Deferred Tax
An accounting measure of future tax consequences arising from temporary differences between a company's financial accounting income and its taxable income.
Deferred tax is an accounting concept that arises from the temporary differences between the profit a company reports on its financial statements and the profit it reports to tax authorities. Because income and expenses can be recognized in different periods for accounting versus tax purposes, deferred tax accounts for these timing discrepancies. It is a non-cash item that represents a company's future tax obligations or benefits.
Deferred Tax Assets vs. Deferred Tax Liabilities
Depending on the nature of the temporary difference, a company records either a deferred tax asset or a liability:
- Deferred Tax Asset (DTA): Represents a future tax benefit. This occurs when a company pays more tax now than it reports as an expense on its income statement. For example, if an expense is recognized for accounting purposes now but is only tax-deductible later, a DTA is created. It's like a prepayment of tax.
- Deferred Tax Liability (DTL): Represents a future tax obligation. This occurs when a company pays less tax now than it reports as an expense. For example, using accelerated depreciation for tax purposes while using straight-line for accounting creates a DTL. The company saves cash on taxes today but will have to pay more in the future.
How Deferred Tax is Treated on the Cash Flow Statement
Deferred tax adjustments appear in the Operating Activities section of the cash flow statement (under the indirect method). Since deferred tax is a non-cash item, it must be adjusted for to reconcile net income to actual cash from operations.
The Rule for Adjustments
This adjustment ensures that operating cash flow reflects the actual cash taxes paid, not the accrual-based tax expense from the income statement.
Why This Adjustment Matters for Analysis
Understanding the deferred tax line is crucial for gaining a complete view of a company's performance and future obligations.
- Bridges Net Income and Cash Flow: The adjustment clarifies how much of the reported tax expense was a non-cash accrual, giving a truer picture of cash generated from operations.
- Indicates Future Tax Impacts: A growing Deferred Tax Liability signals that a company has benefited from lower taxes now but will face higher cash tax payments in the future. A growing Deferred Tax Asset suggests the opposite—the company has prepaid taxes and can expect lower cash tax payments ahead.
- Highlights Tax Strategies: The deferred tax line reveals the impact of different accounting and tax rules. It can signal whether a company is using tax strategies, like accelerated depreciation, to defer tax payments and manage its cash flow.
Presentation on the Cash Flow Statement
In a real-world cash flow statement, this adjustment is typically labeled “Deferred income taxes” and is listed among other non-cash items in the operating section.
Sample Presentation
Example: General Motors
Key Takeaways
Deferred tax arises from temporary differences between the rules for financial accounting and tax laws.
It is a non-cash item. The adjustment on the cash flow statement reconciles the accrual-based tax expense to the actual cash taxes paid.
An increase in a Deferred Tax Liability is a non-cash expense and is added back to net income in the operating cash flow section.
An increase in a Deferred Tax Asset indicates more cash was paid for taxes than was expensed, so it is subtracted from net income.
Analyzing the deferred tax line provides crucial insights into a company's future tax obligations or benefits and helps assess the quality of its earnings.
Deferred Tax
An accounting measure of future tax consequences arising from temporary differences between a company's financial accounting income and its taxable income.
Deferred tax is an accounting concept that arises from the temporary differences between the profit a company reports on its financial statements and the profit it reports to tax authorities. Because income and expenses can be recognized in different periods for accounting versus tax purposes, deferred tax accounts for these timing discrepancies. It is a non-cash item that represents a company's future tax obligations or benefits.
Table of Contents
Deferred Tax Assets vs. Deferred Tax Liabilities
Depending on the nature of the temporary difference, a company records either a deferred tax asset or a liability:
- Deferred Tax Asset (DTA): Represents a future tax benefit. This occurs when a company pays more tax now than it reports as an expense on its income statement. For example, if an expense is recognized for accounting purposes now but is only tax-deductible later, a DTA is created. It's like a prepayment of tax.
- Deferred Tax Liability (DTL): Represents a future tax obligation. This occurs when a company pays less tax now than it reports as an expense. For example, using accelerated depreciation for tax purposes while using straight-line for accounting creates a DTL. The company saves cash on taxes today but will have to pay more in the future.
How Deferred Tax is Treated on the Cash Flow Statement
Deferred tax adjustments appear in the Operating Activities section of the cash flow statement (under the indirect method). Since deferred tax is a non-cash item, it must be adjusted for to reconcile net income to actual cash from operations.
The Rule for Adjustments
This adjustment ensures that operating cash flow reflects the actual cash taxes paid, not the accrual-based tax expense from the income statement.
Why This Adjustment Matters for Analysis
Understanding the deferred tax line is crucial for gaining a complete view of a company's performance and future obligations.
- Bridges Net Income and Cash Flow: The adjustment clarifies how much of the reported tax expense was a non-cash accrual, giving a truer picture of cash generated from operations.
- Indicates Future Tax Impacts: A growing Deferred Tax Liability signals that a company has benefited from lower taxes now but will face higher cash tax payments in the future. A growing Deferred Tax Asset suggests the opposite—the company has prepaid taxes and can expect lower cash tax payments ahead.
- Highlights Tax Strategies: The deferred tax line reveals the impact of different accounting and tax rules. It can signal whether a company is using tax strategies, like accelerated depreciation, to defer tax payments and manage its cash flow.
Presentation on the Cash Flow Statement
In a real-world cash flow statement, this adjustment is typically labeled “Deferred income taxes” and is listed among other non-cash items in the operating section.
Sample Presentation
Example: General Motors
Key Takeaways
Deferred tax arises from temporary differences between the rules for financial accounting and tax laws.
It is a non-cash item. The adjustment on the cash flow statement reconciles the accrual-based tax expense to the actual cash taxes paid.
An increase in a Deferred Tax Liability is a non-cash expense and is added back to net income in the operating cash flow section.
An increase in a Deferred Tax Asset indicates more cash was paid for taxes than was expensed, so it is subtracted from net income.
Analyzing the deferred tax line provides crucial insights into a company's future tax obligations or benefits and helps assess the quality of its earnings.
Related Terms
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