Definition
– A deferred tax asset (DTA) is an item on a company’s balance sheet that represents taxes already paid or tax benefits available now but not yet recognized against taxable income. Practically, it signals that the company expects to reduce its future tax payments because of timing differences, loss carryforwards, or other tax rules that produce a deductible amount in future periods.
Why DTAs arise (plain-language)
– Accounting and tax rules can treat the same income or expense in different periods. When those timing differences, tax credits, or loss carryforwards will reduce taxable income in the future, the expected tax saving is recorded today as a deferred tax asset. Common triggers are: net operating losses carried forward, expenses recognized for accounting now but deductible later for tax, or taxes paid in advance.
Deferred tax asset versus deferred tax liability
– Deferred tax asset: future reduction in taxes payable.
– Deferred tax liability: future increase in taxes payable (an amount the company will owe later).
– Example contrast: a company that claims a tax depreciation method more accelerated than book depreciation may record a deferred tax liability (taxes deferred to the future). A company with a current accounting loss that can reduce future taxable income records a DTA.
Key characteristics from recent tax rules
– For most companies, net operating loss carryforwards generally can be carried forward indefinitely (treatment changed beginning in 2018). Carrybacks were largely restricted starting in 2018, although some specific loss types (for example, certain farming losses) may retain limited carryback rights. DTAs cannot be used to amend a past tax return; they reduce future taxable income.
Step-by-step: how to calculate a simple deferred tax asset
1. Identify the deductible temporary difference or carryforward amount that will reduce future taxable income (for example, a net operating loss of $X).
2. Determine the applicable enacted tax rate expected to apply when the difference reverses.
3. Multiply the deductible amount by that tax rate.
– DTA = Deductible temporary difference (or carryforward) × Enacted tax rate
Worked numeric example
– Company A records a $500,000 net operating loss (NOL) this year that it expects to use against future taxable income. The enacted corporate tax rate expected at the time of utilization is 21%.
– Compute the DTA: 500,000 × 21% = $105,000.
– That $105,000 is reported as a deferred tax asset (a non-current asset on the balance sheet) because it represents future tax savings.
– If the expected tax rate later falls to 18%, the same $500,000 NOL would support a DTA of 500,000 × 18% = $90,000, so the DTA’s value declines with lower tax rates.
Practical checklist before recognizing a DTA
– Confirm the origin: Is the amount a deductible temporary difference, a tax credit, or a carryforward (e.g., NOL)?
– Evaluate realizability: Does the company expect sufficient future taxable income to use the DTA?
– Use the enacted tax rate expected when the deductible difference reverses.
– Note limitations: Are there specific rules (carryback limits, industry exceptions like some farming losses) that affect timing?
– Record classification: DTAs are typically shown as non-current assets.
– Monitor tax-rate changes: an enacted change affects DTA valuation.
Common examples of deferred tax assets
– Net operating loss carryforwards that reduce future taxable income.
– Expenses recognized on the financial statements now but deductible for tax later.
– Tax credits not fully claimed in the current period and carried forward.
Important considerations and risks
– Realizability: a DTA is only meaningful if the company is likely to have future taxable income to absorb it. If not, companies must consider allowances or other adjustments.
– Tax-rate sensitivity: changes in the enacted tax rate change the dollar value of existing DTAs.
– Timing and rules: recent changes to carryback/carryforward rules (beginning in 2018) altered how and when DTAs can be used for many taxpayers.
Quick reference questions
– Do DTAs expire? For many taxpayers, carryforwards
carryforwards may expire depending on the jurisdiction and the type of tax attribute. Many countries limit how long losses or unused credits can be carried forward; others allow indefinite carryforwards but may cap annual use. Always check the specific tax code and recent legislative changes because rules (and temporary relief measures) can change.
Practical checklist: deciding whether to recognize and measure a deferred tax asset (DTA)
– Identify the deductible temporary difference or tax attribute (examples: net operating loss (NOL) carryforward, warranty/reserve not yet deductible, tax credit carryforward).
– Compute the tax base difference (amount expected to reduce future taxable income).
– Apply the enacted tax rate expected to apply when the asset reverses (enacted rate = rate legally in force at the reporting date for the period in which the difference is expected to reverse).
– Assess realizability: is it more likely than not (>50% under US GAAP) that the company will generate sufficient taxable income to use the DTA? Consider:
– Recent history of taxable income (losses or profits).
– Reversing taxable temporary differences (DTLs) that will produce taxable income.
