A deferred tax asset is recorded on the balance sheet when a business has overpaid taxes, or taxes have been paid in advance. These taxes are eventually returned to the business in the form of tax relief, which results in an asset to the company. A carry over of losses is the most popular instance of a deferred tax asset. If a business incurs a loss in a financial year, it usually is entitled to use that loss in order to lower its taxable income in following years. In that sense, the loss is an asset.
A deferred tax liability is an account on a company’s balance sheet that is a result of temporary differences between the company’s accounting and tax carrying values, the anticipated and enacted income tax rate, and estimated taxes payable for the current year. This liability may be realized during any given year, which makes the deferred status appropriate. Since there are differences between what a company can deduct for tax and accounting purposes, there is a difference between a company’s taxable income and income before tax. A deferred tax liability is recorded and reflects that, in the future, the company will pay more income tax because of a transaction that took place during the current period. A common source of deferred tax liability is the difference in depreciation expense treatment by tax laws and accounting rules. The depreciation expense for long-lived assets for financial statements purposes is typically calculated using a straight-line method, while tax regulations allow companies to use an accelerated depreciation method. Since the straight-line method produces lower depreciation when compared to the amount claimed on the tax return, a company’s accounting income is temporarily higher than its taxable income.
On November 20, 2015, the FASB issued Accounting Standards Update 2015-17, Balance Sheet Classification of Deferred Taxes. The new ASU requires that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent on the balance sheet. As a result, each jurisdiction will now only have one net noncurrent deferred tax asset or liability. Under the new guidance, entities are still prohibited from offsetting deferred tax liabilities from one jurisdiction against deferred tax assets of another jurisdiction.
Before the update, GAAP required the deferred taxes be presented as a net current asset or liability, and net noncurrent asset or liability. This necessitated in an analysis by each judicature based on the classification of the assets and liabilities to which the temporary differences relate, or based on the period in which the asset is expected to be realized in the case of loss or credit carry forwards.
The new guidance will be effective for public business entities in fiscal years beginning after December 15, 2016, including interim periods within those years (i.e., in the first quarter of 2017 for calendar year-end companies).
For entities other than public business entities, the amendments are effective for fiscal years beginning after December 15, 2017, and interim periods within fiscal years beginning after December 15, 2018.
Early adoption is permitted for all entities as of the beginning of an interim or annual reporting period. The guidance may be applied either prospectively, or retrospectively. If applied prospectively, entities are required to disclose in the notes to the financial statements that prior periods were not retrospectively adjusted. If applied retrospectively, entities are also required to disclose quantitative information about the effects of the change on prior periods.
If you would like to learn more about this topic, please contact:
Kenneth R. Cerini, CPA, CFP, FABFA
Ken is the Managing Partner of Cerini & Associates, LLP and is the executive responsible for the administration of our not-for-profit and educational provider practice groups. In addition to his extensive audit experience, Ken has been directly involved in providing consulting services for nonprofits and educational facilities of all sizes throughout New York State in such areas as cost reporting, financial analysis, Medicaid compliance, government audit representation, rate maximization, board training, budgeting and forecasting, and more.