December 6, 2021

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Deferred Tax Liability (Assets) Meaning and Key Explanations

Deferred Tax Liability (Assets) Meaning and Key Explanations
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Deferred tax arises as a result of a taxable temporary difference between accounting profit and taxable profit. It is a line item in the statement of financial position. In this article, I will define it and explain it in detail.

Definition of Deferred Tax

Deferred tax means the payment or receiving of tax relief at a future date. The term deferred means an event that will occur in the future. Therefore, we can say it is tax paid in the future but recognized in the statement of financial position on the current date.

Definition of Deferred Tax Assets (DTA)

Deferred tax assets according to IAS 12 arose “if an entity will pay less tax: if it recovers the carrying amount of another asset or liability; or has unused tax losses or unused tax credits.” In summary, if the carrying amount (or book value) is less than the tax base, it results in DTA. This has an impact on cash flow. For DTA, more surcharges are paid now and less in the future. Here, the deferred tax account will be debited and the profit or loss account credited.

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For example, if the depreciation of the carrying amount (that is, the book value) of a firm’s plant and equipment is 30,000 Naira. But the tax base (capital allowance on the plant and machinery) is 45,000 Naira. The temporary difference of 15,000 will be charged as DTA at the company tax rate. If the rate is 35 percent, then the deferred tax asset is 5250 Naira (35% × 15,000).

Definition of Deferred Tax Liability (DTL)

Deferred tax liability is the amount of income tax payable in the future by an entity. You can simply define it as when the carrying amount is higher than the tax base. In this case, you pay fewer taxes now and more in the future. For example, if the above plant and equipment have a depreciation of the carrying amount at the balance sheet date as 30,000 Naira and the tax base is 25,000 Naira. The temporary difference becomes 5,000. Applying the rate of 35 percent gives a DTL of 1,750 Naira. However, as the temporary difference reverses, more surcharges will be paid in the future.

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Why it is important?

Knowing an organization’s deferred tax aid cash flow and budget. It helps the organization plan its cash so that it can pay tax obligations on the due date. When there are DTA, the company will pay more surcharge now, thereby having less cash to use for other purposes. But more cash to use in the future. For DTL, the reverse is the case. There is more cash to use now and less in the future. Therefore, for DTL, the company must plan its cash properly, so that it can pay tax obligations as and when due.

Conclusion

Deferred tax occurs when taxes are to be paid or recovered in the future. There are DTA and DTL cases. More so, it arises as a result of a temporary difference between the carrying amount and tax base of a taxable asset or income. Companies need to understand this so that they can handle cash flow effectively.

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