryforwards of losses or credits
If a company has losses or credits that it can carry forward to future periods, it can use them to offset its taxable income. This will create a deferred tax asset.
2. Timing differences between when revenue is earned and when expenses are incurred
If a company earns revenue before it incurs expenses, it can defer taxes on the income. This will create a deferred tax asset.
3. Overpaid taxes
If a company has overpaid its taxes, the excess taxes paid can be used to offset future taxes. This will create a deferred tax asset.
4. Revenues
In such a scenario, a company mentions its revenues in its tax document before mentioning them in its books. It will let them pay high taxes in advance and hence will assist them in creating DTA.
5. The difference in the depreciation method
If a company uses the straight-line method for calculating depreciation in its books but the accelerated method for tax purposes, it will result in lower taxes and hence deferred tax assets.
6. Bad debts
In the case of bad debts, if a company writes off debt as uncollectible in its books but not for tax purposes, the write-off will create DTA.
7. Inventory
If a company uses the LIFO method (last-in, first-out) for inventory in its books but FIFO (first-in, first-out) for tax purposes, it will result in deferred tax assets.
8. Unused credits
In the case of unused credits, if a company has credits that it can carry forward to future periods, it will create deferred tax assets.
9. Depreciation rate
If a company uses a higher depreciation rate for tax purposes than it does for book purposes, it will create deferred tax assets.
10. Differences in accrual methods
If a company uses different accrual methods for its books and tax purposes, it will result in deferred tax assets.
11. Investment tax credits
If a company has investment tax credits that it can carry forward to future periods, it will create deferred tax assets.
12. Advance payments
In the case of advance payments, if a company makes payments for expenses that it will not incur until future periods, it will create deferred tax assets.
13. Warranties
In the case of warranties, if a company provides warranties for its products, it will incur expenses in future periods. These expenses can be used to offset taxable income in future periods, which will create deferred tax assets.
14. Deferred compensation
If a company has deferred compensation arrangements with its employees, it will have expenses in future periods. These expenses can be used to offset taxable income in future periods, which will create deferred tax assets.
15. Rent
In the case of rent, if a company pays rent for the property that it does not yet own, the payments can be used to offset taxable income in future periods. This will create deferred tax assets.
Conclusion!
Deferred tax balances represent the amount of tax that a company owes in the future. This can be in the form of deferred taxes, which are taxes that have not been paid yet, or deferred tax liabilities, which are taxes that will be due in the future.
Tax authorities also allow a deferred tax asset to be recognized for future tax savings on the balance sheet. On the concluding note, it can be said that deferred tax assets can be created from expenses that are paid in the current year but will not be recognized as deductions until a future year.
What do you think? Is deferred tax asset something your organization should be monitoring? Let us know in the comments below.
