How Deferred Tax Assets work and how to calculate them

Deferred tax assets (DTAs) can result from differences between the tax and accounting treatment of certain expenses or revenue or if a business has carry forward tax losses or credits. DTAs are calculated by multiplying the differences in accounting/tax or carry forward tax loss/credit balances by the current tax rate. 

What is a deferred tax asset and how do they arise? 

Deferred tax assets (DTAs) are an item recorded on a company’s balance sheet and can result from timing differences between tax and accounting treatment of certain expenses/revenue or if a business has carry forward tax losses/credits.  It is important to note that whilst DTAs can arise in the above situations, there is specific criteria that must be satisfied for accounting purposes before a DTA can be recognised on a company’s balance sheet.  

DTAs are calculated by multiplying the differences in accounting/tax or carry forward tax loss/credit balances by the current tax rate.  

Examples of a deferred tax asset 

We’ve listed below some common examples of DTAs: 

Tax losses 

If your business generates a tax loss (revenue or capital in nature) in a previous financial year, these can be carried forward and utilised to offset future tax payable (subject to satisfying certain tax rules regarding loss recoupment). For accounting purposes, this may give rise to a DTA which can be recognised on the company’s balance sheet provided the specific recognition criteria is satisfied. 

Differences in depreciation accounting 

There may be instances where the depreciation rate of an asset differs for accounting and tax purposes, or where the method for calculating depreciation differs. This can result in a temporary difference between the depreciation expense claimed for tax and accounting purposes, which may generate a deferred tax asset. 

For example, an eligible business may be able to claim an immediate tax deduction for the cost of purchasing an asset in the year it was first used or made ready for use. However, for accounting purposes, the asset continues to be depreciated over its expected useful life. This difference between accounting and tax is what may generate a DTA. 

Expenses 

Business expenses can sometimes be recognised as deductible for accounting purposes before the expenses is deductible for tax purposes, which creates a timing difference.  ​     ​ In this instance, a DTA may arise on the basis that the expense will become deductible for tax purposes at a later point in time.   

Product Warranties 

A business may recognise a liability on the balance sheet for potential product warranty claims that may arise from customers in the future. For tax purposes, the cost of a warranty claim is only deductible once the business pays out a claim to the customer. This results in a timing difference for accounting and tax purposes which may generate a DTA.  

What is the difference between a deferred tax asset and a deferred tax liability? 

It’s easiest to think of them as complete opposites. The main difference between a deferred tax asset and a deferred tax liability (DTL) is as follows: 

Deferred Tax Asset – represents an amount of income tax that is recoverable in a future period  

Deferred Tax Liability – represent an amount of income tax payable in a future period. 

How to measure and calculate a deferred tax asset 

DTAs are calculated by multiplying the differences in accounting/tax or carry forward tax loss/credit balances by the current tax rate.  

For example, a watch manufacturer estimates that approximately 2% of its yearly total annual sales will be returned under warranty. In the 30 June 2023 income year, the total annual sales figure is $6,000. This results in an estimated warranty expense for that income year of $120 (2% x $6,000).

The watch manufacturer recognises the $120 liability on its balance sheet and an expense is booked to the profit and loss. Assuming the watch manufacturer has no other income or expenses, its net accounting profit would be $5,880. Based on a tax rate of 25%, the tax payable on the net accounting profit would be $1,470.  

From a tax perspective, the $120 for the estimated warranty claims would not be deductible until a claim is actually paid out to a customer. On this basis the tax payable would be as follows: 

Sales revenue: $6,000

Warranty expenses: $120

Net profit before tax: $5,880

Non-deductible expenses: $120

Taxable income: $6,000

Taxes payable: $1,500

As you can see, from a tax perspective the tax payable would be $30 higher than the tax calculated on the business' net accounting profit. However, this $30 would be deductible in a future period when a warranty claim is actually paid to a customer. This future deduction results in a DTA of $30 as there is an amount of income tax that is recoverable in a future period.

Noting that specific criteria must be satisfied before a DTA can be recognised on a businesses balance sheet for accounting purposes, this example only demonstrates that a timing difference arises for tax and accounting purposes which may trigger a DTA.   

Deferred tax assets FAQs  

Is a DTA considered a current asset or a non-current asset? 

In accounting terms, assets are defined as either ​​current or non-current assets based on the period the financial benefit is likely to be realised by the business. Current assets provide value to a company within 12 months, whereas non-current assets generally won’t be realised within the next 12 months. Generally, most businesses record a DTA as a non-current asset on the balance sheet.  

What is the difference between a deferred tax and a current tax? 

Current tax refers to the amount of income tax payable/recoverable for the specific period (e.g. a financial year). In contrast, deferred tax represents an amount of income tax payable/recoverable for a future period. 

What is the double entry for a deferred tax asset? 

In ​​double-entry accounting, generally, the DTA is recognised on the balance sheet as a debit to the DTA account and the corresponding credit would generally be booked to the income tax expense account.  

Can DTAs and DTLs arise in respect of the same item? 

No, an expense or revenue item can only give rise to either a DTA or DTL. However, depending on the business’ tax profile, a DTA and DTL may both arise during an income year, but in respect of different items of revenue or expense.  

Manage your DTA with MYOB  

Accounting for and utilising DTAs correctly can impact cash flow and profitability. Take control of your ​​accounting and tax with MYOB. Start your free trial now! 

Disclaimer: Information provided in this article is of a general nature and does not consider your personal situation. It does not constitute legal, financial, or other professional advice and should not be relied upon as a statement of law, policy or advice. You should consider whether this information is appropriate to your needs and, if necessary, seek independent advice. This information is only accurate at the time of publication. Although every effort has been made to verify the accuracy of the information contained on this webpage, MYOB disclaims, to the extent permitted by law, all liability for the information contained on this webpage or any loss or damage suffered by any person directly or indirectly through relying on this information.

MYOB is not a registered entity pursuant to the Tax Agent Services Act 2009 (TASA) and therefore cannot provide taxation advice to clients. If you have a query concerning taxation including filing your BAS return or annual tax statements then you should consult with your accountant or other registered tax adviser.