Deferred tax assets

Deferred tax assets generally arise from accounting expenses that are considered deductible temporary differences - meaning the related tax deduction is delayed and will be realized in a future period. In short, a deferred tax asset arises when temporary differences make accounting net income lower than taxable income, because accounting revenues are lower than taxable revenues, accounting expenses are higher than tax-deductible expenses, or both:

$Accounting net income < Taxable income$

$Accounting revenues < Taxable revenues$

$Accounting expense > Tax-deductible expense$

Examples of temporary differences resulting in deferred tax assets

Examples of situations leading to the recognition of deferred tax assets are as follows:

Expenses recognized in accounting income but not in taxable income

Accounting for bad debts can result in deferred tax assets because accounting rules require the allowance method that recognizes expenses in the accounting books in advance of the actual write-off. The direct write-off method is used in the tax books where the expenses are only recognized upon actual write-off.
Accounting for warranties can result in deferred tax assets similar to bad debts by using the allowance method in the accounting books which recognizes warranty expenses in advance, while in the tax books, the warranty expense is only recognized when claims have been made by the customer and the costs have been paid.
Certain accrued expenses (e.g., accrued compensation or litigation costs) result in DTAs when tax rules allow the deduction only when paid.

Income recognized in taxable income but not in accounting income

Advance rent received by the company results in deferred tax assets because in the accounting books, the rent received is not yet earned and is recorded as a liability account while in the tax books, the rent received is recorded already as an income using the cash basis of accounting.

Other: Net operating loss carryforwards create a deferred tax asset because they are future deductible amounts; they aren’t a temporary difference themselves, but the resulting tax benefit is still recognized as a DTA.

Unlike these temporary differences, items such as fines or municipal bond interest are permanent differences - excluded from taxable income entirely, they never create a deferred tax asset or liability. The next chapter, Permanent differences, covers this in detail.

Accounting for deferred tax assets

A deferred tax asset equals the deductible temporary difference multiplied by the future enacted tax rate. Same as for deferred tax liabilities, the company then has to follow the source of the deferred tax asset in subsequent periods to ensure that any reversals of temporary differences are accounted for. The worked example below shows how to compute, record, and later reverse a deferred tax asset using real numbers.

Valuation allowance: A deferred tax asset is recognized only to the extent it’s more likely than not to be realized. If it’s more likely than not that some or all of the DTA won’t be realized - for example, because of a history of losses - the company records a valuation allowance that reduces the DTA, debiting income tax expense and crediting the valuation allowance.

GAAP vs. IFRS: Under US GAAP (ASC 740), the DTA is recorded at its full amount and then reduced by a separate valuation allowance account. Under IFRS (IAS 12), there’s no separate valuation allowance - the DTA is simply recognized only up to the amount that’s probable of being realized.

Deferred tax assets example

Achievable Co. has booked estimated credit losses on accounts receivables amounting to:

$30,000 in Year 1

$10,000 in Year 2

$2,000 in Year 3.

In addition, $5,000 bad debts were written-off in Year 2 and $10,000 in Year 3. The tax rate of the company is 20%.

Solution

When companies book estimated credit losses, these are not normally recognized in the tax books because uncollectible accounts are only recognized in the tax books when they are actually written-off. This creates a temporary difference resulting in deferred tax assets because accounting income is lower than taxable income in this situation.

The best way to determine the deferred tax impact of transactions with multiple years of tax impact would be to summarize the differences between the accounting income and tax income for all years affected.

The difference row below is accounting expense minus tax-deductible expense; positive builds the deferred tax asset, negative (Year 3) reverses it.

Year 1 Year 2 Year 3

Accounting expense:
Estimated credit losses $30,000 $10,000 $2,000

Tax-deductible expense:
Actual write-offs $0 $5,000 $10,000

Difference $30,000 $5,000 ($8,000)

Multiply:
Tax rate 20% 20% 20%

Deferred tax impact $6,000 $1,000 ($1,600)

From the above, it is good to remember that write-offs do not impact the estimated credit losses in the income statement. The expense recognized in the taxable income computation are the actual write-offs of uncollectible accounts.

For Year 1, the journal entry will be as follows:

Account Debit Credit Financial statement element

Deferred tax asset $6,000 Asset

Deferred tax expense $6,000 Expense

To record deferred tax asset on year 1

The Year 2 entry follows the same pattern: it increases the deferred tax asset by another $1,000 (debit deferred tax asset, credit deferred tax expense).

For Year 3, the journal entry will be a reversal of the previously established deferred tax assets since there are more write-offs than estimated credit losses during the year.

Account Debit Credit Financial statement element

Deferred tax expense $1,600 Expense

Deferred tax asset $1,600 Asset

To record reversal of deferred tax assets on year 3

The balance of the deferred tax assets in the balance sheet at the end of each year would be as follows:

Year 1 Year 2 Year 3

Deferred tax assets $6,000 $7,000 $5,400

We still have deferred tax assets of $5,400 in the balance sheet at the end of Year 3 because the estimated credit losses accrued in Year 1 have not yet been fully written-off as of Year 3.

Deferred tax assets: core concept

Arise from deductible temporary differences: accounting expenses recognized before they’re tax-deductible, or revenues taxed before they’re earned in accounting
Occurs when: $Accounting net income < Taxable income$ , due to lower accounting revenues and/or higher accounting expenses than their tax counterparts
Measured as: deductible temporary difference × future enacted tax rate

Common sources of DTAs

Expenses booked in accounting before tax deduction allowed:
- Bad debts (allowance method vs. tax’s direct write-off method)
- Warranties (estimated vs. actual claims paid)
- Certain accrued expenses (deductible only when paid)
Income taxed before earned in accounting (e.g., advance rent received, taxed on cash basis but deferred as liability in accounting)
Net operating loss carryforwards also create DTAs (future deductible amounts, not a temporary difference itself)
Permanent differences (fines, municipal bond interest) never create DTAs/DTLs — excluded from taxable income entirely

Valuation allowance & GAAP vs. IFRS

DTA recognized only if “more likely than not” to be realized
Under US GAAP (ASC 740): record DTA at full value, then reduce via separate valuation allowance account (debit income tax expense, credit valuation allowance)
Under IFRS (IAS 12): no valuation allowance account — DTA recognized only up to the probable realizable amount

Worked example mechanics

Compare accounting expense (e.g., estimated credit losses) vs. tax-deductible expense (actual write-offs) each year; positive difference × tax rate = DTA increase, negative difference = reversal
Journal entries: building DTA = debit Deferred Tax Asset / credit Deferred Tax Expense; reversal = debit Deferred Tax Expense / credit Deferred Tax Asset
Write-offs don’t affect the income statement estimate; only actual write-offs count as tax-deductible expense
DTA balance carries forward until underlying differences fully reverse (e.g., $5,400 balance remained in Year 3 since not all original losses were written off)