Deferred Tax Assets

A deferred tax asset 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.

These are created because of the timing difference between the book and taxable profits. Some items can be deducted, and others are not deducted from the taxable profits.

Let us discuss some of the reasons with examples given below:

# 1 - Business Loss

The simplest method of creating these tax assets is when the business incurs a loss. The Company's loss 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 asset, 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. There are two methods of depreciation - straight line method and the double depreciation method. In the double depreciation method, the depreciation expenses are more in the initial periods. If this method is used for accounting purposes, whereas 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 on the balance sheet.

#3 - Differences in Depreciation Rate in Accounting and Tax Purpose

The depreciation method and 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) on the balance sheet.

Suppose taxable income is $ 5000. Thus, 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 depreciation rates.

In the above two examples, i.e., deferred tax assets arise 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 recorded on DTA in the balance sheet. If the Company feels that this asset cannot materialize in the future with certainty in a certain period, 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 and thus not deducted immediately from the 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 in the income and tax statements. Thus, a DTA of (1050 -900) = $ 150 will be shown on 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, 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 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, it pays tax on $0.5 million. Therefore, this amount will be part of the deferred tax assets on 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, this bad debt is not considered for taxes until it has been written off. Thus, the Company will have to pay tax on $10,500, 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 are recorded whenever the Company pays more tax. The amount under this asset is then utilized to reduce future tax liability. The difference in the deferred tax calculation of book profits and tax profits may lead to the recording of deferred tax assets. It can be caused for many reasons because certain items are allowed/disallowed in the tax income statement than in the accounting income statement.

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.

This article has been a guide to Deferred Tax Assets. Here we discuss the Top 7 examples & calculations of Deferred tax assets, including business loss, warranties, bad debts, expenses, depreciation method, depreciation rates, etc. You can learn more about accounting from the following articles –

• Deferred Tax Meaning
• 4 Best Examples of Deferred Revenue
• Deferred Income