Is a Deferred Tax Asset a Current Asset?
Navigate the key principles for classifying deferred tax assets as current or non-current on financial statements.
Businesses often encounter distinctions between their financial accounting profit and their taxable income, which can lead to future tax consequences. These differences arise because accounting standards, such as U.S. Generally Accepted Accounting Principles (GAAP), and tax laws have varying rules for recognizing revenues and expenses. Such discrepancies necessitate the recognition of deferred tax items on a company’s financial statements. These items represent the future tax effects of transactions that have already occurred.
Understanding Deferred Tax Assets
A deferred tax asset (DTA) represents the future tax benefit a company expects to realize. This benefit arises from temporary differences between the carrying amounts of assets and liabilities on a company’s balance sheet and their corresponding tax bases, or from the carryforward of tax losses and credits. A DTA signifies an overpayment of taxes or a prepayment of tax obligations that will result in a reduction of future taxable income.
Common scenarios that create deferred tax assets include instances where expenses are recognized for financial reporting purposes before they are deductible for tax purposes. For example, warranty accruals or estimated liabilities are expensed in accounting books but may only be tax-deductible when the actual payment is made. Another source of DTAs comes from net operating losses (NOLs) or tax credit carryforwards, which can be used to offset future taxable income or reduce future tax payments.
The Classification Framework for Deferred Tax Assets
Assets on a balance sheet are categorized as either current or non-current. Current assets are those expected to be converted into cash, consumed, or sold within one year or one operating cycle, whichever is longer. Non-current assets are those not expected to be realized within that timeframe. Historically, the classification of a deferred tax asset followed a similar principle, largely depending on the classification of the related asset or liability that gave rise to the temporary difference.
Under this framework, if a deferred tax asset stemmed from a temporary difference associated with a current asset or liability, the DTA would be classified as current. Conversely, if the underlying item was a non-current asset or liability, the deferred tax asset would be classified as non-current. This approach aimed to align the deferred tax asset’s liquidity with the item causing its creation, providing insights into the timing of its reversal. The Financial Accounting Standards Board (FASB) provides guidance on income taxes through Accounting Standards Codification (ASC) Topic 740, which historically detailed these classification rules.
Determining Deferred Tax Asset Classification
For companies preparing financial statements under U.S. GAAP, the classification of deferred tax assets has undergone a significant simplification. The current guidance, Accounting Standards Update (ASU) 2015-17, mandates that all deferred tax assets and liabilities, along with any related valuation allowances, must be presented as a single non-current amount on a classified balance sheet. This means that regardless of whether the temporary difference originates from a current or non-current item, the resulting deferred tax asset is reported as non-current.
The FASB introduced this simplification to reduce the complexity and cost associated with preparing financial statements, as separating deferred taxes into current and non-current portions was deemed to provide little additional useful information to financial statement users. This change also aligns U.S. GAAP with International Financial Reporting Standards (IFRS), which already require all deferred tax amounts to be classified as non-current. While the underlying temporary differences might still relate to items that reverse within a year, the balance sheet presentation of the deferred tax asset is now uniformly non-current.
A valuation allowance is established when it is more likely than not that a deferred tax asset will not be realized. While it affects the asset’s carrying value, it does not change its classification as current or non-current. The valuation allowance is a contra-asset account that reduces the deferred tax asset to its expected recoverable amount.