written by | April 27, 2022

Deferred Tax Asset and Deferred Tax Liability

Deferred tax assets and deferred tax liabilities are significant components of financial statements. The adjustment on account of these is made at the end of the financial year when the books of accounts are closed. The company derives its record profits from financial reports to the Companies Act's requirements, and the Income Tax Act's rules compute its chargeable profit. Because certain things are either allowed or omitted for tax purposes each year, there is a difference between book profit and taxable profit. The difference between both the book and taxable revenue or expense is caused by one of two things: First, on account of temporary differences – These arise due to differences between the book and tax income that can be corrected in the following period. Second, on account of permanent difference — As the name suggests, this difference between book income and taxable income is that difference that cannot be reversed in the following period.

Depreciation is a typical example. Depreciation is permitted only at the rates specified in the Income Tax Act while computing income tax. The Company Act defines the depreciation rates, and the company's account books must include it. As a consequence, the IT Act differentiates between taxable and book income. As per the matching principle of accounting, income taxes accumulate in the same year as the sales and expenditures they correspond to. Since there is a disparity between income as per records and tax liability as per the IT Act, this matching concept is not followed. As a result, income tax based on income as per records is recognised as an expense in the books of account, while the rest is reported as DTA or DTL.

Did you know?

The revenue and costs you declare on your income statement may not necessarily correspond to tax income and deductions. Tax and accounting records have slightly different principles, so your taxable income and the net income on your financial statements aren't usually the same.

Classification of Deferred Tax

Deferred tax liability is an outstanding debt that must be paid in the future. In contrast, a deferred tax asset is a company tax credit that can help settle future liabilities. It's a point of contention. An asset is a deferred tax item, whereas a liability is another. One shows money payable to the corporation (delayed tax liability), while the other shows money owed to the company (current tax liability) (deferred tax asset). 

Also Read: What Is Goodwill in Accounting?

Deferred Tax Assets

A deferred tax asset (DTA) is an asset created when there is a difference between the carrying amount and tax base such that lower tax will have to be paid in the future.

For instance, if your company paid all of its taxes and then obtained a tax deduction for that period, the remaining deduction can be used as a deferred tax asset in future tax filings. 

Examples of various deferred tax assets: 

  • Net operational loss: The company sustained a financial loss during this time.
  • Overpayment of taxes: You paid too many taxes in the previous period.
  • Business costs: When one accounting technique recognises expenses while another does not.
  • Revenue: When money is earned in one fiscal period but not recognised in the next.
  • Bad debt: A debt is reported as revenue before being written off as uncollectible. An unpaid receivable is turned into a deferred tax asset when finally recognised.

Situations in Which Deferred Tax Assets May Emerge

The following are the reasons for deferred tax assets:

  • The taxing authority considers expenses even before they are needed to be recognised.
  • Earned revenue is taxed even before it is due to be recognised.
  • The tax regulations and bases for assets and liabilities differ.

Deferred Tax Liability

Deferred tax liability occurs when there is a disparity between what a firm can deduct as tax and the tax that exists for accounting reasons. A deferred tax liability indicates that a corporation may have to pay more income tax in the future as a result of a current transaction.

Examples of various deferred tax liability

  • Asset depreciation: The Revenue uses a sophisticated asset depreciation model, which leads to a discrepancy between the balance sheet and the tax value of a corporation. This is a postponed tax liability.
  • Underpayment of taxes: The company did not pay sufficient tax in the prior period and will have to make up the difference in the next cycle.
  • Instalment sale: When a corporation sells a product in instalments, it reports the total transaction on its financial statements but only pays income tax on each annual instalment.

The company discovers it has a deferred tax liability for future payments related to the transaction. 

Reasons for the Emergence of Deferred Tax Liability

The following are some reasons why a firm may have delayed tax liabilities.

  • Figures are double-counted. Most corporations, for example, preserve numerous copies of financial statements for their use as well as those provided to the public and tax authorities. This is also because conventional accounting rules and tax law vary significantly in crucial areas such as revenue, expense, and asset depreciation.
  • Companies often strive to increase earnings to maximise rewards for their shareholders.
  • Companies frequently push present profits into the future to decrease their tax burden. This frees up more funds for investment rather than paying taxes to the government.

How to Show Deferred Tax on the Balance Sheet

  • The balance of deferred tax asset and deferred tax liability should be netted off, implying that either DTA or DTL should be declared in the balance sheet, but not both at the same time for the same quarter.
  • The enterprise should offset deferred tax assets or deferred tax liability as it has a legally enforceable right to set off, for example, if the amount representing DTA and DTL is subject to the same controlling taxation rules as per the Income Tax Act. The laws allow for a single net payment, or the company aims to settle the asset and liability on a net basis.
  • Both should be reported separately from current assets and current liabilities on the balance sheet.
  • Finally, the DTA/DTL should be reviewed as of each Balance Sheet Date and revised to reflect the amount that is reasonably/virtually certain to be realised.

Also Read: What is Net Working Capital: See Definition and Importance

Conclusion

The rules for standard accounting procedures and tax accounting methods are different. If you anticipate receiving a payment, you may be required to pay taxes on it now rather than when the money is received. A delayed tax issue occurs when there is a temporal gap.

When attempting to comprehend deferred tax assets and liabilities, consider the distinction between financial and tax reporting. Different rules and procedures apply to these two types of accounting, and these discrepancies can result in deferred tax assets and deferred tax liabilities. 

The term deferred tax refers to the postponement of taxes due to temporary differences. In the future, you have to pay those taxes. DTA occurs when you have to pay less tax in the future, but DTL occurs when you pay less tax today and are thus required to pay more tax.

We can better grasp our balance sheet regarding future tax credits or debits after knowing the examples of deferred tax assets and liabilities. Use dependable accounting software and address any deferred tax accounts with a tax preparer to minimise tax filing problems relating to these topics. Call your trusted CPA or tax professional to learn more about how deferred assets and liabilities affect your small business. This will ensure that you adhere to proper accounting rules while maximising your tax benefit. We hope this article has clarified all your doubts regarding deferred tax, its calculation, and examples. 
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FAQs

Q: Is deferred tax liability an asset?

Ans:

It is conditional. There are two kinds of deferred tax items - assets and liabilities. One indicates money due by the business, i.e. deferred tax obligation, while the other represents money owed by the business, i.e. deferred tax asset.

Q: When can a deferred tax asset be used?

Ans:

Deferred tax assets never expire and can be utilised anytime the firm sees fit.

Q: On the balance sheet, where are deferred tax liabilities listed?

Ans:

They are classified as non-current liabilities on the balance sheet.

Q: What type of asset is a deferred tax asset?

Ans:

A deferred tax asset is intangible because it is not a physical object like equipment or a building, and it just exists on the balance sheet.

Q: Is a deferred tax asset considered a financial asset?

Ans:

Yes, because it reflects a tax overpayment that can be redeemed in the future.

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