What Is A Deferred Tax Asset?
A deferred tax asset is an accounting term used to describe a situation in which a company has paid more taxes in the current financial year than the amount it will owe in taxes for the following year. The excess taxes that the company has paid is referred to as a deferred tax asset. This asset can be used to offset future income tax liabilities and reduce the amount that the company needs to pay in taxes. In this way, a deferred tax asset can help a company to increase its profits and cash flow.
Deferred tax assets arise when a company has incurred expenses that have not yet been recognized for tax purposes. Such expenses may include depreciation, amortization and losses from investments. When the expenses are recognized for tax purposes, the amount of taxes that the company owes will be reduced, resulting in a deferred tax asset. The asset is then used to offset future taxes that the company will owe. In some cases, the deferred tax asset can be used to reduce the company's overall tax liability.
Calculating a Deferred Tax Asset
The amount of a company's deferred tax asset is calculated by subtracting the amount of taxes that the company will owe in the future from the amount of taxes that the company has already paid in the current year. This difference is then multiplied by the tax rate that the company would have paid on the income that generated the excess taxes. The resulting figure is the amount of the deferred tax asset.
For example, if a company has paid $20,000 in taxes in the current year but will owe only $15,000 in taxes for the following year, the company has a deferred tax asset of $5,000. This amount is calculated by subtracting $15,000 from $20,000, resulting in a difference of $5,000. This figure is then multiplied by the tax rate of the company, which is 25 percent in this example. The result is a deferred tax asset of $1,250.
Benefits of a Deferred Tax Asset
The main benefit of having a deferred tax asset is that it reduces the amount of taxes that a company needs to pay in the future. This can help a company to increase its profits and cash flow. A deferred tax asset can also help a company to reduce its overall tax liabilities, as the asset can be used to offset future income tax liabilities.
In addition, a deferred tax asset can help a company to increase its liquidity. This is because the asset can be used to reduce the amount of taxes that the company needs to pay, which can free up funds for other uses. This can be especially beneficial for companies that have limited cash reserves.
Risks of a Deferred Tax Asset
The main risk of having a deferred tax asset is that the amount of taxes that the company will owe in the future may be higher than the amount of the asset. This can lead to a situation in which the company is unable to offset its future tax liabilities with the asset and is thus forced to pay the additional taxes. This can reduce the company's profits and cash flow.
In addition, a deferred tax asset can be difficult to value accurately. This is because the amount of taxes that the company will owe in the future is uncertain and can change depending on a variety of factors, such as changes in the tax laws or the company's financial performance. As such, the value of the asset may not be accurately reflected in the company's financial statements.
Accounting for a Deferred Tax Asset
Deferred tax assets are recorded on the company's balance sheet as a non-current asset. This means that the asset is expected to be used to offset future tax liabilities and is not expected to be used up in the current year.
The amount of the deferred tax asset is also included in the company's income statement. This is done by subtracting the amount of the asset from the company's income before taxes. This reduces the company's taxable income and thus reduces the amount of taxes that the company needs to pay.
Impact of a Deferred Tax Asset on Financial Ratios
The presence of a deferred tax asset can have a significant impact on a company's financial ratios. This is because the asset reduces the amount of taxes that the company needs to pay and thus increases the company's profits and cash flow.
For example, a deferred tax asset can improve a company's return on equity ratio. This is because the asset reduces the amount of taxes that the company needs to pay, which increases the company's net income. This in turn increases the company's return on equity ratio as the ratio is calculated by dividing the company's net income by its equity.
Uses of a Deferred Tax Asset
A deferred tax asset can be used to offset future tax liabilities. This can help a company to reduce its overall tax burden and increase its profits and cash flow. In addition, a deferred tax asset can be used to improve the company's financial ratios, such as its return on equity ratio.
A deferred tax asset can also be used to finance investments or acquisitions. This is because the asset can be used to reduce the amount of taxes that the company needs to pay, freeing up funds for other uses. This can be especially beneficial for companies that have limited cash reserves.
Conclusion
A deferred tax asset is an accounting term used to describe a situation in which a company has paid more taxes in the current financial year than the amount it will owe in taxes for the following year. The excess taxes that the company has paid is referred to as a deferred tax asset. This asset can be used to offset future income tax liabilities and reduce the amount that the company needs to pay in taxes, helping the company to increase its profits and cash flow.
The amount of a company's deferred tax asset is calculated by subtracting the amount of taxes that the company will owe in the future from the amount of taxes that the company has already paid in the current year. This difference is then multiplied by the tax rate that the company would have paid on the income that generated the excess taxes. The resulting figure is the amount of the deferred tax asset.
The main benefit of having a deferred tax asset is that it reduces the amount of taxes that a company needs to pay in the future. This can help a company to increase its profits and cash flow. A deferred tax asset can also help a company to reduce its overall tax liabilities, as the asset can be used to offset future income tax liabilities.
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