Deferred Tax Assets

• Arise from temporary differences where, initially, tax rules require

smaller expenses or bigger revenues than GAAP
– Pre-tax income < Taxable income
– Income tax expense < Income tax payable
• In the future, GAAP will require smaller expenses or bigger revenues
than tax rules
– Pre-tax income > Taxable income
– Income tax expense > Income tax payable
• The Deferred Tax Asset represents the benefit of tax savings in the
future
Today Future
Dr. Income Tax Expense (+E) 90 Dr. Income Tax Expense (+E) 100
Dr. Deferred Tax Asset (+A) 10 Cr. Deferred Tax Asset (-A) 10
Cr. Income Tax Payable (+L) 100 Cr. Income Tax Payable (+L) 90

KNOWLEDGE FOR ACTION

 Example: Deferred Tax Assets
• Brey Co. recognizes $80,000 of bad debt expense on 2010 sales.
There are no write-offs of those sales in 2010. In 2011, Brey wrote-off
$30,000 of accounts. In 2012, Brey wrote off $50,000 of accounts.

Allowance Method (books) Direct Write-off Method (tax)

Year Bad Debt Pre-tax Inc. Tax Bad Debt Taxable Inc. Tax
EBTBD Exp. Income Exp. EBTBD Exp. Income Pay.
2010 100,000 80,000 20,000 7,000 100,000 0 100,000 35,000

• 2010 Journal entry Deferred Tax Asset (A)

Dr. Income Tax Expense (+E) 7,000 ‘10 28,000

Dr. Deferred Tax Asset (+A) 28,000

Cr. Income Tax Payable (+L) 35,000

KNOWLEDGE FOR ACTION

 Example: Deferred Tax Assets
• Brey Co. recognizes $80,000 of bad debt expense on 2010 sales.
There are no write-offs of those sales in 2010. In 2011, Brey wrote-off
$30,000 of accounts. In 2012, Brey wrote off $50,000 of accounts.

Allowance Method (books) Direct Write-off Method (tax)

Year Bad Debt Pre-tax Inc. Tax Bad Debt Taxable Inc. Tax
EBTBD Exp. Income Exp. EBTBD Exp. Income Pay.
2010 100,000 80,000 20,000 7,000 100,000 0 100,000 35,000
2011 100,000 0 100,000 35,000 100,000 30,000 70,000 24,500

Deferred Tax Asset (A)

• 2011 Journal entry ‘10 28,000
Dr. Income Tax Expense (+E) 35,000 10,500 ‘11

Cr. Deferred Tax Asset (-A) 10,500

Cr. Income Tax Payable (+L) 24,500

KNOWLEDGE FOR ACTION

 Example: Deferred Tax Assets
• Brey Co. recognizes $80,000 of bad debt expense on 2010 sales.
There are no write-offs of those sales in 2010. In 2011, Brey wrote-off
$30,000 of accounts. In 2012, Brey wrote off $50,000 of accounts.

Allowance Method (books) Direct Write-off Method (tax)

Year Bad Debt Pre-tax Inc. Tax Bad Debt Taxable Inc. Tax
EBTBD Exp. Income Exp. EBTBD Exp. Income Pay.
2010 100,000 80,000 20,000 7,000 100,000 0 100,000 35,000
2011 100,000 0 100,000 35,000 100,000 30,000 70,000 24,500
2012 100,000 0 100,000 35,000 100,000 50,000 50,000 17,500

Deferred Tax Asset (A)

• 2012 Journal entry
‘10 28,000
Dr. Income Tax Expense (+E) 35,000 10,500 ’11
Cr. Deferred Tax Asset (-A) 17,500 17,500 ‘12
0
Cr. Income Tax Payable (+L) 17,500

KNOWLEDGE FOR ACTION

 Example: Deferred Tax Assets
• Brey Co. recognizes $80,000 of bad debt expense on 2010 sales.
There are no write-offs of those sales in 2010. In 2011, Brey wrote-off
$30,000 of accounts. In 2012, Brey wrote off $50,000 of accounts.

