Tax Accounting Minute – Deferred Tax Assets & Liabilities

In this week’s episode of Weaver: Beyond the Numbers, Tax Accounting Minute, our hosts cover the concept of a deferred tax asset, deferred tax liability and how those are valued on the balance sheet.

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Detailed Description of Weaver: Beyond the Numbers, Tax Accounting Minute, Deferred Tax Assets & Liabilities

00:00:00
Robert: Hello and welcome to our inaugural version of the Tax Accounting Minute. I’m Robert Henry, I’m here with Deanna Johnson. And we’re going to talk through today the concept of a deferred tax asset, deferred tax liability and how those are valued on the balance sheet.

So, Deanna, do you want to talk us through the concepts of deferred tax assets and deferred tax liabilities?

00:00:25
Deanna: Sure. Thank you, Robert. A deferred tax asset, or a DTA, is the difference between the tax basis of an asset or a liability and the amount reported in the financial statements, or the book basis, that will result in tax deductions in future years. If it’s more likely than not, which means a likelihood of more than 50% that some or all of the deferred tax assets will not be realized, a valuation allowance, or VA, should be recorded against the deferred tax assets to reduce the balance to the amount that’s more likely than not to be realized. That’s a mouthful. The balance sheet usually includes many deferred tax assets and their counterpart, deferred tax liability, which are all individually calculated. The need for valuation allowance needs to be reviewed on both individual deferred tax assets and on the total.

00:01:10
Robert: And so, let’s think about this. A common deferred tax asset would be a net operating loss (NOLs) carryforward, right? You’ve got no book basis in it, but eventually it will lead to tax deductions. And so, this valuation allowance analysis it sounds like is to determine, am I more likely than not going to realize benefits from those net operating loss carryforwards. So how do we go about performing the analysis of what the valuation allowance should look like?

00:01:39
Deanna: Well, in that case, you would need to assess whether you could use those NOLs in the future and how much you could use. So, you need to engage in a scheduling exercise that’s tantamount to estimating what your tax returns will look like in future years. You basically have two potential sources of future taxable income to look at. One is the reversals of existing deferred tax liabilities. The other is forecast the future taxable income, excluding the reversals of deferred tax liability. So essentially book income plus perms. If the reversals of existing deferred tax liabilities don’t generate enough taxable income to utilize the losses, then you’d need to consider whether you could rely on future forecasted taxable income, and you’d go through that scheduling exercise and schedule that out for however long you need in the future, and match that up with your net operating loss reversal periods, whether it’s federal or whether it’s state or some other jurisdiction. And that’s how you would determine whether you needed a valuation allowance in any given period.

00:02:41
Robert: And so really, we’re taking a look at both sides of the balance sheet. The deferred tax assets, the deferred tax liabilities, how those play together and if they will offset. Now I know that in our future episode, we’re going to talk about a little bit more about this concept. But some strange things can happen when you schedule out your deferreds and that may impact valuation allowance even when you think you don’t need it.

00:03:06
Deanna: Right.

00:03:07
Robert: Deanna, thank you very much for that insight. And we’ll catch up again on our next episode.

00:03:14
Deanna: Thank you.