In this video, I explain deferred tax liability and asset. Deferred tax liability and asset is tested on the CPA exam and in intermediate accounting course.
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Items on a company's balance sheet that may be used to reduce taxable income in the future are called deferred tax assets. The situation can happen when a business overpaid taxes or paid taxes in advance on its balance sheet. These taxes are eventually returned to the business in the form of tax relief. Therefore, overpayment is considered an asset to the company. A deferred tax asset is the opposite of a deferred tax liability, which can increase the amount of income tax owed by a company.
Deferred Tax Asset
Understanding Deferred Tax Assets
Deferred tax assets are often created due to taxes paid or carried forward but not yet recognized on the income statement. For example, deferred tax assets can be created due to the tax authorities recognizing revenue or expenses at different times than that of an accounting standard. This asset helps in reducing the company’s future tax liability. It is important to note that a deferred tax asset is recognized only when the difference between the loss-value or depreciation of the asset is expected to offset future profit.1
KEY TAKEAWAYS
A deferred tax asset is an item on the balance sheet that results from overpayment or advance payment of taxes.
It is the opposite of a deferred tax liability, which represents income taxes owed.
A deferred tax asset can arise when there are differences in tax rules and accounting rules or when there is a carryover of tax losses.
Beginning in 2018, most companies can carryover a deferred tax asset indefinitely.
A deferred tax asset can conceptually be compared to rent paid in advance or refundable insurance premiums; while the business no longer has cash on hand, it does have comparable value, and this must be reflected in its financial statements.
How Deferred Tax Assets Arise
The simplest example of a deferred tax asset is the carryover of losses. If a business incurs a loss in a financial year, it usually is entitled to use that loss in order to lower its taxable income in the following years.2
In that sense, the loss is an asset.
Another scenario where deferred tax assets arise is when there is a difference between accounting rules and tax rules. For example, deferred taxes exist when expenses are recognized in the income statement before they are required to be recognized by the tax authorities or when revenue is subject to taxes before it is taxable in the income statement.1 Essentially, whenever the tax base or tax rules for assets and/or liabilities are different, there is an opportunity for the creation of a deferred tax asset.