Deferred Tax Asset And Liability

DEFERRED TAX Deferred tax is an accounting concept, meaning a future tax liability or asset, resulting from temporary differences between book (accounting) value of assets and liabilities and their tax value, or timing differences between the recognition of gains and losses in financial statements and their recognition in a tax computation.

DEFERRED TAX ASSET An asset that is used to reduce the amount of tax that a company will have to pay in a later tax period. It is often associated with a loss carryover, and is used as a future write-off if the next tax period is expected to produce positive earnings. The asset is kept on the balance sheet. For example, a deferred tax asset of $100,000 from the previous year could be applied to before-tax income of $250,000 this year, resulting in taxable income of $150,000 ($250,000 - $100,000).

What Does Deferred Tax Asset Mean? An asset on a company's balance sheet that may be used to reduce any subsequent period's income tax expense. Deferred tax assets can arise due to net loss carryovers, which are only recorded as assets if it is deemed more likely than not that the asset will be used in future fiscal periods.

It must be determined that there is more than a 50% probability that the company will have positive accounting income in the next fiscal period before the deferred tax asset can be applied. If, for example, a company has a deferred tax asset of $25,000 on its balance sheet, and then the company earns $75,000 in before-tax accounting income, accounting tax expense will be applied to $50,000 ($75,000 - $25,000), instead of $75,000.

DEFERRED TAX LIABILITY What Does Deferred Tax Liability Mean? An account on a company's balance sheet that is a result of temporary differences between the company's accounting and tax carrying values, the anticipated and enacted income tax rate, and estimated taxes payable for the current year. This liability may or may not be realized during any given year, which makes the deferred status appropriate. Because there are differences between what a company can deduct for tax and accounting purposes, there will be a difference between a company's taxable income and income before tax. A deferred tax liability records the fact that the company will, in the future, pay more income tax because of a transaction that took place during the current period, such as an installment sale receivable.

In simple words: Deffered tax liability means currently you are paying less amount of tax as per IT but in future you have to pay more so for this timing difference we have to create a deffered tax liability in our books of accounts accoding to the virtual certainty that in future company will earn sufficient proft to recover it. for deffererd tax liability the entry will be Profit & loss a\c dr To Deffered tax liability

ILLUSTRATED EXAMPLE The basic principle of accounting for deferred tax under a temporary difference approach can be illustrated using a common example in which a company has fixed assets which qualify for tax depreciation. The following example assumes that a company purchases an asset for $1,000 which is depreciated for accounting purposes on a straight-line basis of five years. The company claims tax depreciation of 25% per year on a declining balance basis. The applicable rate of corporate income tax is assumed to be 35%. Purchase Year 1 Year 2 Year 3 Year 4 Accounting value

$1,000

$800

$600

$400

$200

Tax value

$1,000

$750

$563

$422

$316

Taxable/(deductible) temporary difference

$0

$50

$37

$(22) $(116)

Deferred tax liability/(asset) at 35%

$0

$18

$13

$(8)

$(41)

As the tax value (tax base) is lower than the accounting value (net book value) in years 1 and 2, the company should recognise a deferred tax liability. This also reflects the fact that the company has claimed tax depreciation in excess of the expense for accounting depreciation recorded in its accounts, whereas in the future the company should claim less tax depreciation in total than accounting depreciation in its accounts. In years 3 and 4, the tax value exceeds the accounting value, therefore the company should recognise a deferred tax asset (subject to it having sufficient forecast profits so that it is able to utilise future tax deductions). This reflects the fact that the company expects to be able to claim tax depreciation in the future in excess of accounting depreciation.

EXAMPLES Deferred tax liabilities

Deferred tax liabilities generally arise where tax relief is provided in advance of an accounting expense, or income is accrued but not taxed until received. Examples of such situations include: • •

a company claims tax depreciation at an accelerated rate relative to accounting depreciation a company makes pension contributions for which tax relief is provided on a paid basis, whereas accounting entries are determined in accordance with actuarial valuations

Deferred tax assets

Deferred tax assets generally arise where tax relief is provided after an expense is deducted for accounting purposes.Examples of such situations include: •

•

a company may accrue an accounting expense in relation to a provision such as bad debts, but tax relief may not be obtained until the provision is utilised a company may incur tax losses and be able to "carry forward" losses to reduce taxable income in future years