Deferred Tax Asset

Definition of Deferred Tax Asset

Deferred tax asset refers to the company that is created when there arises a difference in timing of tax payment due to different accounting treatments by different laws or it can also arise when organization has overpaid the taxes by way of advance tax or tax deductions which results in less tax liability in future and the same is opposite of the deferred tax liability.

Explanation

Company has to follow different laws like income tax law, company law etc. There might be difference in the accounting treatment under different laws so, while assessing under income tax law the companies has to follow the regulations and accounting treatment under income tax laws. So, the tax difference arises due to difference in accounting treatment. The tax difference may result in saving of tax or increment of tax, which ultimately will settle in future. The savings in tax in future is termed as deferred tax assets. The deferred tax asset arises when the company has paid more taxes or there are items which resulted in lowering the tax in future for example advance tax paid, prepaid rent, income due but not received etc.

How to Create Deferred Tax Assets?

Deferred tax is created when there is difference between the tax base according to different laws. It is basically the tax difference arise due to timing differences. Deferred tax is created when the income as per books is less than the income as calculated by income tax rules. For example, income as per books is $ 5,000 and income as per income tax laws is $ 6,000 difference is due to different depreciation policies by income tax and company law. So, the organization has to pay tax as per income tax laws as assessed in income tax i.e., organization has to pay more taxes now, the benefit of which is available to organization in the form of deferred tax asset in future. In short, the difference of tax as per income tax and as per books if positive resulted in creation of deferred tax asset.

Deferred tax asset is shown in the asset side of balance sheet underNon-current assets.

Examples of Deferred Tax Assets

Following are the examples are given below:

Income as per Income Statement

	Year 1	Year 2
Net income before depreciation	$5,000	$6,000
Depreciation	$1,000	$500
Net Income after Depreciation	$4,000	$5,500
Tax @ 30%	$1,200	$1,650

Income As Per Tax Calculations

	Year 1	Year 2
Income before Depreciation	$5,000	$6,000
Depreciation	$500	$1,000
Income after Depreciation	$4,500	$5,000
Tax @ 30%	$1,350	$1,500

Calculate the deferred Tax Assets and pass the journal entries for the same.

Solution:

Deferred Tax Assets is the difference between tax as per accounts and as per income tax calculation

	Year 1	Year 2
Tax as per Income Tax Laws	$1,350	$1,500
Tax as per Accounts	$1,200	$1,650
Deferred Tax Asset	$150	($150)

Journal Entries:

Journal Entries (Year 1)

Journal Entries (Year 2)

Deferred Tax Assets Recognition

Deferred tax to be recognised only when the organization is assured that future benefit of deferred tax asset can be availed from the excess taxes as per books. For example organization is loss making and loss is carried forward and it can be set off against the future income hence deferred tax asset is to be created only when organization is sure that in future the organization is able to earn sufficient profits so that the loss can be set off and the deferred tax asset can be utilized.

Deferred Tax Assets Journal Entries

Journal entries for deferred tax assets

• Creation of deferred tax asset

• Utilization of deferred tax in future

Importance of Deferred Tax Assets

• Deferred tax asset can be used to set off the liability of future.
• The benefit of overpaid taxes can be availed through deferred tax asset.
• Gives assurance to the organization that overpaid taxes can be utilized in future.
• Arises only through the temporary difference hence the liability remains unaffected.
• Helps to reduce future tax liabilities.

Deferred Tax Assets vs Deferred Tax Liability

Difference between the two are as follows:

• Deferred tax asset is credit for the taxes already paid and to be less paid in future whereas the deferred tax liability is the credit availed or created for the taxes to be paid in future.
• Deferred tax asset helps to reduce the liability of future taxes whereas deferred tax liability increases the future tax liability.
• Deferred tax is created when tax payable according to income tax law is more than tax payable as per books of accounts as per company law whereas deferred tax liability is created when tax payable as per tax laws is less than tax as per books of accounts.
• Example of deferred tax asset is high depreciation as per income tax and low as per books.

Example of deferred tax liability is recognition of reserve for doubtful debts as per income tax whereas no recognition in accounts.

Advantages of Deferred Tax Assets

Following are the advantages of deferred tax assets:

• Reduce the future tax liability.
• Improves the transparency of calculation.
• Benefit of overpaid tax credit can be availed.
• Calculations and credits ensure legal compliance as per different laws.
• Temporary imbalances can be settled legally.

Disadvantages of Deferred Tax Assets

Following are the advantages of deferred tax assets:

• Lots of calculation, assumptions and legal procedures are involved.
• There is no proof of virtual certainty that credit can be utilized in future due to unpredictable future position.
• Creates the complexity in the accounts as every year 2 sets of books of accounts are to be maintained.

Conclusion

Deferred tax asset can be created when company had overpaid the taxes or the temporary timing differences resulted in payment of more taxes now of which benefit can be availed in the future. Through deferred tax asset the future tax liability can be reduced. The deferred tax asset is different from deferred tax liability as deferred tax liability results in payment of more taxes in future. The calculation also involves lots of complexities.

Recommended Articles

This is a guide to Deferred Tax Asset. Here we also discuss the definition and how to create deferred tax assets? along with advantages and disadvantages. You may also have a look at the following articles to learn more –

1. Estimated Tax
2. Tax Loss Harvesting
3. Income Tax Accounting
4. Deferred Tax