Definition
A “Deferred Tax Asset Journal Entry” in finance refers to a record made in a business’s financial books when an event occurs that will reduce a company’s future tax liability. It’s needed when a difference between tax accounting rules and the accounting methods used by the firm arises, leading to a situation where income tax expense is temporarily higher than actual tax payable. This creates a deferred tax asset as the amount can be utilized to offset future income tax expenses.
Key Takeaways
- Deferred Tax Asset Journal Entry is an accounting approach used to balance the differences that come due to the mismatch between the company’s accounting and tax books. It represents the amount that a business has overpaid or prepaid on its taxes and is considered an asset on the company’s balance sheet.
- The recognition of a Deferred Tax Asset implies that the company anticipates a decrease in future tax payments. Essentially, the business will be paying lower taxes in the future due to the overpayment or prepayment that’s been made in the current period.
- Journal entries for Deferred Tax Assets are made based on the estimated future tax rates and amounts. If the estimated tax rate changes in the future, the Deferred Tax Asset balance might need to be adjusted accordingly to reflect the new expected future tax payments.
Importance
The Deferred Tax Asset Journal Entry is crucial in financial accounting as it pertains to a situation where a business has paid more tax to the tax authority than what they should have owed based on their accounting records.
Deferred Tax Asset Journal Entries are made to reflect these discrepancies in the company’s books.
This discrepancy usually arises due to differences in the rules of accounting and taxation, primarily when income or expense is recognized in books and when it is acknowledged in tax.
Recognizing deferred tax assets helps to ensure the company’s future tax liability is accurately estimated, thus ensuring its financial statements accurately reflect its financial health and performance.
It also aids in financial planning and management, making it a vital aspect of financial accounting.
Explanation
A deferred tax asset journal entry is primarily used in corporate financial management to showcase and manage the timing differences between when a transaction occurs and when it is recorded in the books of accounts. Its purpose is to align the book income with the tax income. The reason behind this alignment is because the financial statement recognized income may not always coincide with the taxable income determined for the same period by tax laws due to temporary differences.
As a result, this leads to the difference of taxes payable in the accounts books and actual taxes paid. The deferred tax asset also plays a pivotal role when the corporation anticipates more profits in the future. It can be used to offset the income tax liability of future periods.
This is based on the business’ expectations that they will use these assets to reduce future tax liabilities. The management tracks, records and reports the deferred tax asset in their ledger through the deferred tax asset journal entry, ensuring they have an accurate representation of their future tax position. This mechanism assists the company to better manage their tax strategy proactively and plan their future financial obligations more effectively.
Examples of Deferred Tax Asset Journal Entry
Company ABC: Company ABC had a revenue forecast of over a million dollars for the fiscal year. However, due to unforeseen losses, the company could not realize its projected revenue, leading to a net operating loss. The tax regulations in their jurisdiction allow them to carry forward this loss to offset against future income. This means they have a deferred tax asset, which they record in their journal entry.
Real Estate Developer XYZ: This company develops and sells properties. In a certain year, they sell a high valued property which leads to a massive amount of book income. However, due to tax laws, the company does not have to pay tax on the sale until the following year. This results in a tax liability for the next year, but due to expectations of a lower tax rate in the future, they recognize a deferred tax asset in their journal story for the current year.
Tech Start-Up DEF: DEF is a tech start-up that has just commenced its operations. In its initial years, it incurs heavy operational losses with no income. It records these losses to be carried forward for a future date when it expects to be profitable. As a result, these losses become a deferred tax asset that the company records in its journal entry.
FAQ for Deferred Tax Asset Journal Entry
1. What is a Deferred Tax Asset?
A Deferred Tax Asset is an item on the balance sheet that results from overpayment or advance payment of taxes. It is an asset to the company because it is an amount that a company can use to offset future taxes.
2. How is a Deferred Tax Asset created?
A Deferred Tax Asset is created when a business pays more taxes to the Internal Revenue Service (IRS) or another tax authority than they show as an expense on their income statement during a reporting period.
3. How do you record a Deferred Tax Asset in a journal entry?
When you record a Deferred Tax Asset in a journal entry, you debit the Deferred Tax Asset account and credit the income tax expense account. This will increase the Deferred Tax Asset and decrease the income tax expense.
4. What happens when a Deferred Tax Asset is realized?
When a Deferred Tax Asset is realized, it means the company has used the asset to pay off future income taxes. When this happens, the Deferred Tax Asset account is debited, and the income tax expense account is credited. This reduces the asset in the balance sheet and reduces the tax expense in the income statement.
5. Is Deferred Tax Asset good or bad?
Deferred Tax Assets can be either good or bad. They can be good because they reduce a company’s future income tax obligation. However, they can also be bad if they are the result of net operating losses, which indicate that the company is not running profitably.
Related Entrepreneurship Terms
- Accrual Accounting
- Income Recognition
- Balance Sheet
- Tax Liability
- Depreciation Expense
Sources for More Information
- Accounting Tools: This website offers comprehensive information about various financial terms, business concepts, and accounting principles, including Deferred Tax Asset Journal Entries.
- Investopedia: This site provides simple explanations for complex financial concepts, making it ideal for individuals who are looking for information on Deferred Tax Asset Journal Entries.
- CFA Institute: As a global association for investment professionals, the CFA Institute website contains in-depth resources and articles relating to various finance topics, including Deferred Tax Asset Journal Entries.
- Accounting Coach: This website offers free and paid learning resources on a wide array of accounting topics, where you can find information about Deferred Tax Asset Journal Entries.
