What’s it: A deferred tax asset represents an inflow of future tax-related economic benefits. It eventually returns to business in the form of tax relief, reducing future taxable income.
For example, a company pays taxes early before they are due. It is similar to deferred expense, where the company has paid the supplier for future delivery of goods or provision of services. The company doesn’t need to spend cash to get inputs. Likewise, with taxes, companies will enjoy the benefits in the future, without having to spend cash.
So, suppose you compare two identical companies. In that case, the company with a deferred tax asset is more attractive because it will pay relatively less tax in the future.
How do deferred tax assets work
Deferred tax assets are in the assets section of the financial statements, indicating that there are future benefits the company will receive.
Deferred tax assets arise because the company pays too much tax. I mean, companies pay more to the authorities than what is shown in the income statement. The tax authorities recognize income or expenses at a different time from the accounting standards that companies use in financial reporting. Or, the company pays taxes before the due date (prepaid taxes).
Some transactions that can give rise to deferred tax assets are uncollectible accounts receivable, warranty, lease, inventories, and net operating losses.
Reporting in financial statements
The company doesn’t report deferred tax assets and deferred tax liabilities separately. Instead, combine the two into a net value. So, you will not find both accounts on one balance sheet.
Net value is included in the assets section if the deferred tax asset exceeds the deferred tax liability. Or, it is a liability if the deferred tax liability exceeds the deferred tax asset.
Deferred tax assets can be as current or non-current assets.
A simple example of calculating a deferred tax asset
For example, suppose a company earned IDR1,000 in sales revenue. The company estimates that the average warranty claims will be around 2% of total sales. In the reporting year, the company did not receive claims. In the income statement, the company will report sales and warranty expenses as follows:
| Value | |
|---|---|
| Revenue | 1,000 |
| Warranty expense | 20 (2% x 1,000) |
| Profit before tax | 980 |
| Income tax expense | 196 (20% x 980) |
| Profit after tax | 784 |
Based on the matching principle, a company recognizes warranty expense in the same period as the sales transaction. Therefore, the company will report it in the income statement, regardless of whether there is a claim or not. As a result, the profit before tax is IDR980.
However, for paying taxes, the calculation is slightly different. Tax authorities forbid recognizing warranty burdens before they actually occur. So, the company will not report warranty expenses to calculate taxable income.
| Value | |
|---|---|
| Income | 1,000 |
| Warranty expense | 0 |
| Taxable income | 1,000 |
| Tax payable | 200 (20% x 1,000) |
| Profit after tax | 800 |
As a result, the company will pay IDR200 in taxes to the authorities. That’s higher than the income tax expense (IDR196) on the income statement. The company will record the difference between IDR4 (IDR200-IDR196) as a deferred tax asset on the balance sheet.
