Tax Assets Delayed: Definition, Illustrations
In the world of corporate finance, deferred tax assets (DTAs) play a significant role in shaping a company's financial health and future tax liabilities. DTAs represent future tax-related economic benefits, arising from temporary differences between accounting and taxable income.
When a company pays taxes in advance or has deductions or losses that can be used to offset taxable income in future periods, a deferred tax asset is created. This asset reduces the company’s future tax liabilities, as it can be utilized when the company realizes taxable profits.
The impact of DTAs on financial statements is profound. On the balance sheet, DTAs are reported as non-current assets, increasing total assets and equity (retained earnings). This indicates that the company expects to pay less tax in the future due to current period differences.
On the income statement, when a deferred tax asset is recognized (for instance, due to a tax loss carryforward or temporary deductible differences), the related tax benefit increases net income in the current period. Conversely, if a DTA previously recorded becomes doubtful (i.e., it is unlikely to be realized), a valuation allowance must be established, which reduces net income.
While DTAs do not directly impact cash flow, they improve future cash flows by reducing actual tax payments when the asset is utilized. Companies must disclose significant DTAs and the judgments involved in assessing their recoverability, including the assumptions about future taxable income.
Recognition of DTAs is based on the probability of future taxable income, and they are measured using the expected future tax rates at realization. Any changes in tax rates (e.g., due to new legislation) are recognized immediately in the period of enactment, impacting the DTA’s carrying value and future tax benefit.
An example of a DTA is when a company records a tax loss in one year, it may recognize a DTA for the estimated future tax savings from that loss (assuming future profits). In subsequent years, as those losses are used to offset taxable income, the DTA is reduced, and the company’s tax liability for those years is correspondingly lower.
In summary, DTAs provide future tax benefits, directly reducing future tax liabilities when realized, and their recognition and measurement have significant impacts on a company’s financial position and performance. Key considerations include the establishment of a valuation allowance when it becomes unlikely that a DTA will be utilized, reflecting legislative changes that affect future tax rates immediately in the carrying amount of DTAs, and transparent reporting regarding recoverability and assumptions about future profitability.
Investing in business can involve understanding deferred tax assets (DTAs), as they significantly impact a company's financial health and future tax liabilities. These assets, created when a company has future tax benefits from temporal differences, are recorded as non-current assets on the balance sheet, increasing total assets and equity.
