Deferred tax assets

IAS 12 Definition of deferred tax assets: The amounts of income taxes recoverable in future periods in respect of:

  1. Deductible temporary differences;
  2. The carry-forward of unused tax losses; and
  3. The carry-forward of unused tax credits.

There are some key characteristics of deferred tax assets to consider.

  • Deferred tax assets are only recognised to the extent that it is probable that the temporary difference will reverse in the foreseeable future and that taxable profit will be available against which the temporary difference will be utilised.
  • The carrying amount of deferred tax assets are reviewed at the end of each reporting period and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow the benefit of part or all of that deferred tax asset to be utilised
  • Deferred tax assets come with an expiration date if they are not used up. In many countries, they expire after 20 years.
  • Consideration should be given to how tax rates affect the value of deferred tax assets. If the tax rate goes up, it works to the company’s favour because the assets’ values also go up, therefore providing a bigger cushion for a larger income. But if the tax rate drops, the tax asset value also declines. This means that the company may not be able to use the whole benefit before the expiration date.

These are some of the logical reasons to allow deferred tax assets only to be recognised as non-current assets.


As a result of the definition provided by IAS 12 Sources of deferred tax assets are:

# 1 – Business loss

The simplest method by which these tax assets is created is when the business incurs a loss. The loss of the company can be carried forward and set off against the profits of the subsequent years thus reducing tax liability. Hence, such a loss is an asset or deferred tax assets to be precise for the company.

Something else -   Deductible temporary tax differences

#2 – Differences in depreciation method in accounting and tax purpose

Due to differences in the methods used for depreciation in accounting and tax purposes, this tax asset can be created. There are two methods of depreciation – straight-line method and the double depreciation method. In double depreciation method, the depreciation expenses more in the initial periods and if this method is used for accounting purposes where a straight-line method is used for tax purposes, the company will pay more tax than shown in its books. Thus, it will record deferred tax assets in the balance sheet.

#3 – Differences in depreciation date in accounting and tax purpose

Not only the depreciation method but the depreciation rate could cause an occurrence of this tax assets. For example, if a depreciation rate of 20% is used for tax purposes while a rate of 15% is used for accounting purposes, it will create a difference in actual tax paid and tax on the Income statement. Thus, the company will record deferred tax assets in the balance sheet.

Suppose taxable income is $ 5000 and thus as per this taxable income, the tax will be $ 750 on the income statement and $ 1000 paid to the tax authorities. Hence, there will be a deferred tax asset of (1000 – 750 = $ 250) due to the difference in depreciation rates.

In the above two examples i.e. deferred tax assets are arising due to depreciation and carry forward losses. This asset is recorded only if it can materialise in future incomes. The company checks and prepares a projection of future income statement and balance sheet and if it feels it can be used, it is only then the recorded on deferred tax assets in the balance sheet. If in a certain period, the company feels that this asset cannot materialise in the future with certainty, it will write off any such entry from deferred tax assets in the balance sheet.

Something else -   Deferred tax assets Future tax profits

#4 – Timing difference expenses

Deferred tax assets can also form when expenses are recognised in the income statement before they are recognised in the tax statement and to tax authorities. For example, some legal expenses are not considered as the expense and thus not deducted immediately in tax statement, however, they are shown as the expense in the income statement.

(Amounts in $)

IFRS accounting in FS

Tax accounting in tax return

Difference

Revenue

5,000

5,000

Expenses

1,500

1,500

Legal expenses

500

500

Income

3,000

3,500

500

Tax @ 30%

900

1,050

150

Clearly, there is a difference in tax payable as in the income statement and in the tax statement. Thus, there is a deferred tax asset of (1,050 -900) = $ 150 which will be shown in the balance sheet.

#5 – Timing differences revenues

Sometimes revenue is recognised in one period for tax purposes and in a different period for accounting purposes. If the revenue is recognised for tax purposes before it is done in accounting, the company will pay tax on such high revenue and thus creating this tax asset.

#6 – Timing difference warranties

Warranties are one of the most common deferred tax asset causes.

Let us say an electrical goods company has a revenue of $5 million and it has expenses of $3 million thus a profit of $2 million. However, the expenses are bifurcated as $2.5 million for the cost of goods sold, general expenses, etc and $0.5 million for future warranties and returns.

The tax authorities do not consider future warranties and returns as an expense because this expense has not been incurred but only accounted for. Therefore, the company cannot deduct such an expense while calculating taxes and thus has to pay tax on $0.5 million as well. Therefore, this amount will be part of the deferred tax assets in the balance sheet.

Something else -   Liabilities and assets for current tax

#7 – Timing difference bad debts provision

Another example of deferred tax assets is a bad debt provision. Let us assume that a company has a book profit of $10,000 for a financial year which includes a provision of $500 as bad debt. However, for the purpose of taxes, this bad debt is not considered until it has been actually written off. Thus, the company will have to pay tax on $10,500 and hence creating this tax asset.

If the tax rate is 30%, the company will make a deferred tax asset journal entry in its book for $150.

Deferred tax assets

Deferred tax assets

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Something else -   Investment component

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