A deferred tax asset is the deferred tax consequences attributable to deductible temporary differences and carryforwards, meaning the income tax an entity expects to save in future years because the return and the financial statements have not taken the same cost, loss, or receipt in the same year. It is measured using the applicable enacted tax rate and provisions of the enacted tax law, and it is reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of it will not be realized (FASB Statement No. 109).
That last clause carries most of the judgment in a corporate tax file, and the evidence work behind it sits in the ASC 740 income tax provision.
What Creates a Deferred Tax Asset
Two things do. The first is a deductible temporary difference, which the standard defines as a temporary difference that results in deductible amounts in future years when the related asset or liability is recovered or settled (FASB Statement No. 109). One place to look is a cost the books have already taken and the return has not, a routine by-product of the accrual accounting the financial statements run on.
Accrued expenses are the everyday case: expenses or losses that are deductible after they are recognized in financial income, where a liability, for example a product warranty liability, is recognized for amounts that become tax deductible when the liability is settled (FASB Statement No. 109). The allowance for doubtful accounts on a client’s accounts receivable works the same way, because the tax side turns on a debt becoming worthless within the taxable year rather than on a book estimate (26 U.S.C. 166).
Income taxed before the books recognize it produces the same result from the other side, since an advance payment for goods or services to be provided in future years is included in taxable income when the cash is received, and settling that liability produces the deduction in a later year (FASB Statement No. 109). On the books that same amount sits as a deferral.
The second is carryforwards, which are not temporary differences at all. An entity recognizes a deferred tax asset for operating loss and tax credit carryforwards as well as for deductible temporary differences (FASB Statement No. 109).
Tax law then decides how long that one stays usable. A net operating loss arising in a taxable year beginning after December 31, 2017 is a carryover to each taxable year following the loss year. In a taxable year beginning after December 31, 2020, the deduction those losses support is capped at 80 percent of the excess of taxable income, computed without regard to the deductions under section 172 and sections 199A and 250, over any losses carried to that year from years beginning before January 1, 2018 (26 U.S.C. 172).
How a Deferred Tax Asset Is Measured
At the rate already enacted for the period the difference reverses in. The objective is to measure a deferred tax liability or asset using the enacted tax rate expected to apply in the periods in which it is expected to be settled or realized, and the effects of future changes in tax laws or rates are not anticipated (FASB Statement No. 109).
Say a calendar-year C corporation accrues a liability its return cannot deduct until the following year, and the enacted rate that will apply then is 21 percent of taxable income (26 U.S.C. 11).
Accrued liability recognized for book purposes 50,000
Amount deducted on this year's return 0
Deductible temporary difference 50,000
Enacted rate expected on reversal 21%
Deferred tax asset (50,000 x 21%) 10,500Nothing in that computation says the entity will ever use the deduction. That is the separate question the valuation allowance answers.
Where a Deferred Tax Asset Sits on the Balance Sheet
Noncurrent, if the entity presents a classified balance sheet at all. Deferred tax liabilities and assets are classified as noncurrent in a classified statement of financial position, and entities that do not present one are unaffected (FASB Accounting Standards Update 2015-17, Income Taxes (Topic 740)). That replaced an older rule splitting deferred taxes into current and noncurrent amounts on the classification of the related asset or liability, so a template that still splits them is out of date. Offsetting was left alone, so within one tax-paying component and one tax jurisdiction the balances are still offset and presented as a single noncurrent amount, and balances belonging to different tax-paying components or different tax jurisdictions are not offset (FASB Accounting Standards Update 2015-17, paragraph 740-10-45-6). A tax-paying component is an individual entity or group of entities that is consolidated for tax purposes (FASB Statement No. 109).
What a Deferred Tax Asset Is Not
It Is Not a Deferred Tax Liability
A deferred tax liability is the mirror image, the deferred tax consequences attributable to taxable temporary differences, measured on the same enacted rate and provisions of the enacted tax law. Direction is what separates them: a deductible temporary difference produces deductible amounts in future years, a taxable temporary difference produces taxable amounts (FASB Statement No. 109). Depreciation deducted faster on the return than in the books is the standard liability case.
It Is Not a Refund the Taxing Authority Owes Now
A current tax liability or asset is recognized for the estimated taxes payable or refundable on tax returns for the current year, separately from the deferred balances (FASB Statement No. 109). An overpayment is cash owed back on a year already computed. A deferred tax asset is the tax effect of a deduction or carryforward not yet used, and realizing it turns on taxable income of the appropriate character within the period the tax law lets that amount be carried back or carried forward (FASB Statement No. 109). The amount a filed return actually reports is a third figure again, the tax liability.
Common Questions
It is a period-end adjustment rather than an entry booked as each difference arises. Deferred tax expense or benefit is the change during the year in an enterprise’s deferred tax liabilities and assets, and income tax expense is the sum of current tax expense and deferred tax expense (FASB Statement No. 109). An increase in the deferred tax asset is recorded against deferred income tax expense, and the amount comes from comparing the deferred balances at both ends of the year. Not all of the change lands there, though, because income tax expense for the year is allocated among continuing operations, discontinued operations, extraordinary items, and items charged or credited directly to shareholders’ equity, so a change attributable to an equity item is charged or credited to that item instead (FASB Statement No. 109).
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