- the difference between the tax basis of an asset or liability and its reported amount in the financial statements that will result in taxable amounts or deductible amounts in future years
Temporary Difference Effect on Financial Statements
When the book amount of an asset or liability differs from the tax basis as a result of a temporary difference, the future tax effects on taxable income must be reported in the current financial statements.
Deferred Tax Liability
-the amount of deferred tax consequences attributable to existing temporary differences that will result in net taxable amounts in future years.
Deferred Tax Expense
-the increase in the deferred tax liability balance from the beginning to the end of the accounting peroid
The concept of a deferred tax liability meets the definition of a liability established in the Statement of Financial Accounting Concepts because it:
- results from past transactions
- is a present obligation
- represents a future sacrifice
Deferred Tax Asset
- represents the increase in taxes refundable (or saved) in future years as a result of deductible temporary differences existing at the end of the current year
When should a DTA be reduced by a valuatiion allowance?
- if it is more likely that not that some portion or all of the DTA will NOT be realized
Permanent differences are items that:
- enter into pretax financial income but never into taxable income -OR-
- entered into taxable income but never into pretax income
Pretax Financial Income
- is a financial reporting term.
- It is determined according to GAAP with the objective of providing useful information to investors and creditors.
-- income before taxes, income for financial
reporting purposes, income for book purposes
-- For Financial Reporting, companies use the
full accrual method to report revenues.
- is a tax accounting term.
- It indicates the amount used to compute income taxes payable.
- It is determined according to the IRS and provides money to support government operations.
- For Tax Purposes, companies used modified cash basis accounting to report revenues.
Net Operating Loss (NOL) Carryovers (-forwards, -backs)
A firm may experience a taxable income loss (i.e. deductible business expenses exceed taxable revenue). Think of this loss as a bunch of excess, unused/unneeded deductions.
It is important to remember in "Corporate Tax Land" expenses are called deductions and revenues are taxable revenues.
The tax code (IRC) enables firms to "irrevocable choose" to use the NOL to recapture past taxes paid (carryback), when filing firm income tax forms in the NOL year.
The cash flow consequences of carryovers are reflected in financial accounts.
If the firm elects to use the NOL to offset taxable income from previous years to obtain refund (currently a 2 year carryback option) the:
benefit is recognized in the NOL year as a "negative" tax expense (ie a refund gain) in the Income Statement
-- unused portion of carryback may then be carried forward 20 years and used to reduce future taxable income.
The NOL may be used when filing tax forms in future years (currently 20) to offset taxable income reducing tax payable.
If we can estimate future tax rates, and we can expect sufficient taxable income to use the dedution with >50% probability, then a future tax benefit from carrying the NOL forward is "more likely than not."
We can then book the estimated benefit, and report it in our current income statement.
The future benefit is a deferred tax asset (DTA) reported on the Balance Sheet and
A balancing entry is a credit to tax expense.
If it is not certain the DTA benefit will be realized (income may not materialize as planned), we may have to book an allowance account (Contra DTA).