Allowance Method (books) Direct Write-off Method (tax)

Year Bad Debt Pre-tax Inc. Tax Bad Debt Taxable Inc. Tax
EBTBD Exp. Income Exp. EBTBD Exp. Income Pay.
2010 100,000 80,000 20,000 7,000 100,000 0 100,000 35,000
2011 100,000 0 100,000 35,000 100,000 30,000 70,000 24,500
2012 100,000 0 100,000 35,000 100,000 50,000 50,000 17,500
80,000 77,000 80,000 77,000

• Temporary difference:
– Timing of bad debt expense and tax expense is shifted across time
– But totals are the same between books and taxes

KNOWLEDGE FOR ACTION

Changes in Future Tax Rates
• Deferred tax assets and liabilities must be based on expected future
tax rates
– Generally, assume that current tax rate will continue into the future
• If the government changes the statutory tax rate, the balances in DTA
and DTL must be adjusted to reflect the new rate, with the adjustment
running through Income Tax Expense
– Tax rate increase:
• DTAs increase -> Dr. Deferred Tax Asset (+A), Cr. Income Tax Expense (-E)
• DTLs increase -> Dr. Income Tax Expense (+E), Cr. Deferred Tax Liability (+L)
– Tax rate decrease:
• DTAs decrease -> Dr. Income Tax Expense (+E), Cr. Deferred Tax Asset (-A)
• DTLs decrease -> Dr. Deferred Tax Liability (-L), Cr. Income Tax Expense (-E)

KNOWLEDGE FOR ACTION

 Example: Deferred Tax Liabilities and Change in Tax Rates
• At the end of 2011, the government increases the tax rate to 40%
Straight Line Method (books) MACRS Method (tax)
Year Depr. Pre-tax Inc. Tax Depr. Taxable Inc. Tax
EBTDA Exp. Income Exp. EBTDA Exp. Income Pay.
2010 100,000 40,000 60,000 21,000 100,000 80,000 20,000 7,000
2011 100,000 40,000 60,000 21,000 100,000 27,000 73,000 25,550

Deferred Tax Liab. (L)

• Balance in DTL is $9,450 (under 35% rate) 14,000 ‘10
‘11 4,550

9,450

KNOWLEDGE FOR ACTION

 Example: Deferred Tax Liabilities and Change in Tax Rates
• At the end of 2011, the government increases the tax rate to 40%
Straight Line Method (books) MACRS Method (tax)
Year Depr. Pre-tax Inc. Tax Depr. Taxable Inc. Tax
EBTDA Exp. Income Exp. EBTDA Exp. Income Pay.
2010 100,000 40,000 60,000 21,000 100,000 80,000 20,000 7,000
2011 100,000 40,000 60,000 21,000 100,000 27,000 73,000 25,550
80,000 107,000
Deferred Tax Liab. (L)
• Balance in DTL is $9,450 (under 35% rate) 14,000 ‘10
• Pre-tax Difference = $9,450 / 0.35 = $27,000 ‘11 4,550

– Note: this is the difference in Accumulated Depreciation

9,450
(107,000 – 80,000)

KNOWLEDGE FOR ACTION

 Example: Deferred Tax Liabilities and Change in Tax Rates
• At the end of 2011, the government increases the tax rate to 40%
Straight Line Method (books) MACRS Method (tax)
Year Depr. Pre-tax Inc. Tax Depr. Taxable Inc. Tax
EBTDA Exp. Income Exp. EBTDA Exp. Income Pay.
2010 100,000 40,000 60,000 21,000 100,000 80,000 20,000 7,000
2011 100,000 40,000 60,000 21,000 100,000 27,000 73,000 25,550
80,000 107,000
Deferred Tax Liab. (L)
• Balance in DTL is $9,450 (under 35% rate) 14,000 ‘10
• Pre-tax Difference = $9,450 / 0.35 = $27,000 ‘11 4,550

