Deferred Tax Assets Journal Entry

Deferred tax assets are financial assets that arise from temporary differences between the amount of income tax a company pays and the amount of income tax it reports in its financial statements. They are recognized when a company pays more taxes than it reports in its financial statements.

A deferred tax asset is an asset to a company when taxes are overpaid, reducing the company’s taxable income in the future. It is the opposite of a deferred tax liability, which indicates a company’s expected increase in income tax.

The asset is generated by the difference between the amount of taxes a company pays to comply with the law in the current period and the amount of taxes the company is expected to pay in future periods. This difference is then reported as a deferred tax asset on the company’s balance sheet.

The amount of the deferred tax asset is based on the amount of the overpayment, but it can be limited by a valuation allowance. This allowance is necessary because the asset could become worthless if the company’s future taxable income is lower than expected. In such cases, the company would not be able to use the asset to reduce its taxable income.

Journal Entry for Deferred Tax Assets

The entry include the following:

• Debit income tax expenses which depend on the accounting rule
• Debit Deferred Tax Assets: it is the difference between income tax paid and income tax expense.
• Credit Income tax payable: it is the amount of income tax which needs to pay to the government based on the tax rule.

How Do Deferred Tax Assets Work?

Receiving recognition for future tax liabilities can be a complex process for businesses. Deferred tax assets work by allowing companies to recognize future tax liabilities that have not yet been paid. This recognition helps businesses to create a more accurate picture of their financial situation and their future liabilities. Deferred tax assets are listed as a current asset on the balance sheet and are governed by Generally Accepted Accounting Principles (GAAP).

Here are three key ways in which deferred tax assets work:

1. Deferred tax assets reduce the amount of taxes owed in the current period. Companies can apply the amount of the deferred tax asset to the current tax liability, reducing the amount of taxes owed.
2. Deferred tax assets are recognized when the income of the company is taxed at a lower rate in the current period than it will be in the future. This allows companies to recognize a lower amount of taxes in the current period, while still recognizing the full amount of taxes owed in the future.
3. Deferred tax assets can be used to offset future tax liabilities. Companies can use the amount of deferred tax assets to offset future tax liabilities, thereby reducing the amount of taxes paid in the future.

What Are the Benefits of Deferred Tax Assets?

Benefiting from recognition of future liabilities can be advantageous for businesses. Deferred tax assets allow companies to recognize a future tax liability as an asset on the balance sheet. This can help to reduce the amount of tax a business will have to pay in the current financial year, while still acknowledging the future tax liability.

By taking advantage of deferred tax assets, businesses can manage their tax payments more effectively by spreading them over a longer period of time, thus improving cash flow.

In addition, deferred tax assets can provide some degree of protection against future tax rate hikes. By recognizing a future tax liability as an asset, the business is able to take advantage of the current tax rate, even if it is higher in the future. This means that the business is able to lock in the current, lower rate, and protect itself from any potential tax rate hikes.

What are the Disadvantages of Deferred Tax Assets?

Despite the potential advantages of recognizing a future tax liability as an asset, there are also potential drawbacks associated with the use of deferred tax assets. These include:

• Companies may have difficulty predicting future tax rates accurately, resulting in lower than expected benefits.
• Companies may have difficulty forecasting cash flows for the period of the deferred tax asset recognition, which could lead to an under- or over-estimation of the benefits.
• Companies may face restrictions on using deferred tax assets due to its legal status, as the Internal Revenue Service (IRS) may not recognize the asset as valid.
• Companies may be subjected to additional taxes if they do not properly report their deferred tax assets.
• Companies may take advantage of the deferred tax asset features in illegal ways.

Conclusion

The use of deferred tax assets can help to reduce taxable income in the present period. For companies that are expecting to pay taxes in the future, this can be a very beneficial tool. However, there are also certain risks associated with deferred tax assets, such as the possibility of a change in the tax laws.

Companies should carefully consider the advantages and disadvantages of deferred tax assets before making any decisions. Ultimately, the decision to use deferred tax assets should be based on a company’s specific circumstances and its expected future earnings.