Deferred Tax Asset & Liability

Deferred Tax Assets (DTA) and Deferred Tax Liabilities (DTL) are essential components of a company's financial reporting.
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Deferred Tax Asset & Liability
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2 min read
23 December 2023

When it comes to understanding a company's financial position and its tax implications, concepts like deferred tax asset (DTA) and deferred tax liability (DTL) play a crucial role. Read on to understand the intricacies of deferred tax assets and liabilities, exploring what they are, why they occur, and how they can impact a company's financial statements.

What is a Deferred Tax Asset?

A Deferred Tax Asset (DTA) is an accounting term that represents the future tax benefits a company is entitled to due to temporary differences between book and tax accounting. Temporary differences arise when certain income or expenses are recognised in financial statements at a different time than they are for tax purposes. These differences create the potential for future tax savings, leading to the recognition of a deferred tax asset on the balance sheet.

Examples of Deferred Tax Assets

Common examples of deferred tax assets include:

  1. Accrued expenses: If a company recognises expenses in its financial statements before they are deductible for tax purposes, a deferred tax asset is created.
  2. Bad debt provisions: When a company sets aside money for potential bad debts, it may recognise this expense in its financial statements before taking the deduction for tax purposes.
  3. Depreciation: Differences in the timing of recognising depreciation expenses can lead to the creation of deferred tax assets.

What is a Deferred Tax Liability?

On the flip side, a Deferred Tax Liability (DTL) represents the future tax obligations a company will have to pay due to temporary differences. These differences typically arise when certain income or expenses are recognised for tax purposes before they are recorded in the financial statements.

Reasons for Deferred Tax Liability to arise

  1. Accelerated depreciation: If a company uses accelerated depreciation methods for tax purposes but straight-line depreciation for financial reporting, it creates a deferred tax liability.
  2. Revenue recognition: If revenue is recognised for tax purposes before it is recorded in the financial statements, a deferred tax liability is generated.

Example of Deferred Tax Liability

Suppose a company uses accelerated depreciation for tax purposes, resulting in lower taxable income. This leads to lower tax payments in the short term. However, as the company's book depreciation catches up and exceeds tax depreciation over time, a deferred tax liability is recognised to account for the higher tax payments expected in the future.

How to calculate a Deferred Tax Asset

The calculation of a deferred tax asset involves multiplying the temporary differences by the applicable tax rate. The formula is as follows:

Deferred Tax Asset = Temporary Differences × Tax Rate

Key characteristics of Deferred Tax Asset

Deferred Tax Assets (DTAs) possess distinct characteristics that distinguish them in the realm of financial reporting. Here are key features associated with Deferred Tax Assets:

1. Timing differences:

  • DTAs originate from temporary differences between the recognition of items in financial statements and their treatment for tax purposes.
  • Timing misalignments can occur in the recognition of revenues, expenses, and other items.

2. Future tax deductions:

  • Deferred Tax Assets represent potential future tax benefits that can be utilised to reduce the company's taxable income in subsequent periods.
  • They act as tax shields, allowing the company to offset future tax liabilities.

3. Valuation allowance:

  • DTAs are subject to a valuation allowance, reflecting management's assessment of the likelihood of their realisation.
  • If it is more likely than not that some portion of the DTAs will not be realised, a valuation allowance is established.

4. Carry forward potential:

  • DTAs often have the ability to be carried forward to offset future taxable income.
  • The carry-forward period varies by jurisdiction and is subject to certain limitations.

5. Dependence on future profitability:

  • Realising Deferred Tax Assets depends on the company's ability to generate sufficient taxable income in the future.
  • If a company faces prolonged losses, it may need to reassess the recoverability of its DTAs.

6. Influence on financial statements:

  • DTAs impact a company's balance sheet by increasing assets, which, in turn, can affect key financial ratios and metrics.
  • Changes in the valuation allowance can also influence the income statement.

7. Affected by tax rates:

  • The recognition and measurement of DTAs are influenced by applicable tax rates.
  • Changes in tax rates can impact the valuation of existing DTAs.

Disclaimer

1. Bajaj Finance Limited (“BFL”) is a Non-Banking Finance Company (NBFC) and Prepaid Payment Instrument Issuer offering financial services viz., loans, deposits, Bajaj Pay Wallet, Bajaj Pay UPI, bill payments and third-party wealth management products. The details mentioned in the respective product/ service document shall prevail in case of any inconsistency with respect to the information referring to BFL products and services on this page.

2. All other information, such as, the images, facts, statistics etc. (“information”) that are in addition to the details mentioned in the BFL’s product/ service document and which are being displayed on this page only depicts the summary of the information sourced from the public domain. The said information is neither owned by BFL nor it is to the exclusive knowledge of BFL. There may be inadvertent inaccuracies or typographical errors or delays in updating the said information. Hence, users are advised to independently exercise diligence by verifying complete information, including by consulting experts, if any. Users shall be the sole owner of the decision taken, if any, about suitability of the same.

Frequently asked questions

Why do Deferred Tax Assets occur?

Deferred tax assets occur because accounting rules and tax regulations often recognise revenue and expenses at different times. This misalignment creates temporary differences that, in turn, result in deferred tax assets or liabilities.

Do Deferred Tax Assets carry forward?

Yes, deferred tax assets can be carried forward to offset future taxable income. However, their realisation depends on the company's ability to generate sufficient taxable income in the future.

Difference between Deferred Tax Asset and a Deferred Tax Liability?

The primary difference lies in the nature of the temporary differences. Deferred tax assets arise when tax recognition lags book recognition, providing future tax benefits. Conversely, deferred tax liabilities result from tax recognition preceding book recognition, leading to future tax obligations.

What is an example of a DTA and DTL?

An example of a deferred tax asset is the recognition of a provision for bad debts in financial statements before it is deductible for tax purposes. In contrast, an example of a deferred tax liability is accelerated depreciation for tax purposes creating a future tax obligation.

What is a Deferred Tax Asset in India?

In India, deferred tax assets are recognised following the accounting principles outlined in the Indian Accounting Standards (Ind AS) or the Generally Accepted Accounting Principles (GAAP), depending on the reporting framework adopted by the company.

What is an example of Deferred Tax Liability?

An example of a deferred tax liability is the situation where a company recognises revenue for tax purposes before it is recorded in the financial statements. This creates a temporary difference, leading to a deferred tax liability as the tax obligation will be higher in the future when the revenue is eventually recognised in the books.

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