How often does your auditor or tax advisor throw out terms like “ DTA” or “DTL” expecting you to understand instantly what he or she is talking about? These are the terms that your professional advisor uses every day, but they are not as commonly known outside of the accounting world. So what are a DTA and a DTL and why do you need to know about them?
When discussing tax returns with companies’ accountants, I am often asked about discrepancies between income/loss on financial statements and taxable income/loss on tax returns. The reason is that tax laws often differ from the recognition and the measurement requirements of financial accounting standards, which may cause differences to arise between:
- The amount of taxable income and pre-tax financial income for a year, and
- The tax basis of assets or liabilities and their reported amounts in financial statements.
These differences are referred to as temporary differences that ordinarily become taxable or deductible when the related asset is recovered or the related liability is settled.
Why it Matters
For US GAAP purposes, a deferred tax liability and/or a deferred tax asset are required to be recognized for future tax consequences of events that have already been recognized in a company’s financial statements or tax returns.
DTL Defined
A deferred tax liability (DTL) is recognized for temporary differences that will result in taxable amounts in future years. For example, the difference between a book and tax basis in fixed assets may result in a deferred tax liability due to accelerated depreciation recognized early for tax purposes and over a longer period of time for book purposes.
DTA Defined
A deferred tax asset (DTA) is recognized for temporary differences that will result in deductible amounts in future years and for carry-forwards. Most common temporary differences resulting in DTA are: accrued compensation not allowable as a deduction until actually paid (with certain exceptions); deferred revenues normally recognized as tax revenues when cash is received, not when revenues are actually earned; net operating losses; and business credits carry-forwards.
In Summary
In other words, when you take tax deduction before expensing the same item for books, or report book income before reporting it for tax purposes you create a deferred tax liability. Meanwhile, when you report taxable income before reporting the same income for financial purposes, or you report an expense for books before taking tax deduction for the same item, you create a deferred tax asset.
Both DTAs and DTLs are an integral part of your financial reporting and understanding temporary differences may allow you to implement tax planning strategies that may affect your current financial reporting.