– Forecasts of future taxable income and the assumptions behind them.
– Possible tax-planning strategies (e.g., elections, asset sales).
– Expiration dates for carryforwards and legislative risk.
– If realizability is doubtful, estimate a valuation allowance (or equivalent under IFRS).
– Document judgment, key assumptions, and sensitivity to changes (especially tax-rate changes).
Key formulas
– DTA = Deductible temporary differences (or tax attribute amount) × Enacted tax rate expected when reversal occurs.
– Net deferred tax asset (reported) = Gross DTAs − Valuation allowance (if any).
Worked numeric example 1 — simple NOL carryforward
Assumptions:
– Company A has an NOL carryforward of $100,000.
– Expected applicable enacted corporate tax rate when used = 21%.
Calculation:
– DTA = $100,000 × 21% = $21,000.
Journal entry on recognition (simplified):
– Dr Deferred tax asset $21,000
– Cr Income tax benefit (or reduce tax expense) $21,000
If evidence indicates only 60% of the NOL is likely to be used:
– Valuation allowance = $21,000 × (1 − 60%) = $8,400
– Net reporting: Deferred tax asset $21,000 − Valuation allowance $8,400 = $12,600
Worked numeric example 2 — timing difference from reserves
Assumptions:
– Book shows warranty expense recognized now: $50,000.
– For tax, warranty is deductible only when paid; expected to be paid in future periods.
– Enacted tax rate = 25%.
Calculation:
– DTA = $50,000 × 25% = $12,500.
Journal entry on recognition:
– Dr Deferred tax asset $12,500
– Cr Income tax benefit (current period) $12,500
How valuation allowances and remeasurement work (examples)
– If new evidence suggests future taxable income will be lower, increase the valuation allowance and record additional tax expense.
– If tax rates are reduced by law, recalculate DTA at the lower enacted rate and recognize a one-time charge for the remeasurement. Example: $21,000 DTA at 21%; tax rate cut to 15% ⇒ remeasured DTA = $100,000 × 15% = $15,000; reduction of $6,000 recognized in tax expense (or separate component per applicable guidance).
Accounting standards — brief comparison
– US GA
AP — Accounting standards — brief comparison (continued)
– US GAAP (ASC 740 — “Income Taxes”)
– Recognition: A deferred tax asset (DTA) is recorded for deductible temporary differences, carryforwards, and other tax attributes when it is “more likely than not” that they will be realized. “More likely than not” generally means a likelihood of >50%.
– Valuation allowance: If sufficient positive evidence does not exist to support realization, management must record a valuation allowance that reduces the DTA to the amount expected to be realized. The valuation allowance is a contra‑asset account.
– Measurement: DTAs are measured using enacted tax rates expected to apply when the temporary differences reverse.
– Remeasure
Remeasurement: Deferred tax assets (DTAs) and deferred tax liabilities (DTLs) are remeasured when enacted tax laws or rates change or when management revises its estimates of the timing or amount of future taxable income. Under US GAAP, remeasurement effects are generally recognized in income tax expense in the period of change, except to the extent the underlying item giving rise to the tax effect was recorded in other comprehensive income (OCI) or equity — in which case the tax effect follows the same component of equity/OCI. Under IFRS (IAS 12), similar remeasurement principles apply: use enacted (or substantively enacted) tax rates expected to apply when temporary differences reverse and recognize the effect in profit or loss, except where the tax arises on items charged or credited to equity/OCI.
Presentation and offsetting
– Classification: IFRS (IAS 12) requires deferred tax assets and liabilities to be presented as non‑current on the statement of financial position. US GAAP permits presentation by current and noncurrent classification consistent with the classification of the related asset or liability (and permits netting to the extent that a single taxpaying component and jurisdiction allow).
– Offsetting (netting): Both frameworks allow offsetting DTAs and DTLs only when the taxpayer has a legally enforceable right to set off current tax assets against current tax liabilities and the deferred tax balances relate to the same taxing
jurisdiction. In practice that means both deferred tax balances must belong to the same taxpayer (or a group of entities that are taxed on a net basis) and relate to the same tax authority and period. If those conditions are not met, the balances are presented gross rather than net.
Practical checklist for accounting for deferred tax assets (DTAs)
– Identify temporary differences and carryforwards: list items that create timing differences (e.g., warranty provisions, accelerated tax depreciation, bad‑debt allowances) and tax loss/capital loss carryforwards.
– Determine the applicable tax base and the carrying amount: compute the difference between an asset’s or liability’s book basis and its tax basis.
