CFA Level I: Deferred Tax Assets & Liabilities

Financial reporting standards sometimes differ from tax reporting standards. This can give rise to differences in taxable assets and liabilities between the two reporting formats, which creates deferred tax assets or deferred tax liabilities. These may be reversed by changing laws, and so can be temporary differences only.

Deferred tax assets are taxes that have already been recognized and paid for tax purposes, but are not on the income statements of the company’s financial reports yet. The company may expect to recover some of these taxes paid in the future, which creates a valuation amount, a reserve against these assets. Deferred tax liabilities are the opposite, taxes recognize on financial reports, but not on tax reports.

Deferred Tax Assets and Liabilites

These deferred assets usually occur from differences between reporting methods, for instance using accelerated amortization vs straight line amortization on an asset. In this scenario, there is a temporary difference in the carrying amount of the asset and the tax base of the asset. If this difference continuous to exist at years’ end, based on recalculations of the carrying amount, a deferred tax is created.

Under IFRS, these are non-current items, but under GAAP, their classification depends on the classification of the underlying assets which caused the tax differences. These deferred taxes are then added to the company’s income tax credit or expense. Because of this, deferred taxes can only be created when it is not doubtful that they will be claimed. Under GAAP, the valuation amount provides an extra reserve for doubtful deferred taxes, but under IFRS, we simply have a reversal procedure. Deferred taxes should be regularly reassessed for reversibility with the tax laws under which they are expected to be claimed.

If the tax rate increases, then the value of these deferred taxes increase. With a tax rate decrease, these amounts will decrease. Note that permanent differences between the tax bases and carrying amounts do not create deferred taxes, as they will not be claimed.

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