Deferred Tax Asset

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What is a 'Deferred Tax Asset'

Deferred tax assets are created due to taxes paid or carried forward but not yet recognized in the income statement. Its value is calculated by taking into account financial reporting standards for book income and the jurisdictional tax authority's rules for taxable income. For example, deferred tax assets can be created due to the tax authority recognizing revenue or expenses at different times than that of an accounting standard. This asset helps in reducing the company’s future tax liability. It is important to note that a deferred tax asset will only be recognized when the difference between the loss-value or depreciation of the asset is expect to offset future profit.

Reasons deferred tax assets arise include:

BREAKING DOWN 'Deferred Tax Asset'

For example, a computer manufacturing company estimates based on previous lines of production that the probability a computer will be sent back for warranty repairs in the next year is 2% out of the total production. If the company's total revenue in year 1 is $3,000 and the warranty expense is $60 (2% * $3,000) then the company's taxable income is $2,940. However most tax authorities do not allow companies to deduct expenses based on expected warranties, thus the company would actually require to pay taxes on the full $3,000.

If the tax rate for the company is 30% then:

The difference of $18 ($900 - $ 882) between the taxes payable in the income statement and the taxes payable to the tax authority is considered the deferred tax asset.

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  3. What is the justification for allowing deferred tax liabilities?

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  4. What are some examples of ways businesses can use a deferred tax asset?

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  5. Who is eligible to hold a deferred tax asset?

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