Deferred Tax Assets and Liabilities: Identification and Reporting
- Graziano Stefanelli
- 2 days ago
- 3 min read
Temporary differences between accounting profit and taxable income can create deferred tax assets (DTAs) and deferred tax liabilities (DTLs).
These amounts arise because accounting standards and tax laws recognize income and expenses at different times, affecting current and future tax payments.
1. The Concept of Deferred Taxes
Deferred taxes are the result of differences in timing between when items are recognized for accounting purposes (following US GAAP or IFRS) and when they are recognized for tax purposes.
Deferred Tax Asset (DTA): Future tax benefit from deductible temporary differences, tax loss carryforwards, or tax credit carryforwards.
Deferred Tax Liability (DTL): Future tax obligation from taxable temporary differences.
Temporary differences are differences between the carrying amount of an asset or liability in the financial statements and its tax base.
2. Common Sources of Deferred Taxes
Depreciation methods: Accelerated depreciation for tax, straight-line for books.
Allowance for doubtful accounts: Deductible for books when estimated, for tax when written off.
Warranty liabilities: Expensed for books when accrued, for tax when paid.
Revenue recognition: Differences in timing (e.g., installment sales, unearned revenue).
Pension and employee benefit obligations
Tax loss and tax credit carryforwards
3. Recognition Criteria
a) Deferred Tax Liabilities
Recognized for all taxable temporary differences, unless arising from initial recognition of goodwill or assets/liabilities in a transaction that is not a business combination and affects neither accounting nor taxable profit.
b) Deferred Tax Assets
Recognized for deductible temporary differences, and for unused tax losses or credits, only to the extent it is probable that taxable profit will be available against which they can be utilized. A valuation allowance is required under US GAAP if realization is not probable.
4. Measurement
Deferred taxes are measured using the enacted tax rates expected to apply in the periods when the asset will be realized or the liability settled, based on the laws in force at the reporting date. The effect of changes in tax rates is recognized in the period in which the law is enacted.
5. Presentation on Financial Statements
Balance Sheet:
DTAs and DTLs are presented as non-current.
Net presentation is allowed if the entity has a legally enforceable right of offset and intends to settle on a net basis.
Income Statement:
Income tax expense includes both current and deferred tax.
Deferred tax impacts are often presented in tax expense (benefit) or separately disclosed.
6. Calculation Example
Scenario:
Book value of equipment: $100,000 (straight-line depreciation)
Tax base: $80,000 (accelerated depreciation for tax)
Tax rate: 25%
Temporary difference: $100,000 (book) – $80,000 (tax) = $20,000 (taxable temporary difference)
Deferred tax liability:
$20,000 × 25% = $5,000
Journal Entry:
Dr. Income Tax Expense (P&L) $5,000
Cr. Deferred Tax Liability (B/S) $5,000
If instead there was a deductible temporary difference:
Dr. Deferred Tax Asset (B/S)
Cr. Income Tax Benefit (P&L)
7. Reassessment and Valuation Allowance
DTAs are reviewed at each reporting date. If realization is not probable (e.g., company may not generate enough taxable income), a valuation allowance must be established (US GAAP) or the DTA is not recognized (IFRS).
Changes in assessment or in tax rates are reflected in profit or loss.
8. Disclosure Requirements
Financial statements must disclose:
Major components of DTAs and DTLs
Unrecognized deferred tax assets
Nature of evidence supporting recognition of DTAs
Reconciliation of effective tax rate and statutory rate
Amount and expiry of unused tax losses and credits
9. Standards Reference
US GAAP: ASC 740 “Income Taxes”
IFRS: IAS 12 “Income Taxes”
10. Practical Challenges and Best Practices
Tracking temporary differences: Requires detailed schedules and reconciliation.
Projection of future taxable profit: Needs realistic, supportable forecasts.
Tax law changes: Monitor and update rates promptly.
Disclosure completeness: All significant details must be included in the notes.
Deferred tax accounting ensures that tax effects of transactions are recognized in the periods in which those transactions occur, resulting in more meaningful comparisons of financial results across periods. The process is technical and requires careful attention to both accounting standards and tax law.
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