– Classify the difference as deductible (creates a DTA) or taxable (creates a deferred tax liability, DTL).
– Apply the enacted tax rate(s): measure DTAs using the tax rates that are expected to apply when the temporary differences reverse.
– Assess realizability: under US GAAP, consider a valuation allowance if it is more likely than not (>50%) that some or all of the DTA will not be realized; under IFRS, assess the probability of sufficient taxable profits without a separate valuation allowance construct.
– Record the entry: debit Deferred Tax Asset and credit Income Tax Benefit (or reverse for DTLs), with offsets to equity for items recorded directly in OCI/equity when applicable.
– Reassess each reporting period: update measurements for changes in tax law, enacted rates, and changes in projected taxable income; adjust valuation allowances or recognition as needed.
– Presentation and disclosure: present DTAs/DTLs as required by the reporting framework and disclose significant judgments, the nature of temporary differences, and valuation allowance/realization assumptions.
Worked example — deductible timing difference (warranty)
Assumptions
– Company records a warranty expense for accounting purposes when products are sold: $100,000 in Year 1.
– For tax purposes, warranty costs are deductible only when cash is paid to settle claims, expected in Year 2.
– Statutory tax rate: 25%.
Year 1 (recognition)
– Book expense recognized now: warranty expense = $100,000.
– Tax deduction deferred: taxable income is higher now by $100,000.
– DTA calculation: deductible temporary difference = $100,000; DTA = $100,000 × 25% = $25,000.
Journal entry (Year 1):
– Debit Deferred Tax Asset $25,000
– Credit Income Tax Benefit (or reduce Income Tax Expense) $25,000
Year 2 (reversal when warranty paid)
– Cash paid to settle warranty: $100,000 (tax deductible now).
– Taxable income reduces by $100,000; tax cash outflow = $100,000 × 25% = $25,000.
Accounting entries in Year 2 when claim paid and tax effect realized:
– Debit Income Tax Expense (or reduce benefit) $25,000
– Credit Deferred Tax Asset $25,000
– Cash tax paid recorded separately when remitted to the tax authority.
Net effect over the two years: tax expense in accounting profit/loss is matched to the timing of accounting expense recognition; deferred tax timing differences create a temporary mismatch that reverses when the deduction is allowed for tax.
Worked example — valuation allowance (US GAAP)
Assumptions
– Company has a tax loss carryforward that creates a DTA of $200,000 at a 21% tax rate = $42,000.
– Management projects future taxable income is uncertain and concludes realization of $30,000 of the DTA is more likely than not.
Accounting result under US GAAP (ASC 740):
– Recognize DTA = $42,000, but establish a valuation allowance of $12,000 (42,000 − 30,000) to reduce the net DTA to the amount expected to be realized.
Journal entries:
– Debit Deferred Tax Asset $42,000
– Credit Income Tax Benefit $30,000
– Credit Valuation Allowance (contra‑asset) $12,000
Subsequent change
– If future profits become more likely, reduce the valuation allowance and recognize the increase in tax benefit in earnings; reductions cannot be recognized directly in equity.
Notes on measurement and changes in tax law
– Use enacted tax rates: DTAs and DTLs are measured using tax rates that have been enacted (or substantively enacted under IFRS) by the reporting date.
– Remeasure when rates change: if a tax rate is changed retroactively or prospectively before the
reporting date or financial statement issuance, the DTA and DTL amounts are remeasured using the new enacted rate and the effect is recognized in the period of enactment. Under U.S. GAAP (ASC 740) that remeasurement generally hits income tax expense in the period a rate change is enacted. Under IFRS (IAS 12), the effect is recognized in profit or loss except when the underlying transaction giving rise to the deferred tax was recognized in other comprehensive income (OCI) or equity — in that case the deferred tax adjustment follows the same statement (OCI or equity).
Classification and presentation
– Noncurrent presentation: Most major accounting frameworks require deferred tax assets (DTAs) and deferred tax liabilities (DTLs) to be presented as noncurrent on the balance sheet, rather than split into current and noncurrent amounts.
– Netting: Jurisdictions and accounting frameworks differ on whether DTAs and DTLs can be offset (netted). U.S. GAAP allows netting within a tax-paying jurisdiction; IFRS permits netting when there is a legally enforceable right to set off current tax assets against current tax liabilities and the deferred amounts relate to the same taxable entity and tax authority.
– Disclosures: Companies must disclose the components