As a business owner, have you ever studied the financial statements of your business and looked at the accounting terms closely? Even though you are not familiar with accounting and have outsourced your accounting tasks to an accounting firm in Singapore, it does not mean that you do not need to deal with those reports anymore. You still need to understand what the financial statements are trying to tell about your business (Also see Identifying the Profitability of a Business). So, knowing certain accounting terms is crucial as this will help you to understand your company’s financials.
When you are studying the balance sheet of your company, you may see a section called the deferred tax asset under the asset section. This is an item that you can use to reduce your future taxable income. Deferred tax asset arises when a company has paid the taxes in advance or has overpaid the taxes. After that, the business will receive these amounts in the form of tax break or tax relief. Thus, one may consider the overpayment as the company’s asset (Also see Differences between Current Assets and Fixed Assets That You Should Know).
Typically, the accountants will create deferred tax assets for the taxes that the company has paid but has not recognised on the profit and loss statement. The deferred tax asset arises due to the difference in the timing of revenue and expenses recognition between the company and the tax authorities. These assets can help a company to reduce the company’s tax liability in the future. However, note that the accountants will only recognise the deferred tax assets when they expect that the difference in depreciation will offset the company’s profit in the future.
The dissimilarities between the accounting treatments and taxation rules is the main reason for the deferred tax assets to arise. For example, in some cases, some of the revenues earned are subjected to taxes from the taxation aspect, but it has not become taxable in the profit and loss statement. Generally, when the accounting treatments and the taxation rules on assets (and liabilities in some cases) differ from each other, deferred tax assets may occur.
To understand the concept of deferred tax assets better, you can compare them with rentals or insurance that you paid in advance. They work under the same concept, that is, you have made the payment beforehand, and the prepayment becomes your asset. This is because although the payment has caused the amount of cash you have on hand to reduce, the value of the payment still exists. Hence, you need to reflect them in your financial statement, where, in the case of taxes, it is the deferred tax asset.
What will happen if we “underpaid” the taxes then? The accountants will, in turn, record a deferred tax liability in the balance sheet. This is the opposite of deferred tax assets, and it will cause the amount of taxes the business owes to the tax authorities to increase.