Deferred tax assets

Definition

Deferred tax assets are financial accounts that arise when a company has overpaid taxes or has taxes that can be carried forward to future periods. They represent future tax benefits, allowing companies to reduce taxable income in subsequent years. This concept is critical for understanding how companies manage their tax obligations and the timing differences between when income is recognized and when it is taxed.

5 Must Know Facts For Your Next Test

1. Deferred tax assets can arise from various sources, including net operating losses, tax credits, and provisions for warranty expenses.
2. A company must assess whether it is more likely than not to realize the deferred tax asset; if not, it may need to establish a valuation allowance.
3. The realization of deferred tax assets is closely tied to a company's future profitability since they can only be used when taxable income is available.
4. Companies report deferred tax assets and liabilities on their balance sheets, reflecting the expected future tax effects of temporary differences.
5. Understanding deferred tax assets is essential for investors and analysts as they provide insights into a company's financial health and potential future cash flows.

Review Questions

• How do deferred tax assets arise, and what impact do they have on a company's financial statements?
  • Deferred tax assets arise when there are temporary differences between the accounting income recognized in financial statements and the taxable income reported to tax authorities. For example, if a company recognizes an expense for accounting purposes but cannot deduct it for tax purposes until later, this creates a deferred tax asset. On financial statements, these assets appear on the balance sheet, providing insights into potential future tax savings which can enhance the company's overall financial position.
• Discuss the importance of assessing the realizability of deferred tax assets and how it affects financial reporting.
  • Assessing the realizability of deferred tax assets is crucial because it determines whether a company can expect to benefit from these future tax deductions. If a company believes it will not generate enough taxable income to utilize the deferred tax assets, it may need to record a valuation allowance. This affects financial reporting by potentially reducing the asset value on the balance sheet and increasing expenses in the income statement, thereby impacting net income and shareholders' equity.
• Evaluate how deferred tax assets influence investment decisions and the perceived value of a company.
  • Deferred tax assets can significantly influence investment decisions because they indicate potential future cash flow benefits for companies. Investors often analyze these assets to understand how well a company can manage its tax obligations and its ability to utilize these benefits in upcoming years. A substantial amount of deferred tax assets may suggest that a company has experienced losses or other adjustments, raising questions about its current profitability. Therefore, assessing these assets helps investors evaluate risk and make informed decisions regarding a company's overall value and growth prospects.

Related terms

deferred tax liabilities: Deferred tax liabilities are taxes that are owed but not yet paid, resulting from temporary differences between accounting and tax treatment of certain items.

temporary differences: Temporary differences occur when there are discrepancies between the accounting income and taxable income due to differing recognition timing.

carryforward: A carryforward is a tax provision that allows an unused portion of a tax deduction or credit to be applied to future tax periods.