• DTL at new rate = $27,000 x 0.40 = $10,800 10,800

KNOWLEDGE FOR ACTION

 Example: Deferred Tax Liabilities and Change in Tax Rates
• At the end of 2011, the government increases the tax rate to 40%
Straight Line Method (books) MACRS Method (tax)
Year Depr. Pre-tax Inc. Tax Depr. Taxable Inc. Tax
EBTDA Exp. Income Exp. EBTDA Exp. Income Pay.
2010 100,000 40,000 60,000 21,000 100,000 80,000 20,000 7,000
2011 100,000 40,000 60,000 21,000 100,000 27,000 73,000 25,550
80,000 107,000
Deferred Tax Liab. (L)
• Balance in DTL is $9,450 (under 35% rate) 14,000 ‘10
• Pre-tax Difference = $9,450 / 0.35 = $27,000 ‘11 4,550
1,350 Adj.
• DTL at new rate = $27,000 x 0.40 = $10,800 10,800
• Required increase in DTL = $10,800 - $9,450 = $1,350
Dr. Income Tax Expense (+E) 1,350
Cr. Deferred Tax Liability (+L) 1,350

KNOWLEDGE FOR ACTION

 Example: Deferred Tax Assets and Change in Tax Rates
• At the end of 2011, the government increases the tax rate to 40%
Allowance Method (books) Direct Write-off Method (tax)
Year Bad Debt Pre-tax Inc. Tax Bad Debt Taxable Inc. Tax
EBTBD Exp. Income Exp. EBTBD Exp. Income Pay.
2010 100,000 80,000 20,000 7,000 100,000 0 100,000 35,000
2011 100,000 0 100,000 35,000 100,000 30,000 70,000 24,500

Deferred Tax Asset (A)

• Balance in DTA is $17,500 (under 35% rate) ‘10 28,000
10,500 ’11

17,500

KNOWLEDGE FOR ACTION

 Example: Deferred Tax Assets and Change in Tax Rates
• At the end of 2011, the government increases the tax rate to 40%
Allowance Method (books) Direct Write-off Method (tax)
Year Bad Debt Pre-tax Inc. Tax Bad Debt Taxable Inc. Tax
EBTBD Exp. Income Exp. EBTBD Exp. Income Pay.
2010 100,000 80,000 20,000 7,000 100,000 0 100,000 35,000
2011 100,000 0 100,000 35,000 100,000 30,000 70,000 24,500
80,000 30,000
Deferred Tax Asset (A)
• Balance in DTA is $17,500 (under 35% rate) ‘10 28,000
• Pre-tax Difference = $17,500 / 0.35 = $50,000 10,500 ’11

17,500

KNOWLEDGE FOR ACTION

 Example: Deferred Tax Assets and Change in Tax Rates
• At the end of 2011, the government increases the tax rate to 40%
Allowance Method (books) Direct Write-off Method (tax)
Year Bad Debt Pre-tax Inc. Tax Bad Debt Taxable Inc. Tax
EBTBD Exp. Income Exp. EBTBD Exp. Income Pay.
2010 100,000 80,000 20,000 7,000 100,000 0 100,000 35,000
2011 100,000 0 100,000 35,000 100,000 30,000 70,000 24,500
80,000 30,000
Deferred Tax Asset (A)
• Balance in DTA is $17,500 (under 35% rate) ‘10 28,000
• Pre-tax Difference = $17,500 / 0.35 = $50,000 10,500 ’11

• DTA at new rate = $50,000 x 0.40 = $20,000

20,000

KNOWLEDGE FOR ACTION

 Example: Deferred Tax Assets and Change in Tax Rates
• At the end of 2011, the government increases the tax rate to 40%
Allowance Method (books) Direct Write-off Method (tax)
Year Bad Debt Pre-tax Inc. Tax Bad Debt Taxable Inc. Tax
EBTBD Exp. Income Exp. EBTBD Exp. Income Pay.
2010 100,000 80,000 20,000 7,000 100,000 0 100,000 35,000
2011 100,000 0 100,000 35,000 100,000 30,000 70,000 24,500
80,000 30,000
Deferred Tax Asset (A)
• Balance in DTA is $17,500 (under 35% rate) ‘10 28,000
• Pre-tax Difference = $17,500 / 0.35 = $50,000 10,500 ’11
Adj. 2,500
• DTA at new rate = $50,000 x 0.40 = $20,000
20,000
• Required increase in DTA = $20,000 - $17,500 = $2,500
Dr. Deferred Tax Asset (+A) 2,500
Cr. Income Tax Expense (-E) 2,500

KNOWLEDGE FOR ACTION