Understanding Deferred Tax Assets: Calculations, Applications, and Real-World Examples

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

Anyone who has run a business of any size understands how confusing and, at times, complex the tax code can seem. So deferred tax assets (DTAs) can be challenging. However, understanding them is essential to minimizing your tax liability.

What Is a Deferred Tax Asset?

In its simplest form, a deferred tax asset is an item on your company’s books that represents a future tax benefit, which you can claim in an upcoming tax return. It arises when an organization’s accounting income is lower than its taxable income. This is usually due to how items are treated for accounting purposes as opposed to their tax purposes.

Essentially, deferred tax assets represent the amount of taxes a company has overpaid in the current year, but plans to claim in a subsequent year. Usually, they arise due to expenses recorded in a company’s financial statements that are not yet deductible under tax regulation.

How Deferred Tax Assets Work

You can think of deferred tax assets as a timing issue. For instance, as you keep your company’s books, you normally record purchases, debt, and other costs and liabilities as they occur. However, when you prepare your tax return, tax law might prohibit you from using certain items to reduce your current tax bill. But that doesn’t mean you will never get to claim them. It merely means that you must wait until a future tax season. So, a deferred tax asset is created, a mechanism by which you can track this future benefit.

Common causes of deferred tax assets are items such as net operating losses, eligible business expenses, certain revenue, bad debt, warranty liabilities, and more. These will be explained further below.

Deferred Tax Assets Vs. Deferred Tax Liabilities

As far as your company is concerned, consider deferred tax assets and deferred tax liabilities as polar opposites. While a deferred tax asset represents an item for which you will realize a tax deduction in the future, a deferred tax liability refers to a record of taxes that your company will owe in the future but are not due yet. 

For clarity’s sake, a common example of a deferred tax liability is an installment sale. When the sale is made, your company’s books reflect the total amount of the sale. However, tax law allows you only to use the actual payments made during the taxable period and thus only pay taxes on a portion of the total sale. So, you know that you will have to pay taxes on the remaining payments in future fiscal periods. That is your deferred tax liability.

Here are the key differences between deferred tax assets and deferred tax liabilities:

Examples of Deferred Tax Assets

Deferred tax assets come in many forms. Here are some common examples.

• Net Operating Losses (NOLs): If your business incurs a net loss for a certain tax period, you might be able to carry it forward to a future tax period. This would be shown as a deferred tax asset in your books.
• Depreciation Accounting: The methods you use to calculate depreciation can result in your business paying more tax than is required. This can result in a deferred tax asset.
• Warranties: If you have set aside money to cover future warranties, which have not been claimed yet, it could result in a deferred tax benefit in your accounting.
• Business Expenses: Depending on how you represent expenses in your books, legitimate business expenses that are not claimed on your tax return could become deferred tax assets.
• Bad Debt: Because companies cannot write off their estimated future bad debt until it is deemed uncollectible, it is represented as a deferred tax asset.

The Importance of Deferred Tax Assets in Financial Reporting

Deferred tax assets help determine a company’s tax strategies, financial outlook and financial reporting. Here are common ways deferred tax assets impact and shape a company’s strategy and financial reporting.

• Future Tax Benefits: Because deferred tax assets have the potential to lower future taxes, they hold the possibility of improving their cash flow and profitability.
• Financial Health Indicator: Because they could reduce future tax liability, deferred tax assets can signal a company’s potential for future profitability.
• Valuation Bolster: Investors and analysts consider deferred tax assets when evaluating a company’s future viability. They can be seen as a benefit or a drawback, depending on factors such as whether they are realizable or not.
• Impact on Equity: Deferred tax assets can influence shareholders’ equity if a company has a large deferred tax asset that it successfully realizes.
• Debt Reduction: Deferred tax assets can lower tax payments, which could free up cash used to pay down debt.
• Investment Decisions: If a company has deferred tax assets, it might be seen as a way to make projects less costly.
• Compliance and Reporting: Optimum tax planning means remaining compliant with tax regulations while maximizing deferred tax asset benefits. So companies need to assess whether and when to realize DTAs routinely.

Deferred Tax Asset Valuation Allowances

It’s important for deferred tax assets to be evaluated for their likelihood of being realizable in future tax filings since they can have a major impact on a business’ strategic planning. If a company expects that it might not be able to use its DTAs, a valuation allowance is created, which reduces the number of deferred tax assets on its balance sheet.

• Assessment of Future Taxable Income: Based on its past performance and plans for the future, a company determines whether it expects to generate enough taxable income to use its deferred tax assets.
• Valuation Allowance Calculation: If the company won’t be able to use its deferred tax assets, a valuation allowance is created, reducing the amount of DTAs on their balance sheet.
• Impact on Financial Statements: The valuation allowance will impact the income statement, typically reducing the company’s net income. Company leaders can reverse the valuation allowance later if they determine they were wrong, thereby improving net income.

Frequently Asked Questions

Is a deferred tax asset current or non-current? Deferred tax assets are recorded as non-current, or long-term, on balance sheets since they will be realized in the future. Deferred tax liabilities are recorded the same way.

When should deferred tax assets be recognized? DTAs should only be recorded in balance sheets when it is probable that they will be realized at some future date[8].How do deferred tax assets affect cash flow statements? Because deferred tax assets represent potential tax benefits, they can increase cash flow.

Share This Article: