DTA and DTL

CFA Level I
#1

Can someone please assist me in clarifying these?

deferred tax asset gets created when taxable income is greater than pre tax income. And the opposite occurs for a DTL (taxable income is less than pre tax income).

#2

I think that the easiest way to keep them straight is to remember the definitions of assets and liabilities:

  • Asset: a potential _ future _ economic benefit
  • Liability: a potential _ future _ economic detrement

If you focus on what will happen in the future, you’ll get it:

  • If you pay lower taxes today (lower taxable income than pre-tax income), then you’ll likely pay higher taxes in the future; that’s a future economic detrement, so it creates a DT_ L _.
  • If you pay higher taxes today (higher taxable income than pre-tax income), then you’ll likely pay lower taxes in the future; that’s a future economic benefit, so it creates a DT_ A _.
#3

Thanks, that’s a great way to remember.

#4

You’re welcome.

#5

Magician, please help me understand something in addition to this:

Taxable income is what you pay (or owe the government) and pre tax income is what shows on your books, correct?

So, your logic from above pertains to the fact that at some point in time, if considered a temp difference a liability is created. And if this liability is not ever believed to reverse, it should be charged to equity. Does the same occur with DTA’s ? And does this realization show up on the cash flow statement as a non-cash event?

#6

I corrected that to what I believe you meant. Yes, you’re correct.

Yes.

Yes.

There is something similar for DTAs, but you don’t remove the DTA; you create a contra-asset: DTA valuation allowance.

It wouldn’t affect the statement of cash flows: it’s noncash, and it doesn’t affect the income statement (i.e., it doesn’t appear in the indirect method for CFO); it affects only assets and equity.

#7

You’re going to make me pass this exam. Thank you once again.

#8

It’s my fondest hope.

Once again, you’re quite welcome.