Financial Accounting Part - Accounting for income taxes - Temporary differences and deferred taxes

Deferred tax asset. 

An asset on a company's balance sheet that may be used to reduce any subsequent period's income tax expense as a result of deductible temporary differences.

Often associated with a loss carryforward: 

These future deductible amounts cause taxable income to be less than pretax financial income as result of temporary differences.

Deferred tax liability. 

Represents an increase in taxes payable in future years as a result of taxable temporary differences existing in the end of the current year.

Current tax expense (=amount of income taxes payable for that period) and deferred tax expense (=increase in taxes payable).

It must be applied that there is more than a 50% probability that the company will have positive accounting income in the next fiscal period befpre the tax asset can be applied.

A company should reduce a deferred tax asset to its expected realizable value by a valuation allowance if it is more than likely than not that it will not realize some portion or all of the deferred tax asset. 

Increasing the valuation allowance increases deferred income tax expense.

Deferred tax assets increase and deferred tax liabilities decrease.

Initial difference between the book basis and tax basis of an asset or liability --> when the difference first arises

'More-likely-than-not'- criterion and the amount should not be discounted for the valuation.

A reversing difference occurs when a temporary difference that originated in prior periods is eliminated and the related tax effect is removed from the tax account.

A deferred tax asset is recognized for all deductible temporary differences. However, a deferred tax asset should be reduced if, based on all available evidence, it is probable that some portion or all of the deferred tax asset will not be realized.

The loss carryback provision permits a company to carry a net operating loss back two years and receive refunds for income taxes paid in those years. The loss must be applied to the second preceeding year first and then to the preceeding year.

The loss carryforward permits a company to carry forward a net operating loss twenty years, offsetting future taxable income. 

The loss carryback can be accounted for with more certainty because the company knows whether it had taxable income in the past; such is not the case with income in future.

A deferred tax asset should be reduced by a valuation allowance if, based on all available evidence, it is more likely than not (a level of likelihood that is at least slightly more than 50%) that it will not realize some portion or all of the deferred tax asset. 

The company should carefully consider all available evidence, both positive and negative, to determine whether, based on the weight of available evidence, it needs a valuation allowance.

Significant components of income tax expense should be disclosed in the income statement or in the notes to the financial statements. The most commonly encountered components are the current expense (or benefit) and the deferred expense (or benefit).

(1) revenue or gains that are taxable after recognition in financial income

(2) expenses or losses that are deductible after recognition in financial income

(3) revenues or gains that are taxable before recognition in financial income

(4) expenses or losses that are deductible before recognition in financial income

Companies may use tax rates other than the current rate only after enactment of the future tax rates.

When a change in the tax rate is enacted, a company should immediately recognize its effect on the deferred income tax accounts. The company reports the effects as an adjustment to income tax expense in the period of the change.

This is a temporary difference that will result in future deductible amounts and, therefore, gives rise to a deferred income tax asset.