Deferred Tax Assets and Liabilities

A friend says to you, “I don’t understand how taxable temporary differences can be ‘liabilities’ and how deductible temporary differences can be ‘assets.’ It seems to me that these temporary differences relate only to the future and that accounting is based on ‘historical cost.’ In addition, the government frequently changes the tax laws, so no one knows what the future tax laws will be.”

Required:

Prepare a written response for your friend that explains why deferred tax assets and deferred tax liabilities are recognized and reported on a corporation’s balance sheet. Include a discussion of a valuation allowance.

Write a response to your friend explaining the reasons for the recognition and reporting of deferred tax assets and liabilities on a company’s balance sheet and also explain valuation allowance.

Memo

From,

Person ABC

To,

Person XYZ

The reasons for the recognition and reporting of deferred tax assets are as follows:

The following three features of deferred tax asset are as follows:

• First feature: It is anticipated that the company would reap economic benefits in future.
• Second feature: The Company has acquired the rights to the benefits and controls other entities’ access to it.
• Third feature: The transaction or event resulting in the company’s right to/ control of benefit has already happened.

The temporary difference would result in future deductible amounts in the future years. The reasons behind the deferred tax asset of a company to meet the given features are as follows:

• The first feature is satisfied because the future taxable amount would be reduced by the deductible amounts that would provide the economic benefit to the company through the reduction in the amount of income tax.
• Since, the company is having the exclusive right in the reduction of income taxes that would be paid, the second feature is satisfied.
• Since, the circumstances in the deferred tax asset has already occurred, the third feature is also met.

Thus, the company reports deferred tax liabilities on its balance sheet because they satisfy the definition of a liability, including being based on “historical events”.

The reasons for the recognition and reporting of deferred tax liabilities are as follows:

The following three features of deferred tax liability are as follows:

• First characteristic: It is an obligation of the business entity to offer economic benefit to another entity that would be met in the future.
• Second characteristic: The responsibility forces the company so that it cannot avoid the future sacrifice...