Deferred Tax Asset Journal Entry

Deferred tax asset is the company asset that will reduce the future income tax expense. It happens when the income tax expense is greater than the income tax paid to the government.

Income tax is the amount of expense that the company pays to the government or tax authority which depends on company profit and the tax rate. The tax rate is various from one country/state to another.

The income tax expense is simply equal to the earnings before tax (EBT) multiply by the income tax rate. However, the EBT or taxable income may be different between accounting and tax law. In the company financial statement, the income tax expense will be based on the accounting profit and tax rate. But the amount that a company pays to the government depends on the taxable profit and the tax rate.

The income tax expense will be calculated by multiplying the earnings before tax and income tax rates. The earning before tax will arrive from the revenue and expense which comply with accounting principles such as IFRS or US GAAP. The revenue and expense follow the accounting framework by using accrued basic.

The income tax paid will base on the taxable profit and the income tax rate. The taxable profit arrives from the revenue and expense which comply with tax law. The tax law requires the business to record revenue when receiving money from the customer even the goods or services not yet provided. The expenses are recorded when the cash is paid to the suppliers. Moreover, the depreciation expense under tax law may be different from accounting. These are the reasons that earning before tax differs from taxable profit.

When the tax paid is higher than income tax expense, it means company needs to pay more than the income tax expense on the income statement. So they need to record the deferred tax assets which will be utilized in the future. The difference is due to the temporary difference which will be settled later. It means the income tax expense will increase higher than the tax payable in the subsequent period.

Deferred Tax Asset Journal Entry

When company prepares the financial statement, the accountant needs to record income tax expenses based on the earnings before tax. It is the accounting rule which determines this amount. After that, they record the income tax expense and income tax payable.

To determine the exact amount to pay to the government, accountants need to adjust the earning before tax to comply with the tax law. This amount is known as the taxable profit which purely follows the tax law. When the amount paid is greater than, company needs to debit deferred tax assets and credit additional income tax payable. Deferred tax assets are the difference between income expense and income tax payable.

Most of the time, we may combine both transactions as the following:

If the tax paid is less than the income tax expense, it will create the deferred tax liability which will be discussed in another article.

Deferred Tax Asset Journal Entry Example

Company ABC has prepared the income statement and the main items are listed below:

The earning before tax is $ 600,000 based on the accounting record. However, the tax depreciation expense is only $ 50,000. The income tax rate is 30%.  Please prepare the journal entry of income tax expense and deferred tax assets.

Based on the accounting rule, the earnings before tax is $ 600,000.

So the income tax expense is:

Income tax expense = Earning Before Tax * 30%

= 600,000 * 30% = $ 180,000

However, the amount of tax payable that company owes to the government is depend on the tax law. As the tax payable is equal to the taxable profit multiplied by the tax rate, so we need to adjust the accounting profit. As the tax depreciation is only $ 50,000 so we need to calculate the taxable profit as follows.

The taxable profit is $ 650,000, so we need to calculate income tax payable as following:

Income tax payable = taxable profit * 30%

= 650,000 * 30% = $ 195,000

As the income tax payable is greater than income tax, there will be deferred tax assets.

Deferred Tax Asset = income tax payable – income tax expense

Deferred Tax Asset = $ 195,000 – $ 180,000 = $ 15,000

The journal entry is debiting income tax expense $ 180,000, deferred tax asset $ 15,000 and credit income tax payable $ 195,000.

Income tax expenses will be present on the income statement. Deferred Tax Asset is the current asset on the balance sheet and it will use in the subsequent year when income tax expense is more than income tax payable.

The income tax payable is the amount of liability that company needs to pay to the government after the year-end closing.