Tax Assets Postponed: Definition, Illustrations
Deferred tax assets are a common feature in the financial statements of many companies. These assets represent potential future tax benefits that a company may enjoy due to temporary differences between accounting and tax recognition of income and expenses.
Deferred tax assets arise when a company has overpaid taxes or recognized expenses or losses under accounting rules that can reduce taxable income in the future. This could occur in situations such as carrying forward tax losses, recognizing provisions or expenses in financial statements before they are deductible for tax purposes, or when taxable income is lower than accounting income temporarily.
For example, if a company incurs a loss in a current year that cannot be currently claimed for tax relief but can be carried forward and applied to reduce tax in future years, that expected future tax saving is recorded as a deferred tax asset.
In financial statements, deferred tax assets are reported on the balance sheet as non-current assets. They reduce future taxable income and thus future tax payments. The asset's value depends on expected future profitability and applicable tax rates. Companies must assess whether it is probable they will have sufficient taxable income to realise the deferred tax asset; if not, a valuation allowance may be required to reduce the asset to the amount expected to be recoverable.
It's important to note that companies do not report deferred tax assets and deferred tax liabilities separately, but combine them into a net value. The net value of deferred tax assets and liabilities is included in the assets section of the financial statements. Companies with a deferred tax asset will pay relatively less tax in the future compared to identical companies without it. If the deferred tax liability exceeds the deferred tax asset, it is considered a liability.
Transactions that can give rise to deferred tax assets include uncollectible accounts receivable, warranties, leases, inventories, and net operating losses. Deferred tax assets and liabilities are not reported separately on a balance sheet, but combined into a net value.
Under the matching principle, warranty expenses are recognized in the same period as sales transactions, even if no claims are received. This means that companies may report a higher income tax expense on their income statements than they ultimately pay to the tax authorities. The difference between the actual tax payment and the income tax expense is recorded as a deferred tax asset on the balance sheet.
Deferred tax assets and liabilities can be classified as either current or non-current assets, depending on their expected realisation period. Current assets are those expected to be realised within one year, while non-current assets are those expected to be realised after more than one year.
In summary, deferred tax assets are an important aspect of a company's financial statements, representing potential future tax benefits. They are recorded as non-current assets on the balance sheet subject to realization assessments. Understanding deferred tax assets can provide valuable insights into a company's financial health and future tax obligations.
Investing in business opportunities might yield not only immediate financial gains, but also deferred tax benefits, as carrying forward tax losses or recognizing provisions before their tax-deductible periods could generate deferred tax assets. Companies that have deferred tax assets have the potential to pay less tax than comparable entities without such assets, as these assets reduce future taxable income and payments.
