Question

Write the definitions and any other required information for the items below.

Deferred Tax Asset

Valuation Allowance

Deferred Tax Liability

Answer 1

DEFERRED TAX ASSET

A Deferred Tax Asset is an asset on a Company's balance sheet that may be use to reduce taxable income. It refers to a situation where a business has overpaid taxes or taxes paid in advance.

Deferred tax assets are often created due to taxes paid or carried forward but not yet recognized in the income statement.

Example: Carry over of losses

If a business incurs a loss in a financial year,it usually entitled to use that loss in order to lower its taxable income of the following years. Therefore, the loss is an asset

VALUATION ALLOWANCE

A valuation allowance is a reserve that is used to offset the amount of a deferred tax asset.

A business should create a valuation allowance for deferred tax asset if there is a more than 50% probability that the company will not realize some portion of the asset.

The need for valuation allowance is especially if a business has a history of letting various carry forwards expire unused, or it expects to incur losses in the next few years.

DEFERRED TAX LIABILITY

A deferred tax liability is a tax that is due for the current period but has not yet been paid.It commonly arises when in depreciating fixed assets, recognizing revenues and valuing inventories.

A deferred tax liability is recognized in the current period for the taxes payable in future periods.

Because of accrual accounting rules a company may be able to defer taxes on some of its income. This unrealized tax debt is put into an account on the balance sheet which we called deferred tax liability.