Definition
Deferred Tax Assets are items on a company’s balance sheet that reduce future tax liability because they are overpaid taxes or carried-forward losses. They can be used to offset future tax obligations. Essentially, they’re future tax savings or payments already made that a company can use to reduce its tax burden in the coming years.
Key Takeaways
- Deferred tax assets represent the amounts that a company has overpaid or prepaid on its taxes and are considered assets because they can be used to offset future tax obligations.
- They often arise due to differences between accounting rules and tax laws, such as the timing of income or expense recognition, and are used to reconcile these differences over time.
- Deferred tax assets can be hard to value because they depend on future profitability. If it’s not likely that the company will make a profit in the future, these assets can become worthless, creating a risk for the company.
Importance
Deferred tax assets are important in finance as they represent the decrease in future tax liability of a company and are considered a crucial part of a company’s financial statement.
They arise when a company pays more taxes to the government than what they owe in their accounting books, typically due to differences in income recognition or allowable tax deductions.
Essentially, these are future tax savings that can be used to offset tax liabilities.
Thus, it increases a company’s future earning potential, given that the company will have to pay fewer taxes in upcoming periods.
Therefore, the presence of significant deferred tax assets can hugely impact the company’s valuation and investment desirability.
Explanation
Deferred Tax Assets are essentially credits a company can utilize to offset future tax liabilities. The purpose of such assets is to lessen the company’s future tax burden. They often come into existence when a business anticipates that it will pay more income tax in the future than what is due in the immediate term.
Such circumstances might include instances where a business has overpaid taxes or has carried forward net operating losses that can be used to offset future profitability—thereby reducing the income tax due in those future periods. One key use for Deferred Tax Assets is in instances of temporary differences. These occur when business expenses are recognized in different periods on tax returns versus income statements, creating a disparity.
By having a Deferred Tax Asset, the company can use this amount to reduce the payable income tax in future accounting periods when these temporary differences become payable. This could be a critical element in a company’s strategic financial management as it can significantly influence the financial health and profitability of a company. Thus, a Deferred Tax Asset can provide a company with valuable relief in times of high tax expenses.
Examples of Deferred Tax Assets
Capital Losses: Let’s say a company, ABC Inc., faced a capital loss in the current fiscal period due to disposing of some assets at a value under their recorded cost. This capital loss can be used to offset capital gains in the forthcoming years thereby reducing their future tax liability. So, the capital loss becomes a Deferred Tax Asset.
Allowance for Doubtful Accounts: If a company, XYZ Ltd., estimates that a certain portion of their accounts receivables might prove uncollectible, they can create an allowance for doubtful accounts. This reduces current period income and thus, current tax liability. However, this allowance can be reversed in the future if those debts are paid, resulting in future taxable income. In this case, the allowance constitutes a Deferred Tax Asset.
Net Operating Losses Carryforward: In scenarios where a company, EFG Corp., posts a loss for a financial year (Net Operating Loss), these losses can be carried forward to be offset against future profits, reducing the amount of taxable income in the future. Hence, these Net Operating Losses (NOLs) can be considered as Deferred Tax Assets. Remember that these examples depend on the specific tax laws of the country where the company is operating. It’s always best to consult with a tax professional or accountant for advice.
FAQs on Deferred Tax Assets
What Are Deferred Tax Assets?
Deferred Tax Assets are items on a company’s balance sheet that can be used to reduce its taxable income in the future. They are essentially credit earned by the company due to over-payment or pre-payment of taxes.
How Are Deferred Tax Assets Created?
Deferred Tax Assets are created when a company over-pays or pre-pays its taxes. This can happen as a result of business losses, over-estimation of tax liability, or through certain types of tax credits.
What is The Significance of Deferred Tax Assets to a Company?
Deferred Tax Assets can significantly affect a company’s financial position. They can lower a company’s future tax liability, increase its future earnings, and provide a more accurate picture of its financial health.
How Are Deferred Tax Assets Valued?
Deferred Tax Assets are valued at the amount of tax benefit they should provide in the future. This is calculated by estimating the company’s future tax rate and applying it to the total amount of the Deferred Tax Assets.
How Are Deferred Tax Assets Recognized in Financial Statements?
Deferred Tax Assets are recognized in the balance sheet of a company’s financial statement. They are counted as an asset since they reduce future tax liabilities, thus providing future economic value.
Related Entrepreneurship Terms
- Tax Liability
- Income Statement
- Balance Sheet
- Future Tax Deduction
- Temporary Difference
Sources for More Information
- Investopedia: Investopedia is a reliable source for definitions, examples, and deep dives into many financial terms, including Deferred Tax Assets.
- Corporate Finance Institute: This website provides helpful online resources and professional financial analyst training programs. They cover a wide range of financial topics including Deferred Tax Assets.
- Accounting Tools: A great source for financial and accounting concepts. They provide information about a wide range of topics, including Deferred Tax Assets.
- My Accounting Course: This website offers detailed courses on a variety of accounting topics, and has comprehensive guides on topics like Deferred Tax Assets.
