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Definition:  Deferred tax asset indicates the situation where a firm has paid additional taxes or taxes in advance, which the company then claims as a tax relief amount.

What Does Deferred Tax Asset Mean?

What is the definition of deferred tax asset?  A deferred tax asset is an income tax created by a carrying amount of net loss or tax credit, which is eventually returned to the company and reported on the  company’s balance sheet  as an  asset . Companies use tax deferrals to lower the income tax expenses of the coming accounting period, provided that next tax period will generate positive earnings.

For example, a company that pays a tax rate of 35% depreciates its equipment that has a value of $25,000 and a life of 5 years. In Year 2, the company records the straight-line depreciation of $5,000 and a tax of $10,000 in its books. Normally, the company would pay a tax of $8,750. The difference between the accounting value of the equipment and the tax paid is the deferred taxes.

Let’s look at an example.

Example

Company XYZ is a manufacturer of trade mills. The company has recently expanded its operations. The management has decided the purchase of new equipment for 8 years for a cost of $30,000. The company pays a tax rate of 40%.

Deferred Tax Asset Example

From Year 1 to Year 7, the straight-line depreciation is higher than the tax paid, which indicates that the company claims a tax depreciation deduction in excess of the cost of equipment. Therefore, the company has a  deferred tax liability . In the coming tax period, the company will claim the accounting depreciation minus the tax depreciation.

In Year 8, the straight-line depreciation is lower than the tax paid, and the company recognizes a deferred tax asset, suggesting that in the coming tax period it expects to claim accounting depreciation in excess of tax depreciation.

Summary Definition

Define Deferred Tax Asset:  Deferred tax asset means a company prepays taxes up front, so it doesn’t have to pay this amount of taxes in the future.


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