I understand overall concept of how deferred taxe assets are created - lower tax expense on financial statement than on tax return and also tax loss carryforward creates that. Investopedia has this example, if a company experienced a negative net operating income (NOI) in year one but positive NOI in one of the next two to seven years, the company could reduce its tax expense for one of those years by applying the loss experienced in the first year. So if NOI is negative, why would firm report taxes payable for year 1 and create carry forward tax loss and so DTA? Can anyone please clarify this?
Rhz, From what I understand it goes like this: If you experience a loss in the first year of 100$, and in year 2 you experience a profit of 400$, you calculate the income tax expense for year 2 at the 400$-100$=300$. So you “use” the loss from the year one to diminish the base for calculating the tax. Alex.
Thanks Alex. Well what am trying to say is - The loss of year 1 $100 which is purely loss and not tax paid (assuming taxes are not paid on losses), how can that be used as a DTA to reduce income tax expense for future years. …or have I miss understood grossly. Can any L2, accounting experts chip in?
it is a reported loss so they can use this loss to diminish the base for the tax
Fundamentally what’s going on is that tax accounting and financial accounting are not one in the same. In theory it’s due to timing differences and they have to converge to the same over the long run, but the difference gives rise to things like this that need to be accounted for. In the investopedia example the company had tax deductions in year 1 that aren’t applicable under GAAP for their financial reporting. So they could very well show a profit on their income statement but an operating loss on their tax return. Because they’re allowed the carry forward (subject to a variety of laws) they can reduce their future tax expense and it has to be accounted for. So it creates an asset on the balance sheet and when/if they get to use it it moves from the balance sheet to the income statement (as a reduction in their tax expense) or it gets subject to impairment.
First: Governments take their share in profits (taxes) therefore they should share in losses as well. Second : Governments do share in losses. If a firm shows a loss of $200 and tax rate is 30%… Government should pay $60 to the firm as share of loss (just the opposite of when the firm is in profit… government collects tax). Third: However, governments do not pay in cash. Rather they allow the firm to deduct this amount from future tax payments. Fourth: If firm expects that it will earn profit in future years… it has a right to not pay tax of $60. This furture economic benefit is reflected in balance sheet as deferred tax asset.
Thanks Kamran - This makes complete sense. paul_ledin, Alex - Thanks for suming it up and chipping in !